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the psychology of successful trading

Negativity Bias And Financial Markets

Introduction

Negativity Bias is perhaps the most expensive and dangerous item in our psychological repertoire insofar as it impacts on our performance in financial markets.  In this post, I will outline the bias and then discuss how its effects play out in markets.

Negativity Bias means that negative events affect us much more strongly than positive ones.  I should immediately distinguish this effect from the bias I was discussing in my previous post (https://timlshort.com/2017/11/05/attentional-bias-and-financial-markets/

There, I discussed the subset of Attentional Biases. People who are depressed or anxious pay more attention to mood congruent information.  Negativity Bias differs from that in that it affects everyone, irrespective of mood and psychiatric diagnosis.  Some forms of Attentional Bias do that as well, but in the previous post I considered only mood-related variants thereof.

The bias is a mis-calibration, like many of our cognitive biases.  There is a “right-size” for the amount of impact that an event should have on us which is related to the “intensity” of that event.  Obviously, intensity is rather a slippery concept here, but we can give some meaning to it with illustrations.  Two negative events of different intensities would be stubbing one’s toe and breaking an arm.  Two positive events with differing intensities would be receiving a birthday card or falling in love.

Data on Negativity Bias

So without Negativity Bias — and with what we might regard as a purely rational response to events — there would be a link between the intensity of an event and its impact upon us.  There would not be a link between whether the event  was positive or negative and the size of the impact of the event on us.  This does not mean that it is strange that we react negatively to negative events and positively to positive events (in fact, it would be very strange were this not so!).  What it means is that it is odd that we react more strongly to negative events than we do to positive events of the same intensity.

Experimental social psychologists measured this in financial terms using sums of money. They found that the mis-calibration is very strong: the factor is about 2.5.  In other words, we react 2.5x as strongly to losing $10 as we do to gaining $10.  So, losing something is much, much worse than gaining the same amount.

The Negativity Bias then will have huge impacts on our risk aversion. That we know is a key driver of performance in financial markets.  Many people perform extremely badly as a result of excess risk aversion.  In the current environment, it is unwise to be holding substantial amounts of cash.  People should have some emergency funds of course.  But if CPI is running at 3% and interest rates paid by the banks are more like 1%, then anyone holding cash in the bank is basically prepared to pay 2% a year in order to avoid any risk, as they see it.

See CPI stats: https://www.ons.gov.uk/economy/inflationandpriceindices

Market Effects of Negativity Bias

As I see it, paying to avoid risk like this is just concretising the risk.  You don’t gain: you just get the loss in a form you can pretend doesn’t exist.  It would be much better — and in fact less risky understood correctly — to invest in something.  There is an enormous spectrum of assets and geographies out there from equities in the US, Japan, Emerging

Photo by Lorenzo Cafaro on Pexels.com

Markets and Frontier Markets to bonds issues by governments, investment grade corporates and junk corporates.  There are thousands of ETFs available offering the widest imaginable range of exposures.  Overcome your Negativity Bias and pick one.

See Also:

The Illusory Truth Effect And Financial Markets

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the psychology of successful trading

Attentional Bias And Financial Markets

Introduction

Many cognitive biases affect our trading performance. One of them is Attentional Bias. I will describe what it does and explain how it affects your trades.

Are happy people better at picking up information that will make them happy?  Do sad people do the opposite?  Have you wondered how your mood can affect your behaviour

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in ways you don’t know about?  All of this is true and can be explained by considering one form of a Cognitive Bias called Attentional Bias.

We are subject to approximately 150 Cognitive Biases, at the last count.  All of them affect our thinking without us necessarily knowing too much about when they are at work or what the results are.  My project initially is to list and describe these mental subroutines before critically examining them and assessing how they work in a market environment.  The objective is to allow market participants to look out for the operation of Cognitive Biases in their own thinking and trade on the expectation that they will also figure prominently in the thinking of other players.

What is Attentional Bias?

