David Keller, CMT, is president and chief strategist at Sierra Alpha Research, a boutique investment research firm focused on managing risk through market awareness, and author of the blog, Market Misbehavior. David calls himself a right-brained person in a left-brained industry and prides himself on his ability to bridge the gap between academic and practical finance. He is past president of the Chartered Market Technician Association, and most recently served as a subject matter expert for Behavioral Finance. David was formerly a managing director of research at Fidelity Investments in Boston and a technical analysis specialist for Bloomberg in New York.
At Sierra Alpha, David combines the strengths of technical analysis, behavioral finance, and data visualization to identify investment opportunities for active investors and enrich relationships between advisors and clients. He uses his blog to teach readers about investing through metaphors, most frequently paralleling the process to aviation and flying. The blog platform also provides him the opportunity to make observations on market psychology. On top of this, David is a featured contributor on StockCharts.com, where he authors The Mindful Investor column, and on the See It Market platform for “smart, unbiased financial minds”. His articles have also appeared in Bloomberg Markets magazine and he edited the book, Breakthroughs in Technical Analysis (Bloomberg Press). In line with his passion for sharing knowledge, he was an adjunct professor for three years at Brandeis University International Business School.
“One of the reasons we fall into a lot of behavioral challenges or poor decision making as analysts is because you are programmed to do just that … pound the table, put your foot down and insist that you have the right answer … to be completely fair, probably almost half the time you do not have the right answer.”
Worst investment ever
Markets begin to recover after bottom of 2009
In mid-2008, David left New York to work for Fidelity Investments in Boston and what followed was a very difficult first year on the job from a market point of view. The market topped out in late 2007 while a lot of stocks hit their peaks in early 2007. Then 2008 started a little weaker. The markets then continued their sell-off into the autumn of that year. The market bottomed out at the beginning of 2009. His March, April and May were very confusing and there was a great deal of volatility at the low points. Through 2010, 2011 and 2012, the market start to recover consistently, with some surprises along the way, and people were starting to put 2009 behind them.
Wrong turn begins as he goes bearish in 2013
In mid-2013, David took the completely erroneous view on the markets by turning bearish on US stocks. Of course he now knows that that was not the right time to be bearish, as the next few years showed strong growth across the board, especially in the US. The upshot for him leading up to his error was that he was very focused on the March 2000 high, when the S&P neared the 1550 mark. He watched as at the beginning and then in the late stages of 2007, the index reached almost exactly the same level. This triggered in David the beginning of his wrong call as he was expecting a repeated pattern. He has realized since that if he had looked at all the evidence, it would probably not have supported his call.
How did that impact him professionally?
He has learned a lot. As an analyst and as a professional researcher, he pointed out that in such jobs you need to take a stand, to have an opinion. One of the reasons we fall into a lot of behavioral challenges or poor decision making as analysts is because such professionals are programmed to do just that – pound the table, put your foot down and insist that you have the right answer. He admits though, probably almost half the time you do not have the right answer. The markets make for a very humbling report card for your calls. So he learned very quickly that while it is important to have an opinion, it is also very important to have the humility and intellectual honesty to understand when your call is not working out and then just as important to be open and clear on what evidence has caused him to change others’ minds.
Road to when ‘Dr. Doom’ realized he was wrong
It was definitely a contrarian idea to be bearish at that point because stocks in general were pretty strong and the US market looked very good, riding at record highs. He realized that he’d made his mark when the trading desk chief referred to him as “Dr. Doom” to a group of people. The driver behind his call though was not just the market being at new highs. He had looked at price momentum in different ways. A common way that technical analysts measure price momentum is with an indicator called the Relative Strength Index (RSI), which asks when something goes up, how much does it tend to go up? And when it goes down, how much does it tend to go down? It is a ratio of the average up moves versus the average down moves. And what you’re looking for is when a market moves to extremes, and that is one of the reasons why today, a lot of analysts are turning negative on the US markets. So that was another piece of evidence that told David that the market had risen a lot, and that it was probably too much, and that he believed he needed to be defensive.
Sector levels supported his bias
The third item he was looking at was sector levels. He remembered that tech stocks in particular were underperforming. This group he expected would do well in a bowl phase, and it was not doing well anymore. On the other hand, consumer staples, were doing quite well. So what he realized there and what he realized from that sector perspective (when did he know he was wrong?) was when he looked at the sectors and saw technology, weak; staples, strong; he has realized since that because those conditions supported his argument, he had succumbed to confirmation bias, and decided he was bearish. Still under the spell of such bias, he had then just tried to gather evidence to support that call. As the market continued a little higher, he doubled down in the worst way, and was trying to continue to back it up with only the evidence he wanted to find.
