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the psychology of successful trading

What Is “Theory Of Mind?”

Introduction to Theory of Mind

“Theory of Mind” is the label for how we predict and explain the behaviour of others. More details at the link below:

https://www.amazon.co.uk/Simulation-Theory-psychological-philosophical-consideration-ebook/dp/B00S1DDMKI

People are very good at predicting and explaining each other’s behaviour.  We are so good at it, that often we do not realise we are doing it.  And it is very unclear how we do it.  In this post, I will briefly introduce some ideas in psychology about how we do it.

Theory of Mind was originally called that because the first idea was that we have a theory of other people.  On this account, we learn this theory as children, or it is innate — meaning we are born with it.  It ought to be something like a theory in that it has some kind of rules in a system.  They would say things like “everyone who wants some ice cream will go where they think the ice cream is.”

Subsequently, there was a debate as to whether this was really the right explanation for our Theory of Mind.  Alternative accounts emerged.  This means that some new terminology was required.  The account I have already outlined above, where people use a theory to predict and explain others, became known as Theory Theory.  It was, if you like, the theory that using a theory is how we do Theory of Mind!  We use rules to predict and explain the actions of others.

The Simulation Theory Account of Theory of Mind

The challenger account was called Simulation Theory.  This says that people predict and explain others by simulating them.  In other words, I predict what you will do in a situation by imagining that I am in that situation and then deciding what I would do.  I might think (implicitly probably) “I want some ice cream, where would I go?”

We can see that both methods produce results that look plausible, to begin with.  Both of them would account for the way that if I say to you “why did Jimmy go to the ice cream van?,” you don’t have any difficulty coming up with what looks like a good answer.  What we don’t know is whether you came up with that answer by using a rule (Theory Theory) or put yourself in Jimmy’s place (Simulation Theory).

An Objection to Simulation Theory

The debate continues as to whether Theory Theory or Simulation Theory is correct.  The major objection to Simulation Theory was that it could not explain cases of systematic Theory of Mind error.  In the Stanford Prison experiment, for example, the participants acted much more harshly than anyone outside the situation predicted.  Those objecting to Simulation Theory said that if it was the correct account of Theory of Mind, then we would be able to get the right answer.  We would be able to correctly predict the harshness of the participants by imagining that we were there.

Handling the Objection

I have provided what I think is the only response to this objection.  I call it the bias mismatch defence.  In it, suggest that if there is a systematic error in Theory of Mind, like the one in the prison experiment, it is because the people in the experiment are acting under a common cognitive bias, and the people outside it are not.  They do not simulate the bias, in other words.  There could be several reasons why they do not simulate it.  They might, for example, have no particular emotional involvement in the situation.  After all, being outside prison is much less intense than being in prison!

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In this particular case of the prison experiment, I think the bias in question is Conformity Bias.  This is the way we all tend to do what we are told, to some extent.  But I could use this bias mismatch approach much more widely.  It could be used to explain any cases where people systematically fail to predict how experimental participants will react, if those participants can be seen to be exhibiting any cognitive bias.  We know about more than 150 of those so far, so there is plenty of opportunity for bias mismatch to arise.  This bias mismatch happens a lot I think, and it is why so many results in social psychology are interesting and surprising — and also why so often, we fail to understand others.

See Also: Simulation Theory: A psychological and philosophical consideration

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the psychology of successful trading

Collective Narcissism

Introduction

Some people claim that “collective Narcissism” explains some episodes where people behave in unexpected ways. For example, they elected Trump and they voted for Brexit. If Narcissism is interpreted in the formal way that psychiatrists do, this can’t really be true. On the other hand, as I will explain, there are ways of constructing the claim such that it reveals some valuable insights.

Theory of Mind

The way we predict and explain the behaviour of others is called “Theory of Mind.”  I explain that here: http://timlshort.com/2018/09/26/what-is-theory-of-mind. The short version is as follows.  

There are two major accounts of how we predict and explain the behaviour of others. One is Simulation Theory, where we predict others by simulating them. The other is Theory Theory, where we predict and explain others by using a theory of them. While the second account is the mainstream one, I have defended the simulationist account in my first book, “Simulation Theory:” https://www.amazon.co.uk/Simulation-Theory-psychological-philosophical-consideration-ebook/dp/B00S1DDMKI

The major objection to Simulation Theory has been that it cannot explain systematic errors in Theory of Mind. This happens when people think about the infamous Milgram experiment. Participants are willing to give electric shocks to strangers, while everyone systematically fails to predict this. In addition, we have hundreds of experiments showing such errors predicting the behaviour of others.

Bias Mismatches

I dealt with this objection in my book by suggesting “bias mismatch” as the answer. If the person you are simulating exhibits a cognitive bias and you don’t, your simulation will fail. Cognitive biases are a fundamental feature of our psychology. Everyone has them. There are more than 180 of them.

For example, in the case of the Milgram Experiment, the bias you are not simulating is Conformity Bias. This is also called the Asch Effect. It is basically the idea that people tend to act the same as others. This effect is surprisingly strong.

