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The Psychology of Successful Trading

 

Getting your trading psychology right and understanding that of others are both essential prerequisites to successful trading in financial markets. I discuss the most important elements of trading psychology in my new book.

Buy the book here:

Thanks to Karine Sawan and film crew for video production.

Omission Bias and Financial Markets

Omission Bias is the tendency to judge the omission of an act more harshly than its commission.  It is widely studied in psychology and has been reliably replicated in a variety of scenarios.  In the context of financial markets, this can have adverse effects because there is no practical difference between investing $100 in a stock that declines 10% the next day and failing to buy one that appreciates 10% the next day.

This of course assumes that you actually have $100.  If you don’t have a float of cash available at all times, then you will not be in a position to seize opportunities.  So that would be the first piece of advice.  Maintain a certain percentage of your investable assets in the form of cash —  perhaps 10%.  Alternatively, you could arrange for a line of credit in a similar amount but make sure you do not do too much of this because it is high risk.  Conversely, holding 10% cash acts to reduce risk.

Another adverse effect of Omission Bias is that it impairs your ability to assess performance.  This is of crucial importance.  Many investors do not have clear enough data of what has worked for them and what has not.  It is essential to have a good focus on this for a number of reasons.  

One benefit is that you can only manage your portfolio appropriately if you have been examining its performance precisely.  A second benefit is that you might be able to identify some specific sorts of trade that you are particularly good at.  You can then seek to identify relevantly similar situations and exploit them.  Also — you might have a chance of avoiding disasters from the past occurring again!

Photo by Alexander Krivitskiy on Pexels.com

Our ability to look at our failures and learn from them is also impeded by our natural distaste for thinking about the unpleasant — but failures are always more instructive than successes.  One might almost say that any fool can succeed — but only an expert can fail well…

A major practical impediment to any attempts to correct for Omission Bias is due to the sheer scale of the problem.  The number of shares you did not buy yesterday is absolutely huge.  There is no way you can think about all of those.  Nor should you.  The more useful comparison is to think about the shares you could have bought or the ones you almost did buy.  So that tells us that you should be looking at several buy options at a time.  Look at what factors led you to choose the one you did choose.  

Maybe you were looking at three oil companies.  You compared them on price/earnings ratios, dividends and price/book value.  You made a choice.  Did that work out?  (Don’t do this next day.  Wait for a reasonable period.  Otherwise you will just be looking at noise.)

What fundamentally is going on with Omission Bias is a sort of agency effect.  If something bad happens and you could have prevented it but did not, this is seen as morally less culpable than if you did something which caused a bad outcome.  After all, “you didn’t do anything.”  I think this perception might be strengthened by the fact that the law says a lot about what we cannot do but rarely says anything about what you must do.  You are at liberty to walk past a baby drowning in a pond.  You are not at liberty to throw a baby in a pond.

This might be fine morally.  But stock markets are not outlets for moral action.  They are locations where you can profit.  Or not.  Bear in mind the possibilities of Omission Bias affecting your judgements of your own decision-making and your decisions will get better and more profitable.

Learn more in the video below:

Au Pied de Cochon, Montreal

This is a quite spectacular world-class restaurant which somehow combines new world informality with a completely unique focus on quality. Nothing could express more fully, intensely and joyfully the spirit of its home. If Michelin came here, it would definitely get a star. The question of whether it got two would depend on whether they said “but this is not Paris.” Of course, we don’t want it to be Paris. We want it to be Quebec. On that basis, it would get two stars. (You don’t want three. That means six staff standing behind you at all times and a “cathedral of food” atmosphere. Here it would presumably be three ice hockey players and some big dogs pulling a sled full of ice wine, which would be less disturbing…but that’s not the ideal approach…)

The evening began with a couple of Canadian wines which were the only part of the evening which was less than stellar. These one would have put in the category of “I am glad I tried some Canadian wine but there is more development time needed.” Both lacked a little structure and depth. However, this was instantly forgotten when our amazingly friendly and informed maitre’d, Sam, brought out a Canadian white which could stand up to competition from anywhere.

This was the Stratus 2014 White from VQA Niagara Lakeshore from winemaker J-L Groux. Chardonnay-led, it had an extraordinarily satisfying viscosity without losing punch and sharpness. This turned out to be because of an unusual combination of grapes. The list was headed by Chardonnay at 52% but was then followed by a significant 32% Sauvignon Blanc component. There were further floral notes added by minor but important elements of Semillon, Viognier and Gewürztraminer.

