Beware False Numbers

The small print: this newsletter is mostly stories, pop-psychology, and half-baked trading ideas. This is NOT financial advice. Best to think of this as a community of like-minded gamblers. If you are having a punt, make sure you restrict your trade size to whatever change you can find down the back of the couch.

Beware the 200-day moving average.

Sure, it’s useful - it gives a quick read on the long-term trend, and can act as a support or resistance level.

But it’s also a psychological trap.

Here’s what I mean…

In 2003, professors Dan Ariely and George Loewenstein ran an experiment. It involved MIT students and wine.

First, students were asked to write down the last two digits of their social security number. Then they were shown some products, like wine bottles, and asked what they’d be willing to pay.

If their last two digits were 84, they were asked if they’d pay $84 for the bottle of wine. Some agreed, some didn’t.

After that, all the MIT students bid for the products.

The result?

Students with higher social security digits bid far higher amounts than students with lower numbers.

Meaning: two random digits of their social security numbers had influenced their opinion on the value of the products.

That’s the problem with unintended anchors: they can distort your perception of something.

Even when the numbers themselves are completely irrelevant…

Anchoring is our tendency to latch on to a reference point, and then judge everything else against it.

And sometimes that reference point is completely arbitrary.

It’s a real problem for traders and investors:

Take IPO prices. Valuations on IPO day tend to be frothy - it’s banker math, after all. But that Day 1 stock price can take up far more mindshare than it should. It can impact how we view the stock in the long-term, and how we trade it.

(Bonus IPO stat for you: the average newly public company tends to get cut in half at some stage during its first 12 months trading. Ouch.)

Same anchoring problem with entry price. I bought Lemonade back in April 2021 for around $90 (I know, peak pandemic-investor behaviour). Then the stock fell. And fell some more. Until it was down 80%.

But I had it in my head that I’ll hold until it gets back to $90. Because that was my anchor. 5 years later, and still I hold…

The 200 DMA is another one. It’s useful as a trend marker, but it can also be an arbitrary psychological line in the sand. Full of sound and fury, signifying nothing.

There’s also round numbers, analyst price targets, all-time highs, breakeven levels… Lot of potential anchors out there.

So watch the number you’re leaning on. It might be useful. Or it might be a completely irrelevant reference point.

Now that we got that all out of the way, let’s go and trade the 200-day moving average 🤷‍♂️⬇️

We’ve pointed out how dangerous the 200 DMA can be.

So naturally, now we’re going to trade it.

Tesla, Inc (NASDAQ: TSLA)

Tesla is sitting just below its 200 DMA.

And right now, the bulls are pretty happy - there’s Robotaxis in Austin, stronger China sales, a JP Morgan upgrade, and the SpaceX IPO is almost here.

But here’s the thing:

Despite all that good news - TSLA hasn’t fully reclaimed its 200 DMA. So… maybe the hype has peaked for now…?

The SpaceX IPO also looks priced for perfection. Huge valuation. Major retail excitement. Any wobble on June 12th, or fading momentum in the days after the IPO, and the ripple effect could travel across the Musk universe.

We’ll be watching the price action into the SpaceX IPO.

And if TSLA creeps back toward the 200 DMA, then:

I’m buying: TSLA July 24 $385 puts.

On the other hand, if TSLA rebounds and just blasts through the 200 DMA, then we’ll have to go back and re-read our own newsletter.

And then buy a big mallet so we can hit ourselves over the head with it.

There’s psychological traps everywhere in life. They shape how we think, how we make decisions, and spend money.

But enough theory. Let’s gamify this:

💲💲Let’s say you recently bought short-dated calls in a rare earth stock you don’t follow too closely.

The company beat earnings, the stock gapped up, and you 3x’d the trade. Hats off.

Now you’re staring at an eerily similar setup for another rare earth stock, just before earnings…

The answer - and the psychology behind it - will be revealed in the next edition.

Last Week’s Answer:

Last week’s trap was Anchoring. When we see a recent high of $300, we tend to think: “It’ll get back there someday. $150 is pretty good value.” But a lot of the time the stock isn’t half-off, it’s just been repriced by the market. Better to reassess the business, and not be anchored to old highs.