Everyone exhibits Conformity Bias sometimes. But the observers do not exhibit it in the same way as the participants in the experiment.  In the experiment, the subjects are told very emphatically to proceed with the shocks. The experimenter is an authority figure in a lab coat. The experiment was conducted in the 1960s so people are more likely to do as they are told.  So the effects of Conformity Bias are very strong. The observers do not simulate Conformity Bias. As a result, they are surprised by how subjects behave.

Collective Narcissism: What is It?

Next we come to the Narcissism ideas, which I will situate in the above framework. The claim is that “collective Narcissism” about the greatness of a country causes people to make poor decisions. In the case of the US, they have elected someone who promised to make their country great again. In the UK, they have decided to take unwarranted risks with the trade position. Above all, they have done this without any benefits being available.

Certainly, the claim cannot really be that substantial numbers of people are actually suffering from Narcissistic Personality Disorder. This is because NPD subjects make up around 1% of the general population. This is quite common. Many psychiatric disorders have around a 1% prevalence rate. I think that this is because if it is much less, we cannot see it. And if it is much more, we redefine it as normal!

So 1% of the population is not enough to elect a President or tilt a referendum. However, people can show Narcissistic tendencies. This could be a much larger element of the population. We don’t really have the data to say either way. But we need an explanation of why people voted for Trump and Collective Narcissism is a good candidate.

In order to look at the plausibility of that, let us consider what Narcissism looks like clinically. To help do that, I will now describe the criteria for a diagnosis of NPD.

Informally, Narcissism is excessive self-regard. Though it is perhaps unclear how one would characterise such excess. Subjects are often successful high-status individuals. Sometimes, the individual should have high self-regard.

Criteria for a Narcissism Diagnosis

Formally, four criteria must be satisfied in order for a subject to be diagnosed with Narcissistic Personality Disorder. These are: impairments in self-functioning, impairments in interpersonal functioning, impairments in intimacy and antagonism. Each of the requirements can be met in one of two ways.

Impairments in self functioning could mean excessive reference to others for self-definition and self-esteem. Or goal-setting may be based excessively on the aim of obtaining approval from others.

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Impairments in interpersonal functioning may result in either impaired empathy or by impaired intimacy. Empathy is the ability to recognise or identify with the feelings and needs of others.

Meanwhile, impaired intimacy means that relationships are largely superficial. They exist mostly to serve the ends of the subject.

Finally, a diagnosis also requires antagonism. That is characterised either as grandiosity, meaning feelings of entitlement or self-centredness, or attention-seeking behaviour.

Conclusions on Collective Narcissism

In conclusion, we can agree that many more people than 1% of the population could show tendencies like the above. I also think we can regard Narcissistic tendencies as a cognitive bias. That would be Narcissistic behaviour falling short of the criteria for a diagnosis. This would be much more widely prevalent in the population than the number of diagnosable subjects.

Therefore, if you simulate such people and you do not yourself have the same Narcissistic tendencies about the same issues, you will get it wrong. So we see how the claims that Narcissistic tendencies can explain our failure to predict the explanation of Trump and Brexit, despite abundant data pointing that way, can be because of our failure to account for something like Narcissism in others.

See Also: The US Was Defeated In #Vietnam By Systematic Theory Of Mind Error

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the psychology of successful trading

The Illusory Truth Effect And Financial Markets

Introduction

The Illusory Truth Effect is a variant of how we inaccurately use our feelings to make decisions.  We use at least two methods to decide on the truth of a claim or the correctness of new information.  The first method is somewhat allied to one of the philosophical account of knowledge: coherentism.  We assess the claim based on whether it is consistent with what we think we already know.  The second method is to consider how we feel about the claim or purported new information.

Drawbacks of the Illusory Truth Effect

Both approaches have drawbacks.  The first method, while probably the best available, can lead people into multiple errors.  If you already believe something false, you are more likely to believe further false claims. This is especially true if the new false claims are linked to the first false claim.  We see many pernicious illustrations of this; for example, in political polarisation and various forms of prejudice.

The second approach is more damaging.  In fact, deciding whether something is true or not based on how we feel about it looks so odd that you might wonder whether it can possibly be the case that this happens.  This is another example of a puzzling psychological bias which in fact it makes sense for us to exhibit because, on average, it will produce an answer which is “good enough.”

We Dislike Work

One thing we don’t like is work.  If we have seen a claim a lot before, we don’t need to work too hard to decide whether it is true again.  (This is also a processing fluency effect.) We are comfortable with the claim or the apparent information.  I don’t need to think about the route to walk to the gym because I have done it a lot before and it always worked.  This familiarity effect or ease of processing effect is fine in relation to the route to the gym.  And there are going to be a lot of daily questions like that where it would be inefficient to reevaluate them.

This is all fine.  However, it turns out that we also do this with false claims which we have seen often.  That of course is going to be a huge problem.  The Illusory Truth Effect is also known as the Reiteration Effect for this reason.  Basically, if I tell you something which is false a lot of times, you are likely to get comfortable with it and more likely to believe it.

