About five years ago I passed the Certified Sommelier Exam. It took about four years of training to get there.
On my first day of Sommelier kindergarten, I realized right away these Master Sommeliers were Technical Analysts, just like me.
The process of properly blind tasting wine was remarkably similar to the “Top-Down” approach to financial markets.
In the wine world, it’s called the “Deductive Method.”
I still train with Master Somms and work on my blind tasting skills.
But this isn’t about me.
It’s about humans.
Deductive Method
When we’re trying to make decisions in the market, we want to first eliminate what we don’t want to do.
In bull markets, for example, where consolidations in stocks keep resolving to the upside, do we want to spend most of our time looking for stocks to short?
Probably not.
If a stock is making new multi-year highs, is it in a downtrend?
Probably not.
If the wine is red, then is it likely a Pinot Grigio?
Probably not.
So we’re already eliminating our possibilities, to break it down to what it could possibly be.
If it’s a white wine, then we know it’s not a Cabernet Sauvignon, or a Merlot, or a Sangiovese.
Then we look at it and test the viscosity and type of purple or garnet colors it may have.
Then we smell it to see which characteristics stand out.
By a certain point, we haven’t even tasted the wine – but we’ve already eliminated 90% of the possibilities.
That’s the Deductive Method to blind wine tasting.
It’s like what we call the “Top-Down” approach to financial markets.
It’s a deductive process, in blind tasting wine and in finding stocks to trade, so we can make money.
If all the Tech stocks are breaking out and making new highs, while the bank stocks are falling and making new lows, should we be spending all our time looking for bank stocks to buy?
Or should we be focused elsewhere?
If the wine has a ton of red and garnet color, and high tannins and high alcohol, should we pretend that it’s a Chardonnay?
Nope.
A Time and a Place
Also, there’s a time and a place for everything.
In some markets you want to own Tech stocks. In others you want to own Bonds.
Some cycles you don’t want to own either, and Energy stocks are where you might want to be.
That’s just how the market works. Sectors and even asset classes rotate.
In wine it’s the same thing
If you’re having a delicate white fish, do you really want a big heavy red wine with that? Like a Barolo or a Bordeaux?
Probably not.
You want a nice refreshing white wine to balance that oil from the fish and not overpower the dish.
You want the wine to improve the food experience, not hurt it.
Here’s the rule of thumb:
If you’re at a restaurant, you want to order a wine that will help the food shine.
The food is the star of the show. The wine is just designed to help.
If you’re at a winery, then it’s the wine that’s the focal point.
Any food involved in the wine tasting should be designed to enhance the wine tasting experience.
You don’t want the food to steal the show there. Quite the opposite. You’re there to taste wine. Let the wine be the star.
In markets it’s like that, too.
You don’t want to overpower the market and force strategies upon it if it’s not the right time.
You want to adapt to the data and act accordingly.
You are not the star of the show. The market is. We’re just trying to make our experience better – or more profitable, if you will.
If you’re having a big juicy ribeye, you don’t want a sweet dessert wine to go with it. You’re looking for a high-acid, high-tannin, high-alcohol red wine to balance out the flavors from the beef.
You want a Cabernet Sauvignon, perhaps a Merlot.
Chicken & Waffles? Champagne.
Oysters? Muscadet
BBQ Ribs? Zinfandel
Every wine has its place.
Every strategy has its time.
The Biggest Mistake
Humans have no patience. We want to find a hack and skip to the answer.
It’s perfectly natural. To not feel these emotions would be inhuman.
So recognize them, and embrace them.
When it comes to financial markets, we often jump to conclusions based on a single data point or anecdote.
We can’t help ourselves.
Professionals who are aware of these natural emotions embrace this behavior.
But they put it into context within a Top-Down, deductive approach.
Still, one headline can spark a ton of emotion for investors who can’t help themselves – often costing them a fortune.
Sommeliers are the same, me included. I am 100% guilty of this when I train with Master Sommeliers.
We can’t help but see that dark purple color and peppery flavors and shout, “That’s a Northern Rhône Syrah. Easy!”
When it turns out to be a Gamay from Beaujolais you missed because you didn’t weigh all the evidence…
That’s how it works in markets.
You want to weigh ALL the evidence. To make conclusions without doing that FIRST, is irresponsible.
It’s the same thing with wine.
In fact, the Court of Master Sommeliers even has a Deductive Method tasting sheet
Take a look at that.
This is what I fill out as I think about what grape I’m drinking…
What country it’s from…
What year it was harvested…
And where on the hierarchy of quality the wine falls.
Look how detailed the Sommeliers get.
That’s how detailed we get in markets too!
What is the direction of the primary trend?
What is the direction of the shorter-term trend?
Which sectors are leaders?
Which Industry groups are driving those sectors?
How does the intermarket landscape impact equities?
Is it a rising volatility regime or falling volatility environment?
The problem is that most humans see a data point, jump to it, and act.
In blind tasting wine, the humans are doing the same thing.
And that’s part of why everybody’s wrong.
They jump to conclusions.
Don’t do that.
Act like if you’re blind-tasting four wines, say two whites and two reds.
You have to weigh all the evidence you have, in order to make the best decision you can make.
Or it’ll cost you.
Stay sharp,
JC Parets, CMT
Founder, TrendLabs