One of the most important Cognitive Biases is Attentional Bias.  It comes in several forms, but all of them have in common that they systematically slant which information we pay attention to.  Obviously this has dramatic effects on thinking and market outcomes.  In this post, I will first describe Attentional Bias and then outline how it might play out in a market setting.

Much of the psychological literature on Attentional Bias looks at what we can term mood congruency.  The basic idea here is that we are more likely to look at information which fits our mood.  So, anxious subjects are more likely to look at anxiety-inducing information and depressed subjects are more likely to consider depressing information.  Clearly this is already rather unhelpful for such subjects, but my aims here are only to look at what this might do in markets.

Depression as an Example

This is widely important because generalised anxiety affects a significant proportion (estimated at between 5% and 30%) of the population.  This is people who are more-or-less anxious more-or-less all of the time. Since it is a significant  minority, it is likely that some of these subjects participate in financial markets, although it is possible that some anxious individuals will self-select out of stock markets.

Depression of sufficient gravity to merit a psychiatric diagnosis affects about 1% of the population; many more people will experience a less severe depression or a more episodic form.  Again, we can expect plenty of depressed market participants to be trading.

See: https://www.who.int/news-room/fact-sheets/detail/depression

Experimental Data on Attentional Bias

Experimental investigations of mood-disorder linked Attentional Biases have focused on reaction time studies.  A pair of words was briefly presented to experimental subjects on a computer screen.  Sometimes, one of the words was replaced with a dot, which was the signal that a button should be pressed.  The experimenters record the time it took for subjects to press the button.  It would typically be in the range of several hundred milliseconds.

Sometimes, the other word presented on the other side of the screen to the dot was a threatening word.  The word could be socially threatening (‘humiliated’) or physically threatening (‘injury.’)  The experimenters found an RT spike. That’s what psychologists call a delay in reaction time.  People took longer to see and react to the dot if a threatening word appeared on the other side of the screen.  These effects were quite large.

Perhaps most interestingly, the RT spikes were larger for anxious or depressed subjects, especially if the threat word was specifically related to either anxiety or depression.

What Effects Of Attentional Bias Should Such Individuals Be Aware Of?

It is obvious that such effects could impair traders on a trading floor who are making rapid trade decisions themselves.  Information near their field of vision which is threatening — such as a negative Bloomberg headline — could grab the trader’s attention and cause a delay in response time even if it is unrelated to the trade under consideration at the time.

While this is a real issue, I want to consider non-professional traders as well. In general, you should avoid day-trading. 85% of day traders lose money.  

Day-trading is popular among people new to investing.  The aim is to minimise risk by not holding any positions over-night.  However, the necessarily short-term nature of this approach means that one can really only benefit from ‘noise’ in stock movements and there is no way to rationally forecast noise.  Relying on luck is even worse in markets than elsewhere because the punishment is swift. It is better to be a buy-and-hold investor.  

Don’t Trade Depressed — or in Any Strong Emotional State

If you are depressed or anxious, don’t trade. It is almost always better to do nothing.

Negative mood-congruent information will grab attentional resources and make traders much more likely to exit positions.  This may or may not be the right decision to make. You should make such a decision rationally and with a fair and open consideration of the relevant data.  Often this will not be what everyone else is doing, so my approach lends itself naturally to a contrarian investment stance.  There are other good reasons to be a contrarian investor, including that it fits with a long-term approach — so it is not something much engaged in by day-traders.

If you are permanently depressed or anxious, then you should get treatment. Abstain from trading until you see an improvement.  If you can’t improve, then I am sympathetic, but I would suggest hiring financial advisers in that circumstance.  It would be one thing less to be concerned about and would likely have more optimal outcomes, despite the extra fees involved.

See Also:

What Is “Theory Of Mind?”