The Illusory Truth effect and the Bitcoin Bubble

This will have frequent damaging effects in financial markets.  For example, in the case of the Bitcoin bubble, which I forecast approximately three days before the peak. See https://en.wikipedia.org/wiki/History_of_bitcoin for some history.

There are I think some causal factors deriving from the Illusory Truth Effect, though as I discuss there, there are many other psychological biases and errors at work in the bitcoin bubble.

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In particular, what we saw in the case of the Bitcoin bubble was the cult-like nature of the phenomenon.  Proponents of the cryptocurrency repeated hundred of times the same false claims. For example: “it can only go up;” or “Bill Gates is enthusiastic about it. ” Finally: “all we have to do is HODL (sic) and everything will be fine.”  Cult members believed all of this partly because they had heard it all many times and so they became familiar with it.

Other Symptoms of the Illusory Truth Effect

Turning to the professional sphere, we can expect that the Illusory Truth Effect will play a part in any bubble involving more than just the inexperienced investors who became infected in the Bitcoin epidemic.   DotCom caught a lot of people (including myself, because I was young and inexperienced.). We heard many times that anything involving the internet was going to be a huge success.  So we started to believe it.

There are many features of markets that are true until they aren’t.  Try to avoid believing something merely because you have heard it a lot.  Look for evidence.

See Also:

The Late Evaluation Effect And Financial Markets

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the psychology of successful trading

The Late Evaluation Effect And Financial Markets

Introduction

It is no secret that people dislike working hard.  The corollary is that they like not working hard.  This much is well-known, but perhaps less obvious is that this can affect our judgments.  This is called the Late Evaluation Effect. We tend to be more positive about things we saw most recently or have looked at before.

Various experiments show that if a scenario is arranged such that the people involved are having a better time, or working less hard, they will make more positive judgements.  This can be quite alarming.  For example, it has been shown that judges making parole decisions are more likely to be lenient right after lunch and more strict before it.

New Data on the Late Evaluation Effect

A recent experiment has expanded this literature in a direction which I think is interesting in a financial markets context.  The University of Virginia’s O’Connor and Cheema, writing in Psychological Science in the issue of 01 May 2018, describe a bias of this type.  See: https://journals.sagepub.com/doi/abs/10.1177/0956797617744517

I will term it the Late Evaluation Bias.  They observe the following.

Evaluations become more positive when conducted later in a sequence

The authors examined three particular types of evaluation.  Firstly, they looked at judges from 20 years of Dancing With The Stars. Second, university professors who had taught the same course for several years. Thirdly, they investigated people judging short stories over a couple of weeks.  In each case, they found that evaluations became more positive as time went on.

People find it easier to do something when they have more practice doing it.  This means they need to put in less effort so they will find it less like hard work.  This is fine, but the strangeness is that this will then lead them to make more positive evaluations. This is a bias since it will lead to a systematically false evaluations.

The Late Evaluation Effect in Financial Markets

How might this play out in financial markets?  One simple and obvious answer is that investors will tend to be more positive than they ought to be when evaluating a stock they have evaluated many times before.  Someone who has looked at owning GE stock many times in the past will be more likely to find it easier to do again. They will therefore be more likely to come to a positive decision on that stock.  Clearly GE stock does not get any better because you looked at it before.

This could feed into bubbles such as Bitcoin. However, there is no reasoned positive evaluation possible of that cryptocurrency since it is valueless on fundamentals.

Similarly, people will evaluate asset classes with which they are more familiar more positively than they ought to.  This explains why investors tend to be over-invested in their home markets. That particular bias is extremely dangerous. Some Brexit voters for example have their entire portfolios in the UK, which is madness. Some geographical diversification is always beneficial.  

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There is no need to combat lack of diversification by entering risky frontier markets.  US investors could safely invest in the UK market without taking much additional risk and vice versa.  Both groups would gain valuable diversification.

People who have never bought a corporate bond will find it harder to evaluate than an equity if they have considered equities many times previously.  This will also rob them of a potentially valuable diversification.   The answer, as it often is, is to do more work!

See Also:

The Illusory Truth Effect And Financial Markets

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the psychology of successful trading

Passporting Is Essential for The City

Introduction

Some people deny the claim that passporting is essential for the City. For example, Jacob Rees Mogg made the claim below this morning on the Today programme:

“Passporting is mainly retail and UK financial services mainly wholesale.”

This was aimed at supporting the further claim that loss of passporting will not be much of a problem.  Passporting is the regulatory feature whereby financial institutions located in any EU member state can offer financial services in any EU member state.

Distinctions Between Retail and Wholesale Banks

The first thing we need is clarity on the distinction between retail and wholesale banking.  This maps approximately on to what we might call “high street banking” and “investment banking.”

The former are retail banks such as for example RBS or HSBC.  Their primary lines of business involve dealing with retail customers — i.e. individuals — and their financial needs.  They will offer deposit acceptance, interest bearing accounts (often in pre-crisis times with non-zero amounts of interest!) and mortgages.

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Investment banks such as Goldman Sachs or will mostly deal with HNWIs and corporate clients.  HNWIs are merely very rich individuals, who require additional services such as estate planning and access to hedge funds.  Corporate clients will want funding usually.  This is provided by investment banks often by issuing bonds for them on the global financial markets.  (There are also some banks like Citi who are both retail and investment banks.)