Then to the food. You can order from the menu, but why not let the experts do their thing? Sam offered to just bring us stuff and we agreed.

Poutine is a legendary Canadian dish made up of fries, curd cheese and gravy. In snowy climates, one needs fat, salt and sugar and this dish does that and does nothing else. The version at Au Pied de Cochon however, is the Rolls Royce variant, because it adds their signature element of hot foie gras. This combines a light crust with an intensely flavoured liquid interior and matches perfectly the underlying poutine elements. Naturally, the fries were cooked in duck fat. And the punch through of the Sauvignon-assisted Chardonnay was clear in a wine very well chosen by Sam.

This was combined with a quite extraordinary salad which had citrusy zing, apple, walnuts, cabbage and blue cheese. A very arresting combination which managed to be intense but also very light so as to offer some good contrast with the poutine. There was also a very intense mushroom dish to round this section off.

For the main courses, Sam brought us items we would never have ordered, which was another reason to let him make the choices to both showcase the items of the day and match them with each other and the wine. There was a pig’s trotter from which the meat has been extracted, braised and reinserted coated in breadcrumbs. This was accompanied by a mushroom/tomato/herb led sauce of great depth and intensity. We drank a Burgundy with it which was superb but I am not going to say anything about it because we’ve all had good Burgundy. Though note that Jancis says 80% of Burgundy is disappointing and this wasn’t…

We then realised we had not had one of the signatures: Duck in a Can. We were told that this would need another 32 minutes but that was fine. In fact, leisurely pacing of courses was perfectly done throughout the evening. Rushing a sequence of what are after all some very rich foods would be a terrible mistake.

This duly arrived and was spectacular in a fatty yet well-contrasted manner. Again it had elements of depth added to it by foie gras which was perfectly placed in the context of the dish.

And the final wine of the evening was really remarkable. I had a lot of trouble answering the challenge from Sam as to whether it was New World or Old World because it was extraordinarily complex and interesting yet came in a. screw cap. (I have nothing against screw caps, it’s just it almost always tends to be a New World method. And this wine drank like it had centuries of experience behind it.)

Here is what I wrote about this wine:

Le Cigare Volant Central Coast CA 2012 Mourvèdre/Grenache/Syrah/Cinsault nose: dark cherries, vanilla and a quite extraordinary amount of smoke. Plus forest floor/mushroom (on advice!). Palate: again remarkable yet well integrated smoke reminiscent of a high end Pauillac.  Strong but balanced acidity, fruit back in the mix somewhat so well aged.  Very subtle tannins. Quality: outstanding — great balance, length, intensity and complexity 18.5 

A massive wine like that needs massive food to complement it and this was there.

Further highlights: some insanely deep Italian spirits, some dark shots, amazing pecan pie with caramel ice cream, and the world’s only dessert with foie gras. (It worked.)

The wine list runs to six pages (Burgundy, French Red, French White, World Red, World White) and is brilliantly chosen but if you have a great Sommelier like Sam you can just let him decide and read the list for fun.

In sum: one of the best restaurants in the world yet totally informal. This place is only about the food. It doesn’t care about the inessential. It isn’t even that expensive. Being anywhere in North America and not coming here is a mistake. Actually, being on the planet and not coming here is a mistake. Vive le Québec.

LGC Coin Comment Confirmation Emails

 

https://ftalphaville.ft.com/2019/05/08/1557332510000/LGC-Coin-fights-back-against-the-Financial-Times/

The above file is the receipt provided by Margret C.

And below is the photo provided by Margret C.

 

Plan Continuation #Bias And Financial #Markets

Plan Continuation Bias is a major factor driving investor losses in stock and other financial markets.  For example, many investors tend to hold on to losers for too long when they should cut their losses.  In this article, I will outline how this bias permeates our psychology by looking at how it works in air crashes, and then go on to examine its effects in financial markets. Investors will learn how to address this bias and improve trading performance.

Plan Continuation Bias, simply put, is the tendency we all have to continue on the path we have already chosen or fallen into without rigorously checking whether that is still the best idea or even advisable at all. Operating with this bias, as with the other 180+ biases that are an unavoidable feature of our psychology, is generally a good idea. We simply don’t have the time to constantly re-analyse our decisions.