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

The Late Evaluation Effect And Financial Markets

Sherlock Holmes as Enemy of Confirmation Bias

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the psychology of successful trading

The “Wisdom of Crowds:” Very Risky in Financial Markets

Introduction

The “wisdom of crowds” is the idea that people are generally right so we should generally do what they do. Unfortunately, while they are generally right, they are usually wrong in financial markets. So there is no wisdom of crowds to be found there. That doesn’t stop people relying on it. Here I will suggest you should go your own way. It will be very expensive to follow the crowd.

We all tend to do what everyone else does, even when we can see that everyone else is wrong.  In financial markets, this can lead to bubbles and herd behaviour.  It is important to be aware of this tendency within our psychology, so you can at appropriate times avoid joining in the bubbles.  It is important to do this because you will lose a lot of money if you participate or, once in, fail to exit before everyone else does.

In this post, I will briefly outline the relevant psychology. So you can both look for the effects in your own thinking and expect those same effects in other market participants.  This will improve your trading.  I discuss this bias and many others in a financial markets context in my new book The Psychology of Successful Trading.

Photo by Mike Chai on Pexels.com

Conformity Bias

Conformity Bias is also known in the literature as the Asch Effect, after the pioneer experimenter.  Asch obtained really surprising results, which will show you how strong this effect is.  He had a naive member of the public sit in a room in front of a blackboard with four other people.  The member of the public thought that the other four people were also naive members of the public. In reality they were actors who were going to behave in a specific way suggested by Asch.

https://www.simplypsychology.org/asch-conformity.html

The experimenter draws a line of a certain length on the left side blackboard.  The experimenter also draws other reference lines of different lengths on the right hand side.  One of them was clearly the same length as the reference line. All of the rest were clearly much shorter or much longer.  Asch then had the people say which of the test lines on the right was the same length as the reference line.

If the naive member of the public went last and heard all of the actors give a wrong answer, he tended to go along with them. That was true even though the answer was obviously and clearly wrong.  Amazingly, Asch found that most people gave an obviously wrong answer some of the time. Some people gave wrong answers most of the time.

This is how strong Conformity Bias is: it works even when the answer is obvious.  Imagine how much more dangerous it is in financial markets. The answers are much less clear cut and much ambiguous and conflicting data must be weighed.

Bubbles are Caused by the Wisdom of Crowds

I think this is one factor behind a lot of famous bubbles in financial history. Right now, it looks to me as though the cryptocurrencies, most notably Bitcoin, are exhibiting bubble characteristics.  One sign of this is the enthusiasm of a particular football manager, one noted for his lack of financial acumen, for Ethereum.  I do not say this is a scam; I merely suggest that one should look to more fundamental underpinnings for value than “everyone likes it and it has gone up a lot.”

Avoid Conformity Bias and trade better by trading the other way when you see it happening.

The wisdom of crowds might get you across the road but it will kill you in trading.

See Also:

What Is “Theory Of Mind?”

The Illusory Truth Effect And Financial Markets

If You Like Gin And Marmite, You Are Probably A Better Trader

The Late Evaluation Effect And Financial Markets

Categories
the psychology of successful trading

Millennials Make Bad Financial Decisions

Introduction

Many Millennials make bad financial decisions. But that can be fixed.

It is reported that 71% of Americans express regret about their ability to handle their finances; the percentage rises to 83% among Millennials.  The most common regret, expressed by 48%, is failure to plan early enough.  

Why does this happen?  I will explain it using an element of our psychology called Hyperbolic Discounting.  This is one of 180+ different sorts of Cognitive Bias.  In my new book, I discuss the most important Cognitive Biases and how they will affect your investment performance (see link below).

Hyperbolic Discounting: Why Millennials Make Bad Financial Decisions

So what is Hyperbolic Discounting and how does it explain our failure to plan early enough?

As with many Cognitive Biases, they have a kernel of value within them.  This has to be true because otherwise we would not have them.  They can be seen as “quick and dirty” heuristics which in most everyday situations are good enough to allow us to get by.  If they are mostly right and avoid any scenarios of catastrophic error, then they probably do enough to pay their way in our mental architecture.