Why is Passporting Essential for the City?

So now we see that the Rees Mogg position is approximately that the passport enables banking across the EU to individuals whereas the City specialises in corporate clients.  Rees Mogg is definitely correct that the passport enables retail banking.  Basically, the passport means that a banking licence in any EU member state is a banking licence in all EU member states.  With that in hand, one can be regulated by the ECB, open a branch anywhere in the EU and start accepting deposits and making loans.

So the key contestable element of the claim becomes the one that one does not need to be an EU bank to conduct business with corporate clients in the EU.  One point to bear in mind is that many if not all investment banks which operate in The City will also be banks in Frankfurt.  So they will be fine; but of course London could easily lose a lot of high paying jobs and tax revenue. That is one reason why passporting is essential to the City.

The Impact of Brexit on Financial Services

But to look in more detail, I turn to a report entitled “THE IMPACT OF THE UK’S EXIT FROM THE EU ON THE UK-BASED FINANCIAL SERVICES SECTOR” from Oliver Wyman, commissioned by lobby group TheCityUK.  

https://www.oliverwyman.com/content/dam/oliver-wyman/global/en/2016/oct/Brexit_POV.PDF

This report considers four aspects of the wholesale financial ecosystem:

Sales and Trading

Sales means buying financial assets such as stocks in bulk for major investors; trading is attempting to make a profit by e.g. predicting future directions of market assets.

Wyman suggest that economies of scale mean that:

“banks could move other activities that are not directly restricted into the EU and away from the UK”

Market Infrastructure

This means “clearing.” When there are large volumes of trading — and there is well over £2tn (yes, trillion) of daily foreign exchange trading done in London — there are lots of trades that must be cleared.  This means basically moving cash from the bank that bought something to the  bank that sold it and changing the documentation accordingly.  (Incidentally, this sort of thing is why the blockchain is so interesting.  That however, is not a reason to buy Bitcoin: https://timlshort.com/2017/09/16/bad-arguments-for-the-permanence-of-bitcoin/)

Wyman suggest that fragmentation of clearing across jurisdictions will increase costs.

Due to these inefficiencies, some firms could move their clearing out of the UK

Asset Management

This is managing large investment portfolios for corporate and financial clients such as large EU insurance companies.

Wyman note that inefficiencies will arise if sales/trading desks migrate to Frankfurt or elsewhere. So the benefits of managing portfolios from the UK could be eroded. That could end up

leading some companies to manage a greater portion of their assets from within the EU

Corporate and Specialty Insurance

This is the Lloyds market, specialising in writing large bespoke insurance contracts for major corporate clients.

Here Wyman suggest:

A loss of depth in the marketplace due to the loss of EU-related activity might lead some insurance firms to relocate outside of the UK

Conclusion: Passporting is essential to the City

Taking all of this into account, Wyman conclude that no passporting means:

up to 50% of EU-related activity (£20BN in revenue) and an estimated 35,000 jobs could be at risk, along with £5BN of tax revenues per annum

I therefore conclude that some elements of the Rees Mogg claim are true.  It is indeed the case that passporting is on the face of it more of a retail matter than a corporate one.  But corporate clients are still EU clients in a number of important lines of business.  And losing access to those clients from London desks will cause significant impairment to the UK economy.

Wyman confirm this when they estimate the effects of retaining passporting (or some equivalent regulatory arrangement).  They say that in this scenario:

revenues are predicted to decline by up to £2BN (2% of total wholesale and international business), 4,000 jobs would be at risk, and tax revenues would fall by less than £0.5BN per annum

This is still bad — there are no positives to Brexit — but less severe.  Nevertheless, our overall conclusion must be that loss of passporting is very bad news.

See Also:

The Illusory Truth Effect And Financial Markets

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the psychology of successful trading

Better Traders Like Bitter Tastes

Introduction

Evidence shows that there are correlations between liking certain bitter tastes and certain personality factors.  This means we can construct an argument to show that better traders like bitter tastes, because we also know that personality factors correlate with taste preferences.

Personality as generally understood does not really exist; the belief to the contrary is known as the Fundamental Attribution Error.  However, there are some stabilities in character which are or approach being diagnosable as “personality disorders.”  These though are very much in the eye of the beholder in terms of whether or not they impair effectiveness.  It turns out that these same personality stabilities are highly prevalent in competitive professions, so these people must be doing something right.

Data to Show Better Traders Like Bitter Tastes

Researchers found that:

Individual differences in bitter taste preferences are associated with antisocial personality traits

University of Innsbruck
Photo by Pixabay on Pexels.com

Bitter tastes are basically self-explanatory.  Marmite and gin and tonic are two obvious examples, but tea or coffee without sugar could be others.  One could also look at wine types.

The authors found robust correlations between preferences for such bitter tastes and the Dark Tetrad, which is the Dark Triad plus everyday sadism.  The Dark Triad is one of the stable factors in personality.  It consists of Machiavellianism, psychoticism/psychopathy, and narcissism, at levels below threshold for diagnosis as a personality disorder.