Looking at individual stocks is also insufficient
He learned too that looking at individual stocks was not a good enough indicator either and that there is great value in looking beyond the market. If you’re thinking about asset allocation, he said, it is not good enough to just look at equities, or look at global equities or emerging markets as a bundle and make an overall decision based only on that. When you look at the country level or the sector level or at the group and stock level, you start to see movements and themes that can help you understand a sort of deeper level below just an overall market call. He learned a lot about how to qualify what he is seeing from the top down and by also doing a lot of good bottom-up work. He said the bulk of the screening and detailed work he does now was derived from the lessons learned during this period.
“(A key lesson was about) having the humility and having the intellectual honesty of understanding when your call is not working out and then being open and clear on what evidence has caused me to change your mind.”
Have the honesty and courage to admit you’re wrong
Then state what you need to do differently. Admit that your thesis is not working and have the courage to change your perspective.
“It’s OK to be wrong, but it’s not OK to stay wrong.”
David Keller, quoting one of his mentors
You’re not married to your call
Make informed decisions based on what you think the probabilities tell you, but you have the equal opportunity to change that when the evidence supports it.
Keep paying attention
Watch for and understand when things are changing. David takes a page out of flight training here when he learned “situational awareness”. When flying an aircraft, it is essential to have awareness of what is happening outside the aircraft, so you do not fly into a mountain, another aircraft or the ground. A big part of David’s process is having situational awareness of the markets and really understanding what he is seeing around him.
Tracking trends closely is highly valuable
Anytime the market approaches record highs or a stock goes to new highs, start to question it. When the market is strong, switch into more of a trend-following mentality and stick with things that are working, avoid things that are not working, and just look for signals that the trend has reversed.
Dig deeper to gather evidence behind your call
Don’t just start with “I think the market” or “I think this position is doing XYZ, it’s going below that” and then look for evidence to support or contradict the position you are taking. You can look at many factors, such as the advancers/decliners, which is a measure of how many stocks are going up, how many stocks are going down. It remained strong through much of 2013, then hit a peak, but it never really came down much. And in the end, it went up as the market continued to go higher. And so seeing that the average stock was still holding up was an important signal to monitor.
You will eventually be wrong
Enjoy the moments when you are right, but you will, eventually, be wrong. It is inevitable.
Hold back your contrarian instincts
Sometimes momentum can push through harder and longer than you think.
Avoid confirmation bias
The way to do that is to use David’s “second level” idea to look deeper and for views contrary to yours.
David adds here:
Another strategy used in one of his companies as a team was called The Devil’s Advocate meeting, in which an appointed person had to take the other side of a thesis and argue against it. Often the group would disagree with the designated contrarian but it did make everyone think about what the other side of an investment thesis was and what chain of events could cause that opposing scenario to play out. Often, he said, such a discussion uncovers weaknesses in your initial thesis that you would not have arrived at otherwise.
Always have an exit plan. Here David talks again about his experience as a student pilot, as he’s working toward his private pilot’s licence. One thing he has learned with any flight plan, you must always look for what you’re going to do if there is an emergency. One thing is to identify emergency landing areas, such as other airfields, highways, golf courses, so you always have these options, and if something happens you execute that side plan. IN trading, David always says if XYZ happens, then he’s wrong and needs to change it. So he always has a stopping point for a long position or a short position. He always has a price level or a movement or an event or a signal that will cause him to re–evaluate his position, no matter what. He lays out this plan in the beginning, and then the key is sticking with that and having the conviction to actually do it the moment the warning sign triggers.
Q: Now pay attention, 007. I’ve always tried to teach you two things:
First, never let them see you bleed.
James Bond: And the second?
Q: Always have an escape plan.
Desmond Llewelyn, in his final film appearance as Q in the James Bond series (1999, The World Is Not Enough)
No. 1 goal for next the 12 months
David just launched his own research firm about a year and four months ago so he will be working on that.
He is also looking forward to starting a podcast of his own.
David says it was very therapeutic to finally admit his weaknesses to everyone.
“I love what you’re doing with this podcast, it’s a pleasure to be a part of it.”
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Connect with David Keller
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￼Further reading mentioned
- David Keller, editor (2007) Breakthroughs in Technical Analysis: New Thinking From the World’s Top Minds