The U.S. Dollar: Orthodoxy and Heresy   (October 7, 2011)

A stronger U.S. dollar is heresy in some circles. Calls for a major top in the USD are already circulating. Can orthodoxy be misleading?

There is only one word to describe the opinion that the U.S. dollar is in a multi-year uptrend: heresy. Understanding why this is so may well be critical to understanding market action in the 2011-2016 timeframe.

Embracing the contrarian viewpoint offers little joy, because heretics are constantly being hounded by devotees of orthodoxy seeking their conversion to the one true faith or their crucifixion as mortal threats to the orthodoxy.

Why is this so? For two simple but profound reasons. The human mind strongly prefers certainty to uncertainty and simple, fixed explanations over complex, contingent explanations.

The human mind has a second, superglue-like quality: Once a viewpoint has been plucked from the swirling chaos of beliefs and explanations, then the mind quickly solidifies that view, resisting any future modification. Very little energy is devoted to questioning the position, while enormous energy is devoted to defending it.

This reality is expressed via “confirmation bias,” the term used to describe our tendency to focus on data that supports our pre-selected view and ignore data which challenges it.

Orthodoxy—fixed positions that are articles of faith to be defended against all challenges—is thus a psychological safe haven in a risky, dynamic world. Having a belief system or global explanation not only offers us the comforts of certainty, it also enables us to make forecasts based on that explanation. Those forecasts become part of the orthodoxy which must be defended.

Being a trader makes one a heretic, because traders see orthodoxy not as a safe haven but as a mortal danger. This is the root of trader expressions such as “Marry your spouse, not your portfolio.” From painful personal experience, traders learn that trading based on orthodoxy eventually leads to crushing losses.

Why is this so? There is a difference between being “right” and making money. The devotee of orthodoxy is committed to being “right” in a global sense; i.e., confirming that the orthodoxy’s forecast will be proven correct. The trader is only interested in being “right” in a much narrower definition: Did the trade gain value or lose value? The market is the only arbiter of “right” and “wrong” to the trader, and all of the ceaseless debates and arguments between the believers of various orthodoxies are viewed as potentially dangerous distractions.

The trader recognizes multiple timeframes and grasps that a trade has to align with the market action of a specific phase to be successful; i.e., gain in value. A trade may be successful in a three-day timeframe, but  unsuccessful in a three-week timeframe, and ultimately successful in a three-year timeframe.

The problem with orthodoxy is that adherents believe it must be correct in all phases and timeframes. Thus the Bull is wiped out in Bear markets and the Bear is wiped out in Bull markets, trend followers are wiped out in volatile phases, and those trading volatility churn away their capital in non-volatile trending markets.

This partly explains why the number of traders/money-managers who outperform index funds in the long run over both Bull and Bear markets is essentially statistical noise. The appeals of orthodoxy are that powerful.

Traders are heretics for another reason: They reject the illusion that there are “investments.” To a trader, the word “investment” is simply a marketing ploy of the financial Status Quo, a word designed to evince a plummy, wood-paneled security from risk. This reflects the core article of faith of the financial Status Quo orthodoxy, which is that risk can be massaged away.

Traders understand that risk cannot be massaged away, and that capital put into any market at any time is always at risk. Every investment is a trade, and every trade is a speculation. Thus there is no “investment,” there is only speculation, and the slightly sweaty, unpleasant proximity of speculation to risk is not masked with the heavy perfumes of PR, it is embraced as the one true lodestone.

Traders understand that suppressing risk simply guarantees a greater eruption of volatility in the future.

Traders are anathema to orthodoxy on multiple fronts. Devotees of orthodoxy understand the devotion of others in opposing camps, and even as they argue they feel comfortable with their shared worldview. But devotees distrust traders because they reject orthodoxy as the “solution;” it offends devotees that traders either change camps constantly or are studiously unattached to all camps.  

To the true believers of one investment orthodoxy or another, traders are renegades profiting where they “shouldn’t”--being short as the market declines, for example. In other words, the “right” way to “invest” is to choose an orthodoxy and cling to it through thick and thin until proven “right.”

To the trader, this approach is equivalent to lighting one’s capital afire and watching it burn. The trader thinks in terms of probabilities, not certainties, and looks to charts as reflections of human behavior. A forecast is simply an assessment of probability, a snapshot taken in the present of multiple dynamics and timeframes.

The trader also offends orthodoxy, not just by refusing to place his faith in one camp or another, but in rejecting the entire notion that “big” global forecasts have any meaning in terms of making money in the here and now. The trader is aware of the various dynamics of hyperinflation, deflation, stagflation, biflation, “muddle-through” sideways markets, “stocks are cheap,” “don’t fight the Fed,” the potential collapse of advanced civilization, and so on, but doesn’t base trades on these dynamics.

Traders understand that the market, and indeed, human history, is fundamentally a highly complex non-linear system. Change the parameters or the inputs, and even small fluctuations can trigger outsized consequences.

As a result, forecasts of future events become less predictable the farther out in time we extend the forecast. Traders understand that X and Y might well occur in five years, but it’s difficult to distill that potentiality down to a money-making trade in the near term.

We all like being right and making money trading the markets, but the two are not identical. The adherent of orthodoxy finds the markets confounding when they don’t conform to the orthodoxy’s forecasts and explanations, and this frustration finds expression in confirmation bias; i.e., seeking data that supports the position and downplaying whatever doesn’t, arguing vociferously on the basis of financial fundamentals, and seeking external explanations for the failure of the forecast (manipulation, seasonal trends, and so on).

The one phrase you will rarely hear issuing from orthodoxy is “I was wrong and I’m radically changing my view.” It’s painful to be wrong; our human pride is wounded when our convictions turn out to be misplaced. It’s also painful to lose money in a losing trade, but when given a choice between the two, adherents of orthodoxy prefer to lose money rather than surrender their convictions.

Traders view convictions as a potentially deadly trap, and have trained themselves to find comfort in uncertainty and permanent contingency. It’s easier to jettison a trade than a conviction.

As a thought experiment, look at this chart and decide if it is bullish or not.

Does your view change if it is a chart of a commodity? What if it is a chart of a mining company, or a tech stock?

What if it is a chart of the U.S. dollar index, the DXY? Well, it is. How resistant do you find yourself to viewing this chart as unambiguously bullish? Do you find yourself seeking evidence that it isn’t really that bullish, evidence that “this looks ready to roll over and decline?”

In certain camps, it is an article of faith that the U.S. dollar is deservedly doomed to extinction. The trader accepts this as a future possibility, but does not see any tradable evidence of this possibility in this chart/snapshot of the past two years.

As traders, we are well-served by a willingness to seek evidence which undermines or challenges our positions, as this habit counteracts confirmation bias. As traders, we see probabilities for advance and decline in all charts, and the assessment isn’t about being “right” or “wrong” but about the higher and lower probabilities implicit in the chart.

Anything, including a bullish dollar, can become an article of faith in an orthodoxy, just as anything can become heresy.

If this chart is bullish, what does that suggest about the probabilities of future price action in the US dollar (i.e., the DXY)? In Part II: The Technical Argument for a Stronger Dollar, we use technical analysis to explore the case for a possible multi-year advance of the dollar from here. A key question for investors to ask here is this: Whatever the probability, what impact would a sustained rise in the dollar have on your current portfolio?

This entry was commissioned as Part 1 of a 2-part series for

Click here to access Part II of this report (free executive summary, enrollment required for full access). 

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