University of Innsbruck

Machiavellianism

Machiavellianism could also be termed manipulativeness.  It reflects how likely someone is to be devious or to manipulate others for their own benefit.  Psychosis means susceptibility to delusions.  Some false beliefs — especially false positive beliefs about the self — are correlated with individual success.

Psychopathic Tendences

Some authors in the literature include psychopathic tendencies instead of psychosis.  These tendencies come from a wide potential array of behaviours.  Some or all of the following may be present:

  • glibness
  • superficial charm
  • grandiosity
  • pathological lying
  • manipulation of others
  • lack of remorse and/or guilt
  • shallow affect
  • lack of empathy
  • failure to accept responsibility
  • stimulation-seeking behaviour
  • impulsivity
  • irresponsibility
  • parasitic orientation
  • lack of realistic life goals
  • poor behavioral controls
  • early childhood behaviour problems
  • criminal activity

Obviously some of these are very unhelpful.  But we can imagine that others could be extremely useful.

Narcissism

Narcissism is an extreme level of self-absorption and self-belief.  This looks as though it will be really quite useful in terms of allowing people to fail repeatedly with no adverse ego consequences. One well-known example is Donald Trump. He has been in some ways very successful despite frequently and comprehensively failing. His political career has been as negative and damaging as his business career, but he doesn’t care. He may not even know.

We know that the Dark Triad –and presumably also the Dark Tetrad, since that is very similar — are heavily over-represented in certain professions.  That is: investment banking, journalism and politics.  All of these professions are extremely competitive and perhaps also require a certain amount of ability to exploit others.  This can therefore explain why the Dark Triad would often be seen on the trading floor as well.

Conclusions: Better Traders Like Bitter Tastes!

Of course, this shows correlation rather than causation.  However, since we have a plausible explanation as well as a correlation — it seems likely that being a Dark Triad person will be valuable when trading.  And now, since we have observed correlations* with bitter taste preferences, there is an easy way to check!

(Disclosure: I am well-known for liking ridiculous amounts of Marmite.  I don’t mind a gin and tonic either.  And I wrote this: https://www.amazon.co.uk/Psychology-Successful-Trading-Behavioural-Profitability/dp/1138096288/

(So that’s one more data point!)

See Also:

What Is “Theory Of Mind?”

The Illusory Truth Effect And Financial Markets

The Late Evaluation Effect And Financial Markets

The #Bitcoin Bubble Is Caused By The Halo Effect

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the psychology of successful trading Trading trading psychology

The Halo Effect is One Cause of the Bitcoin Bubble

What is the Halo Effect?

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The Halo Effect occurs when people judge the overall quality of an item or person by considering only a single property of that item.  This can lead to dramatic errors; most obviously when all of the other qualities of the item  are negative or highly questionable.  This I will argue here is one causal factor among several which have caused novice investors to buy Bitcoin.  When it crashes, they will lose all of their money.  They will be unable to exit the market because the power of the cognitive bias is too strong.

In this post, I will briefly set out the cognitive biases which are in play here before describing the Halo Effect and how it is another feature of human psychology which leads people to mistakenly buy Bitcoin.

Why People Like Bitcoin

The Halo Effect is not the only causal factor operative among the novice investors who are buying Bitcoin.  I have already argued elsewhere that another causal element is that Bitcoin buyers prefer their own experiences to any consideration of statistical data. In addition, Bitcoin buyers share with Trump voters a distrust of experts, as I have also argued elsewhere.

We can see that as a two variants of the Dunning Kruger effect.  Here, people who lack competence are unable to detect such lack of competence. This makes intuitive sense since people who lack competence and are aware of it would presumably either take steps to address that lack or avoid activity requiring the relevant competence.

https://www.psychologytoday.com/gb/basics/dunning-kruger-effect

A corollary of that is seen in another variant of the Dunning Kruger effect. People who lack expertise are unable to detect true expertise.  We can see this when someone is able to publish a book on Bitcoin when it is quite apparent that they do not have even a basic understanding of it.  For readers of this book, it must be impossible to recognise and benefit from well sourced, properly constructed arguments, for example in the mainstream media.

Origins of the Halo Effect

The Halo Effect was first seen in data about personality assessment in the military.  Officers asked to rate their subordinates would in fact rely on a single criterion. They would then assume that all other relevant factors were correlated with that one criterion.  This is obviously dramatically false unless all of the other variables are correlated with the one assessed.  And that is highly unlikely to be true.

False Claims About Bitcoin

Many people are unable to distinguish Bitcoin from the blockchain.  This leads many of the novice investors who are buying Bitcoin to fail to distinguish between the two claims “I am buying Bitcoin” and “I am investing in blockchain technology.”

The blockchain is a distributed ledger system which offers transparent recording of transactions (or any data) without the backing of any central authority.  It is an extremely interesting technology which holds great promise.  It could create corruption-resistant property ledgers.  That would be of great benefit, not least in combatting money laundering.

