O Ashuji....
Daniel Kahneman's book -Thinking Fast and Slow - is a path breaking book and takes tour of the mind and explains the 2 systems that drive the way we think and make choices. One system is fast, intuitive and emotional; other is slower, more deliberative and more logical.
Quoting from the book - "When uncertain, System 1 bets on an answer, and the bets are guided by experience. The rules of betting are intelligent: recent events and the current context have the most weight in determining an interpretation. When no recent event comes to mind, more distant memories govern."
Uncertainty is the essence of the market and price moves in the market. Certainty will kill the market (certainty is what central bankers are trying to instill in the market and paradoxically it will create the most uncertain conditions). while, market outcomes are ever-changing, most participants bets are based on recent experience/events. Hence, very few traders make big in the market.
Recent Beliefs and Market (India's Nifty) Outcomes....
Beliefs - 2008....
World was ending, markets were collapsing, Quantitative Easing was hardly discussed, New Highs for markets over next 5 years was out of question....
Market Outcome - 2009.....
Growth Rebounded, Markets staged sharp come back (Nifty which fell 52% in 2008, rose 76% in 2009), Markets made new in high in late 2010....
Beliefs - 2010...
Quantitative Easing will create sharp commodity boom, Huge Inflows into Emerging Markets, Nifty will continue booming....
Market Outcome - 2011...
QE magic lasted briefly, Most commodities topped out in 2011, Emerging markets had bad year in 2011 (Nifty was down 25% after rising 18% in 2010), European crisis was headline all through 2011...
Beliefs are often shattered....and becomes experience for traders and themes for sell-side analysts...
One can go on in similar way for 2012....whole point is beliefs are based on recent experience and hence betting is done accordingly. It is all too easy to find justification for those bets because justification fits all too well with recent experience/events. What is intellectually appealing is not necessarily a better trade.
Current Beliefs 2013...
Rupee has stabilized after wild swings in July-August 2013, We have magician in form of Raghuram Rajan (India's RBI Governor), India will continue to experience slow growth (4-5%), Factors ascribed to rupee fall (very dangerous to ascribe reasoning to asset market falls) like CAD are stabilizing, Indian markets will largely be range-bound. Upsides will be capped due to slower growth, high inflation/interest rates,etc while bottoming out of economy will limit downside....Beliefs are largely result of recent experience (1 year and stretch it out to 5 years)...we can go through reports and news to get more of beliefs..
Why Market Outcome will shatter all these beliefs....
Lets understand source of such beliefs....
Nifty Market Movement
1) 2013 so far has been the most compressed year in terms of high-low range for the market (which kind of says balance 3 months can potentially have wild moves).
2) Since 2009, markets have been very compressed not only in terms of high-low range but also over-all returns. Since 2009, Nifty has given total (not annual) return of 12%. In other words 12% over period of 45 months.
3) Such compression invariably leads to massive moves. Higher the compression more explosive will be the move.
Conclusion....
1) Beliefs are based on very compressed moves in the markets and reasonings are derived accordingly.
2) Market outcomes favors very sharp move in the Nifty in 2014 but such scenario won't be intellectually satisfying.
3) It is very normal for market to have 50% high low range and 20% odd return. Yet if you tell anyone that Nifty can either go to 4000 or 7500 both outcomes will be ridiculed. Both Outcomes are highly probable, yet market is not prepared for either.
Note - Have a look at New Zealand's Stock market to get sense of what happens when long compressed ranges are broken. Since 2009 end till June 2012 (approx 30 months), NZ market was largely in range of 3000-3600 (20%). When the range was broken post June 2012, NZ market went up by 30%+ over next 11 months.
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