Berman and Dismukes wrote a NASA report on this problem, which they describe in a brief article. They define Plan Continuation Bias as follows:

a deep-rooted tendency of individuals to continue their original plan of action even when changing circumstances require a new plan

Berman and Dismukes “Pressing the Approach” Aviation Safety World, December 2006, pp. 28–33

The authors describe two air crashes which were in their view caused by the operation of Plan Continuation Bias. Flight 1420 into Little Rock, Arkansas crashed in June 1999 because the pilots ignored alarms and persisted with an approach in difficult weather conditions. Similarly, Flight 1455 crashed in March 2000 in Burbank, California because the pilots continued with an approach even though they knew that they were flying at 182 knots which they knew was 40 knots above the target touchdown speed.

It is very easy for us to sit here on the ground and do armchair flying. We would not have made these errors we say to ourselves, wrongly. If we saw that we were flying too fast or that there were multiple alarms sounding, we would abort the landing and go around. This is not difficult to do. This quick and wrong simulation of the pilots misses out many germane factors. The pilots are under some pressure to land planes quickly and efficiently for cost reasons. There are no guarantees that going around will improve weather conditions. But ultimately, the major factor in these crashes in human cognitive bias.

Plan Continuation Bias has significant effects on the psychology of all of us. As the authors observe,

Our analysis suggests that almost all experienced pilots operating in the same environment in which the accident crews were operating, and knowing only what the accident crews knew at each moment of the flight, would be vulnerable to making similar decisions and errors

Berman and Dismukes “Pressing the Approach” Aviation Safety World, December 2006, pp. 28–33

Plan Continuation Bias is just as relevant a factor in making decisions in financial markets. We can be just as liable as the pilots described above to sticking to the plan. We bought a stock, it was a good idea at the time, and we continue to hold it even though the original reasons for it being a buy have dissipated or not transpired.

In trading, while no one is going to be killed, it is still an environment in which decisions need to be made on an inadequate data set and sometimes under time pressure. It is also going to be a highly charged situation emotionally. The inadequate data set could result from factors such as the impossibility of predicting the future or the sheer scale of the operations of a listed company. Time pressure is particularly prevalent in day trading, but even more long-term investors are susceptible to effects such as feeling that “money is burning a hole in their pocket” and they need to put a trade on right now. The emotional charge comes from losing money. We are all highly averse to losses — in fact, we seem to be 2.5x more averse to losing money than we favour gaining the same amount. It hurts to lose. It challenges our self-perception.

Photo by Snapwire on Pexels.com

These observations lead to immediate suggestions as to how one can prevent Plan Continuation Bias from impairing one’s trading psychology.

  • Try to minimise the effects of an inadequate data set by either doing more research or not trading unless you are certain or can set downside limits. Don’t take trades where it looks like you need to know everything about a company or where you think other market participants can easily know more than you. Don’t trade things you don’t understand like Bitcoin.
  • Don’t do anything under time pressure. You will need to get used to FOMO because “just getting one more trade on” will kill you quite quickly. It’s fine to miss things. It is much more important to get a small number of decisions right than to try to catch every opportunity
  • Don’t trade when feeling strong emotions and try to trade emotionlessly. This is hard to do. It is particularly hard to learn this from practice/dummy accounts. It simply doesn’t hurt very much to lose play money. You should still start here, but be prepared for real life to be much harder. Get more Zen about it. It doesn’t matter if a trade loses as long as you are up over the year.
  • Learn more in the video below:

Asking Mark Field MP To #StopBrexit

From: Tim Short
Sent: 17 November 2018 10:45
To: FIELD, Mark
Subject: Brexit Is Economically Catastrophic

To The Rt Hon Mark Field MP

Dear Mr Field,

I would like to know as a constituent of yours and an investment banker what actions you are taking to prevent the severe adverse economic consequences of Brexit, which were extremely clear at the time of the referendum, and yet are becoming more apparent daily.

As you will be aware, we cannot replace the many FTAs we currently enjoy in virtue of our EU membership quickly or easily. It is a chimera to believe that trade with the Commonwealth can replace trade with the EU since it is an empirical law that trade volumes anti-correlate with distance.