Bitcoin is termed a “cryptocurrency” even though it does not fulfil the roles of a currency in that it is not readily convertible and it is not a stable store of value.  It rewards the miners who maintain the blockchain on a widely dispersed set of servers.  However, it is clear that the blockchain and Bitcoin are not identical.

So this is how the Halo Effect kills traders. They confuse a potential positive quality with all properties. Bitcoin uses the Blockchain. The Blockchain is interesting. Therefore Bitcoin is interesting as an investment. This does not work even if it is true that the Blockchain is interesting. And even that claim is highly questionable.

A Potential Response From Bitcoin Proponents

An objection has been attempted here by a Bitcoin proponent that it is not possible to have a blockchain without a cryptocurrency.  There are a number of readings of that, but on the obvious two, the claim is either false, or true but misleading.  If the claim means “you cannot run blockchain code without also generating a cryptocurrency” then it is false. Blockchain code could run with the cryptocurrency elements redacted. Or they could have zero value, which achieves the same thing.

If the claim means “it is necessary to compensate the miners, ” then it is true.   However, the miners could get $.  Or the blockchain could run in the cloud, or in many clouds.  That would carry some costs, but this is not a problem.  It would even be possible to compensate the miners in a cryptocurrency which was pegged against the $.  There is no need for the cryptocurrency to appreciate and definitely not to gyrate wildly.  I therefore conclude that the objection fails.

Why All This Means Bitcoin is Toast

There is one positive property that Bitcoin possesses.  It is true that it is generated using the blockchain technology.  It is also true that the blockchain technology is extremely interesting, and being pursued widely by a number of serious players.  By contrast, no professional, experienced or institutional investor is holding Bitcoin.  Novice investors fall prey to the Halo Effect when they think that the one positive quality of Bitcoin is a measure of its overall quality, when in fact it has no other redeeming features at all.  This will prove to be a very expensive cognitive bias when the Bitcoin crash comes.

See Also:

The Forthcoming #Bitcoin Crash Will Kill The #Trump Demographic

The #Anecdotal Fallacy And The #Bitcoin Bubble

Bad Arguments for the Permanence of Bitcoin

Categories
the psychology of successful trading Trading trading psychology

The Bitcoin Crash Will Kill The Trump Demographic

Introduction

We know that if you voted for Trump, you are more likely to be less intelligent, less educated, poorer and more rural.  I will argue that this leads to a further feature — distrust of experts — which is required to be a supported of either Trump or Bitcoin.  This suggests that the Bitcoin Crash will kill the Trump demographic.

Note that I said “more likely to be []…”  We are talking about two curves here.  It is not certain that you are less intelligent and poorer etc.  It would not be an objection here to say “I have a PhD and I am rich and I voted for Trump.”  To say that would be to commit the Anecdotal Fallacy, which I argued yesterday is also a major feature of the Bitcoin bubble.

Only Amateurs Do Not Expect a Bitcoin Crash

One of the notable points about Bitcoin is that there are no professional, experienced or institutional investors who have invested in Bitcoin.  If that changes, we should all become seriously concerned.

Everyone who holds Bitcoin is an inexperienced amateur.  I put this to a Bitcoin enthusiast, and received the following reply.

Mark Cuban invested big into Unikorn. Peter Thiel invested into bitpay which is a wallet company. Mike Novogratz (former president of fortress investments and partner at Goldman Sachs) runs Galaxy Investments (almost exclusively crypto). Tim Draper bought 30,000 btc in 2014.  And Bill Gates: there are no definitive articles on how much BTC he holds but he has plenty of quotes talking about how it’s the future

I will now show why none of that works.

Mark Cuban and Unikorn

The first point to make here is that it is odd to cite Cuban here since he is on record as saying that Bitcoin is a bubble.  The other problem is that Unikoin, the token involved in this ICO, is not Bitcoin.  (I also believe that almost all of the other ICOs are fraudulent, but I would need a lot more space and time to show that.)  Finally, Unikoin will apparently permit sports betting, so while I do not recommend that, it at least has a theoretical source of value.  Bitcoin does not.

Novogratz

Novogratz and Galaxy Investment Partners have invested into the huge and under the radar Worldwide Asset eXchange (WAX).  This is like selling shovels to miners in the Klondike gold rush.  (Reportedly, Trump’s grandfather ran a Klondike brothel.)  Selling shovels is a great business to be in, irrespective of how many of the miners or Bitcoin holders go bust.  So this again is not an example of a major investor holding Bitcoin.

Tim Draper and 30,000 btc

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This is the only one of the examples which approaches being serious.  We must take it seriously because Draper reportedly invested serious money: $18m.  And he is actually holding Bitcoin as opposed to backing exchanges.  The caveats though are manifold.  First, he lost 40,000 Bitcoin in the Mt Gox fraud, and the fact that this did not give him pause makes me think he is an esoteric thinker.  Secondly, a lot of his remarks concern enthusiasm “for the technology”.  It is very important to keep a clear distinction between Bitcoin — a Ponzi scheme — and the block chain — a very interesting technology.  Thirdly, this is one man against every investment bank, hedge fund, regulator and all the other expert investors in the world.

