A Messy Market

I'm sure many of you heard of the huge fall in the equity markets yesterday. A few might have even seen (or at least anticipated) the huge rally in fixed income yesterday. We see another 97th percentile event, and one of the days that makes or breaks many trading desks. Credit spreads are out, rates rallied, stocks tanked and foreign exchange markets whipsawed. As we navigated through the mess (quite profitably, in fact) something popped out at me in a much more vivid manner than usual.

A lot of people fall into one of two camps. Either they specialize so much that the only movement they see (or care about) is the movement int heir own market, or they see correlation in everything and mistake correlation for causation. In the first camp many people don't see the economy as a whole and often miss the macro opportunities. In the second camp large generalizations such as "oh, bond markets are up because equity markets are down" add to the confusion created by big market moves.

No matter what field you are in, you should not isolate yourself from your general marketplace. It always helps to have a macro view of the world and see the big picture. For example, bankers should keep an eye on the markets so that they know why their deals might be falling through. Retail people should keep track of consumer trends and competitors. I have to say, traders generally are pretty good at keeping a pulse on everything, which is an excellent characteristics. In all other fields, it is usually the people who understand the big picture who get promoted for the big jobs. In trading, people who don't keep a pulse on everything tend to get weeded out.

Confusing correlation and causality is extremely common. Just because two things happened to move together does not mean one caused the other. Most likely there is a third thing that caused both to happen. Just as importantly, seeing two things move together once or twice does not necessarily mean they are correlated (it's called a coincidence, for any who care). Looking at the big picture, it is often easy to see why two things that are "correlated" are actually just something caused by a third party. Even more interestingly, you might be able to predict the next effect this cause will have.

Come out of your holes people. There's nothing wrong with simply not knowing why things are happening, but don't settle for some mediocre reasoning from an easy to spot coincidence.