There are three components of GDP growth, of which an increased workforce — meaning migration — is one. Increasing the other two — productivity and capital intensity — is difficult. We therefore require greatly increased levels of skilled migration, especially in the light of likely future demographic developments. Migration is harmed by Brexit since it creates a strong and accurate perception abroad of UK hostility to migration.

There is as you will know a composite sector model of the UK economy on the day before the referendum composed of the appropriate weightings of sectors in other OECD economies. Naturally, those other OECD economies have been exposed to the same global economic environment as has the UK economy. Nevertheless, UK GDP is currently underperforming the composite model by £500m per week.

I have never understood what it was that the Brexit voters wanted, but whatever it is, we simply cannot afford it.

I look forward to hearing what actions you intend to take to stop Brexit.

Yours faithfully,

Tim Short
timlshort.com/abouthttps://timlshort.com/about

More Data Explaining Why #Women Are Better #Traders Than Men

Why women are better traders and investors than men — a psychological explanation

Warwick University Business School (“WUBS”) have conducted a fascinating study on the investment performance of men and women.  They show that women perform significantly better with a good sample size and temporal range.  They make some interesting remarks on why this might be.  I think I can add some extra psychological depth to this — so we can see that female traders appear to have some quite deep natural advantages and they should feel encouraged about managing their own investments.

What WUBS did was collaborate with the share dealing service offered by Barclays Bank.  They looked at 2800 investors over three years.  There are various ways of measuring stock market performance, but one of the most common is to compare the performance of a portfolio with a relevant stock market index.  (I explain what a stock market index is here: What Is A #Bear #Market?)

It is quite hard to outperform an index consistently.  This fact is what lies behind the recent strong growth of tracker funds.  You may as well buy the index if you can’t beat it.  The results from the WUBS study showed that women consistently outperformed the FTSE-100 index and men did not.  The male investors returned 0.14% above the index which is basically statistically consistent with having performed equivalently to it.  However, I suspect that these investors would have been better off just buying the index rather than paying a lot of trading fees to obtain the same performance.

The female investors outperformed the FTSE-100 by a massive 1.80%.  This may not sound much, but it is actually huge.  Done over a lengthy period, it would lead to significantly improved results.  Let us assume that the FTSE-100 returns 5% a year.  If you started with £10,000 and performed as the male investors do, you would end up with £45,000 after 30 years.  (It is always important to think long term in the stock market; to prefigure part of the answers I will discuss below, the women seem to understand this.)  The female investors would turn £10,000 into £72,000 over the same 30 year period.  That is a huge improvement over £45,000 and bear in mind that the female investors have taken the same risk, making it even more impressive.  (One caveat is in order here: no one performs this consistently over the long-term–if they say they do, it is a huge red flag.  Remember Madoff?  But the point stands.)

How are female investors outperforming?

WUBS and Barclays set out a few reasons which could explain the outperformance.  One of them is the one we already know about.  Women are less over-confident than men.  I explain how that works here: Women Are Better Traders Than Men.  In summary, women tend less often to think that their new idea is brilliant and then abandon their previous idea before it has had time to work.  Men on the other hand just get extremely convinced about their new sure-fire idea and go with it.  Interestingly, women’s lack of over-confidence is not manifested in what they say about their beliefs.  They just don’t act on them as often.  We could discuss philosophically what that means about our account of belief — but the key point is that women are less likely to trade in deleterious ways!

But there are new reasons suggested.  There are three that I think are especially interesting.

  • Women stay away from terrible ideas like #Bitcoin (this explanation is proposed by a Guardian commentary from Patrick Collinson; see links below)
  • Women avoid “lottery style” trading
    • It has always struck me as insanity to own a lot of penny stocks which are supposed to return ten times the amount you invest in a year because this almost never happens.  As I discuss in my book, The Psychology of Successful Trading, traders can get seduced by vivid stories, incorrectly over-estimating massively their likelihood of coming about.  A far better approach is just to sit still in major stocks for a long time, with maybe some spicy options for fun in a minor section of the portfolio.  The problem with picking the next Amazon (or Bitcoin, for that matter) is that you can’t.  You would have to own a million penny stocks for each Amazon or Apple.  So this strategy is exciting but completely unsuccessful.
  • Men hold on to their losers
    • It seems that women are better at getting out of something which hasn’t worked.  This came very close to home for me.  Infamously, I am still holding Deutsche Bank stock, partly because I recommended it in my book as a contrarian trade.  Banks are supposed to trade at at least book value (in fact, 2.0x before the crisis).  So if you buy a bank at 0.25x book value, you can’t lose right?  Because it is buying something for a quarter of its value.  That hasn’t worked for me yet — maybe a female trader would have got out of this position a long time ago.