Discrediting Experts as Diagnostic

I have in fact been told that my 20 year experience of successful investing is a disadvantage, because it means I am unable to understand the “glorious opportunity” allegedly represented by Bitcoin.  There are in fact some advantages to disadvantages, as I argue in my new book:

https://www.amazon.co.uk/Psychology-Successful-Trading-Behavioural-Profitability-ebook/dp/B07885RH42

— but that isn’t one of them.

Bill Gates and the Bitcoin Crash

This is an excellent example of muddled analysis and poor understanding of the importance of precision and sourcing one’s quotes from reputable sources.  (It is no coincidence that Bitcoin supporters and Trump voters alike disparage proper news sources like the New York Times and prefer websites with manufactured quotes.)  We are not actually given a quote from Gates which is the first problem.  

But secondly, it is highly likely that even if Gates thinks the blockchain is the (part of) the future, he is not holding any sizeable numbers of Bitcoin.  Why would he? He does not need to to look at blockchain technologies and he knows that a Bitcoin crash is inevitable.

A distributed transparent ledger, which is what the blockchain is, is indeed a highly interesting piece of technology which would have many very useful applications.  As just one example, imagine replacing property registers with blockchain.  Myriad opportunities for money laundering and corruption would disappear, and be replaced with an efficient technology. The fact that Bitcoin is also built on the blockchain is irrelevant.

Conclusions: Bitcoin Crash Will Kill The Trump Demographic

So none of the arguments described above succeed. They do nothing to deny that the Bitcoin Crash will kill the Trump demographic.

People in this country have had enough of experts

This is actually a quotation from a pro-Brexit politician, but we see the same pattern across the Brexit “debate,” in Trump vs Clinton, in global warming and in MMR Vaccine/autism.  In each case, you need to believe that you are right and anyone educated or with specialist knowledge is wrong.  You also need to believe that those people are lying to you — for no obvious reason.

The quality of the arguments raised by Bitcoin proponents can be seen to be extremely poor.

So now you can decide.  If you invest in Bitcoin, you are lining up with the people who mistrust experts.  If you voted Trump, you did the same thing, because you are probably a climate change denier.  So I think there is a very strong likelihood that many Trump voters are also holding Bitcoin.  

And they are going to pay a heavy price for both decisions. The only thing that will save them somewhat is they are poor. So they won’t lose that much in absolute terms. But it might still be a lot for them.

See Also:

The #Bitcoin Bubble Is Caused By The Halo Effect

The #Anecdotal Fallacy And The #Bitcoin Bubble

Bad Arguments for the Permanence of Bitcoin

The Psychology of Successful Trading: see clip below of me explaining my new book!

Categories
the psychology of successful trading Trading trading psychology

Bitcoin Bubble: Caused By The Anecdotal Fallacy

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There is currently a huge Bitcoin Bubble.  BTC actually has zero value so any trading at a non-zero value represents a bubble.  I will suggest here that the reason for this strange development is a cognitive bias known as The Anecdotal Fallacy.

What Is The Anecdotal Fallacy?

The Anecdotal Fallacy occurs when people ignore statistics and quote a story of events that happened to them.  Often, it will turn out not even to have even happened to them, but to “someone they know.”  While this step is an additional move away from constituting useful data, it is not the worst effect of this bias.  The main problem is that assessing probabilities on the basis of personal experiences is almost completely useless.  This is true even when those personal experiences actually occurred.

There is only one way to assess probabilities, and that is to use statistics on similar events.  This is hard.  In fact, even understanding it when it has been competently done by scientists or statisticians is hard.  It needs a lot of training and it seems as though our psychology is almost designed to trip us up.

The Anecdotal Fallacy is widespread.  Its use seems in many circumstances to be almost automatic.  If you give most people data on a topic, people will generally respond with what they think is a counterargument from their own experience.  Apparently intelligent and successful people fall into this error, so those qualities won’t help you.  For example, Rupert Murdoch recently tweeted a photo accompanied by the text: “Just flying over N Atlantic 300 miles of ice. Global warming!”

How Does The Anecdotal Fallacy Drive the Bitcoin Bubble?

This is a fairly extreme example which may have been deliberately provocative, but it is also quite stupid.  There are two mistakes here. One is the idea that global warming has to have happened already in all locations.  The second is that global warming would eliminate all ice on the planet.  These mistakes show a non-existent understanding of the problem.  The only way to assess the probability that global warming is a genuine threat is to look at graphs showing correlations between greenhouse gases in the atmosphere and temperature rises over several decades.*  Any personal experience is simply irrelevant to that task.

We also tend to over-estimate the probability of vivid events.  I see This as an aspect of the Availability Heuristic, which I think is related to the Anecdotal Fallacy.  We use the Availability Heuristic when we assess the probability of events by considering how hard it is to think of an example of that type of event.  Obviously we will make errors in probability judgment if some events are easier to recall than others, and more vivid events are more easy to recall.  I discuss this aspect of our psychology in the context of financial markets in my new book:

Why is the Anecdotal Fallacy relevant to the Bitcoin Bubble?

