If you don’t know what pareidolia is, don’t be hard on yourself, because it’s likely that your spell checker doesn’t know either.
Basically, pareidolia means that you, as a human, tend to create significance out of events when there is none.
In other words, you can be easily fooled by randomness if you aren't careful.
And when it comes to the stock market, pareidolia can lead to financial ruin.
Examples of Pareidolia
Let’s look at some famous examples of pareidolia that exist in nature, and then tie it back to the stock market.
Looking For Patterns in the Stock Market is the Same as Looking for Patterns in Clouds
You might see some faces in clouds; that’s pretty common.
I can see a beard, lips, nose, and two eyes.
A Great Example of Pareidolia
You might remember this infamous Mars picture; the shadows hit it just right.
It’s got a face, two eyes, and a mouth, but then you see it from a different angle and there is nothing - this picture fed conspiracy theorists for a very long time.
You are a pattern recognition machine, and come on, who doesn't love Jesus toast!?
Another example of Pareidolia
In The Stock Market Pareidolia Gets Dangerous Fast!
Pareidolia has wiped out the majority of traders in the stock market.
I’ve mentioned this stat again and again:
It doesn’t matter if you follow technical or fundamental analysis 95% of traders lose money.
It’s not because you're undisciplined, it’s because you’re not using the right tools.
What does everyone like to jabber on about in stock market forums, CNBC, around the water cooler at work, and in books written 50 years ago by some dead "guru"?
Technical analysis, “head and shoulders patterns”, “double-tops”, “cup-and-handle” patterns…
It's all very easy to see on a computer screen, just like looking at clouds in the sky.
Unfortunately, when you start doing things like writing computer programs to test these patterns, these ideas quickly break down.
How do you tell a computer what a head and shoulder pattern is?
What exactly is a double top, what’s a cup and handle?
What even is a candlestick when you can make them in any random time frame?
10 People, 10 Different Answers
It’s all shades of grey when you want it to be black and white, especially when it comes to risking real money.
The stock market is a mean reverting market where you want to buy dips because most of the time the markets are going to chop around.
You're going to see tons of patterns in the noise when you look at your computer screen.
Stock patterns are just like a new car you want to buy, you start seeing them everywhere, right?
Another Example of Pareidolia, This Time In SPY
Look For Things That Are More Basic
You need to understand that most of the daily movement in the stock market is just random noise.
There's very little signal at all in these price movements.
If you start looking for all these complex patterns you’re only going to get maybe a handful of trades per year.
And there is no way in hell you’re going to be able to get any significance out of those patterns whatsoever.
All technical and fundamental analysis breaks down at a certain point.
That certain point is called testing.
It’s called using the scientific method instead of using your eyeballs to do the judging.
We, humans, do a lot of things right, but we also do a lot of things wrong.
And trading is one of them.
Start connecting the dots, and start translating your ideas into computer code before you risk a single dime on the latest trading idea du jour.
Instead of applying your mental prowess to find shapes and mystical meanings in grilled cheese sandwiches, look for things that are more basic and statistically significant.
Pareidolia Conclusion:
- Humans are pattern-recognition machines
- Getting fooled by patterns in the stock market leads to ruin
- If you use technical analysis to trade stocks you're better off going to a casino (at least you get free drinks at a casino)
- Use a computer, not a crayon, to trade the stock market!