In conclusion, we have seen some deep-seated psychological advantages which female traders will have over male ones.  This should encourage women in their investing.

Links:

WUBS: https://www.wbs.ac.uk/news/are-women-better-investors-than-men/

Guardian: https://www.theguardian.com/money/2018/nov/24/the-truth-about-investing-women-do-it-better-than-men

I would like to thank Dr M R Hampson for suggesting I look at this.

 

#TheAffair And #Nietzsche’s Perspectivism

I will argue that The Affair is a philosophically interesting piece of TV drama which raises deep questions in the areas of memory and our access to “the truth.” Some of these may be understood by reference to Nietzsche’s account of truth (and some of them relate to interpretations of quantum mechanics!) There are no significant spoilers and no references to events beyond the first episode.

The aspect of The Affair that is most immediately apparent is that it is told from multiple perspectives. This is made dramatically arresting by the way it becomes clear that the different perspectives are incoherent with each other — and probably with themselves. In this, the situation parallels real life.

Moreover, the cinematography seems to reflect this. Noah’s view seem somewhat brighter literally and metaphorically. Alison seems more beautiful, which partly perhaps reflects the way she smiles more in his section and could also mean that he perceives her as being more beautiful than she perceives herself to be. It is also a reflection of her affective state, presumably. There are interesting feminist points to be made here also about the male vs the female perspective.

I will focus on a single tiny episode and note the multiple readings. As a preliminary, I should point out that the story at this point is being told in flashback from a subsequent police interview.

The episode in question is when Noah is approaching up the driveway of Alison’s house while she is having sex with her husband in the driveway. The sex is rather aggressive and it is unclear to Noah whether an assault is taking place. The precise event I wish to discuss is that in Noah’s version, Alison shakes her head. Noah appears to interpret this as meaning “no, this is not an assault.”

The head shake does not appear in Alison’s version. There are at least seven readings of this.

  1. Noah remembers it because it happened but Alison does not remember it.
  2. Noah remembers it falsely and Alison does not remember it because it does not happen.
  3. Noah does not remember it because it did not happen but is reporting it to the police for reasons of his own.
  4. Something happened which Noah remembers as a head shake but which Alison remembers as something else.
  5. Noah remembers the head shake correctly but Alison has forgotten it.
  6. Both Noah and Alison remember the head shake correctly but Alison has omitted to mention it because it does not seem important to her.
  7. Both Noah and Alison remember the head shake correctly but Alison has deliberately not reported it for reasons of her own.

I hope it will serve as an indication of the dramatic quality of this production that this amount of consideration needs to go in to a single micro-event!

How does this relate to Nietzsche?

The starting point of Nietzsche’s doctrine of Perspectivism holds that we need to take multiple perspectives to approach the truth. In a way, it is post-modern in that it denies there is any one truth. There are only truths from a perspective. Put another way, since god is dead, there is no omniscient unbiased perspective from which there could be a single truth.

This does not mean Nietzsche is a nihilist or someone who thinks there can be no better or worse ways of proceeding. He instead claims that the optimal approach is one that adopts multiple perspectives. He then adds a couple of typically radical Nietzschean riders which really give the position a strong flavour.

Many philosophers would proceed thus far and then say “but it is important to avoid contradictions.” Not only does Nietzsche not do this, he does the exact opposite. He says that the wisest choice is to hold multiple perspectives especially when they are contradictory!

This is what I think is being brought out in The Affair with great aplomb and intelligence. I commend it to you.

(I won’t discuss the many worlds interpretation of quantum mechanics here, but I think it is also in play, not least because it is actually mentioned by Noah.)

See Also:

What Is “Theory Of Mind?”

The Psychology Of Successful Trading – Behavioural Strategies For Profitability

#Proust: An Argument For #SimulationTheory

The #Bitcoin Bubble Is Caused By The Halo Effect