Everyone who is buying Bitcoin is doing so based on one of two events.  Either they have recently made a large amount of money from buying it or someone they know says they have.  Twitter is full of stories of people claiming they have made money.  This is vivid and alluring.  It draws more people in, which of course is what helps to sustain the Bitcoin Bubble.

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The problem is not that these stories are false.  A lot of people have indeed made a lot of money out of Bitcoin.  However, it is still a terrible investment.  In fact, I don’t think we can even call it an investment.  It has no fundamental value.  So it can crash to zero at any moment.  It will definitely do so; we just don’t know when.  So the problem is rather that people are using the Anecdotal Fallacy to assess the probability of Bitcoin rising.  They are wrongly thinking Bitcoin will rise forever.

What Should We Think About Bitcoin?

People making this mistake are forgetting the bubbles which have often happened in financial history.  Any “asset” which rises this quickly has been a bubble.  It has eventually crashed to zero.  It will do so as quickly as it went up.

The statistics are completely opposed to our psychology here.  Stay away from Bitcoin at all costs.

*The reason I say “several decades” is because we have only been taking detailed measurements for about 150 years.  However, we have data from ice cores etc going back much further.

See also:

The #Bitcoin Bubble Is Caused By The Halo Effect

Bad Arguments for the Permanence of Bitcoin

The Forthcoming #Bitcoin Crash Will Kill The #Trump Demographic

The Psychology of Successful Trading: see clip below of me explaining my new book!

Categories
the psychology of successful trading

The Picture Superiority Effect And Financial Markets

Introduction

The Picture Superiority Effect is a cognitive bias. It means that we all tend to remember images more easily than words. We then attach a higher priority to an image in our reasoning about what is likely to happen. This is incorrect and will cause suboptimal trading performance.

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My basic point throughout is that it is critical for market participants to know about these unavoidable biases for two reasons.  Firstly, knowing about them is the first step to being able to recognise when they are operative. Then you can assess whether they have resulted in an optimal decision, with specific relevance here to trading decisions.  Secondly, no-one is free of these biases. Other market players will be influenced by them. You can trade on that basis.

How Does the Picture Superiority Effect Work?

The Picture Superiority Effect is relatively straightforward.  What psychologists have found is that people find it easier to remember images than words.  

There are different opinions in the literature as to why this might be.  I think our preference for the vivid and concrete over the dull and abstract is the answer. But in fact, the causation is not that important for our purposes here.  

We just need to know that everyone remembers imagery more than text.  This is probably no surprise. In the age of social media, pictures are more widely shared on social media than text. We might also think that there is also a Video Superiority Effect which is even stronger).

Who Suffers from the Picture Superiority Effect?

The short answer is “everyone.” However, evidence suggests some people are more affected.

There is some discussion as to how age interacts with the Picture Superiority Effect.  Early researchers found that younger people recalled more pictures than words while older subjects did not, suggesting that the Picture Superiority Effect exists only in younger people.  More recent work, however, appears to find the exact opposite.  Given the general improvement in experimental methodologies that occurs over time and the parallel increase in knowledge, I would say that the more recent studies are more likely to be correct.  But that observation remains subject to further confirmation/disconfirmation.

As a result, there have been some suggestions that what is happening is that images work as a compensation mechanism for older adults who are experiencing memory deficits.  So the overall story may be that younger people are prone to the Picture Superiority Effect, middle age adults are less prone to it, and then older people embrace the effect for compensation purposes.  This would mean something like older people are deliberately relying more on pictures to assist them in remembering things.  There is also advice from the intelligence community (!) to the effect that the way to remember a lot of items without writing them down is to modify a visual memory of a very familiar location, such as one’s home, and add to it strange and striking items which represent the data one wishes to remember.

What Does the Picture Superiority Effect do to Your Trading?

All of this means that everyone who is involved in financial markets can expect that the Picture Superiority Effect will play a role in their thinking to a differing extent at various life stages.  How would this work?

This type of point — how do cognitive biases affect our performance in financial markets —  is one I discuss at length in my book:

https://www.routledge.com/The-Psychology-of-Successful-Trading-Behavioral-Strategies-for-Profitability/Short/p/book/9781138096288

One example I give there is related to imagery, although I am actually discussing a different cognitive bias called the Availability Heuristic.  For example, take the photos and video of people who had been fired from Lehman Bros. These pictures and ones like them are extremely easy to remember.  In fact, they are difficult to forget.  This sort of thing might make you unreasonably averse to buying bank shares.  Similarly, pictures of Elon Musk looking depressed might make you avoid TSLA stock.  There may or may not be good reasons for

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avoiding such stocks (my view is the opposite at present) — but what is 100% clear is that if you read a story about banks or TSLA and only recall a picture of a fired banker or a sad Elon Musk, you have not retained very much which is useful in terms of making a market decision.  Even if you give equal weight to the picture and the words, you are probably still weighting the evidential value of the total information value available to you wrongly.

Conclusion

Im sum, you should set aside the limited information value represented by imagery. Focus on data. Data may be presented graphically without being a photo. But you just want the numbers.

See Also: The Illusory Truth Effect And Financial Markets