As an example, think of the widespread fear of snakes.  Evolution could have aimed to give us only a fear of venomous snakes, but that would have been difficult to achieve and would have involved a risk of missing some snakes that could kill us.  Better than this is to make people afraid of all snakes.  The cost of that is that people will sometimes run away from some snakes that are harmless.  But that’s fine.  That cost is greatly outweighed by the benefits of avoiding the venomous snakes.

Hyperbolic Discounting is one of these sorts of mostly useful bias.  It is founded on something like the common and accurate idea that “a bird in the hand is worth two in the bush.”  In other words, something I have now is more valuable than something of equal value that I will have in a year from now.

Value Now Versus Future Value

This then raises the question of how to compare the present value of an item I now own and the present value of something I will own a year from now.  This means applying a discount to the future item to account for the delay between now and when I will own it.  In a world of low interest rates, it is easy to forget this.  But when they return to 5% a year, it will be a lot more clear that $100 now is worth 5% more than $100 in a year from now. Because I could save the $100 now and it would be worth $105 in a year from now.

Turning this around, I can work out what the present value of the future $100 by discounting  it.  This means multiplying it by (100/105).  This comes to $95.24.  (You can check this by adding 5% to it and getting back to $100.)

So 5% is the Discount Rate here.  This is how you should discount a future certain $100 by under circumstances where the risk means that is appropriate.  Now we come to the problem with Hyperbolic Discounting. Our default discount rates are way too high.  We set far too much store by what we have in our hands now.  This also explains why we are prepared to smoke and not go to the gym today.  Those things are easy to do and carry only minor immediate costs.

Smoking and Not Going to the Gym: Same Story As Millennials Make Bad Financial Decisions

Smoking of course carries an infinite cost at some point in the future because it will kill you.  It is only through Hyperbolic Discounting that anyone can manage to smoke. Similarly, not going to the gym will kill you.  But not today.

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These and many other Cognitive Biases are who we are and explain much of our decision making.  The approach I take in the book is to describe some of the financially significant ones and then explain how they play out in financial markets.  Thus, by reading the book, you can obtain two key benefits.  Firstly, you can look out for biases like Hyperbolic Discounting in your own thinking and correct for them.  Secondly, and even more valuable, you can expect them in other market participants and trade accordingly.

Millennials make bad financial decisions but you don’t have to be one of them.

Learn more at: https://www.amazon.co.uk/Psychology-Successful-Trading-Tim-Short/dp/1138096288

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the psychology of successful trading

Cognitive Biases And Stock Markets

What is a Cognitive Bias?

A Cognitive Bias is an element in our psychology which makes decisions for us.  In fact, given there are so many of them, you might even say that our psychology is just Cognitive Biases.  I discuss about 20 of them and give market context in my new book:

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

One example which I discussed in a previous post is Hindsight Bias.  This makes us think that everything which has happened was inevitable.  This in turn makes us very bad at knowing what level of probability we assigned to past events.   We seem to remember that we said that a prior event was going to occur with 90% probability when in fact, we gave it a probability of 30% before that event occurred.  This will obviously have unhelpful effects in the context of markets.  It will make us greatly overestimate our chances of knowing what is going to happen next, which may make us trade with over-confidence.  There is nothing quite like over-confidence to kill market performance.

Learn More About Cognitive Biases

As I said, the book covers around 20 biases and their effects in markets in much more detail than I can give above.  The thing is though, that there are way more biases than that.  In fact, in the chart below, you can see just how many there are.

Every one of these biases will affect your market thinking and that of everyone else involved.  So it looks like we all have some work to do!

In the links below I give you more information about a wide set of cognitive biases. These are all in addition to the ones I cover in the book. Many of them are very surprising.

See Also:

#Narcissism and #Unexpected Behaviour

The Illusory Truth Effect And Financial Markets

If You Like Gin And Marmite, You Are Probably A Better Trader

The Late Evaluation Effect And Financial Markets

The #Bitcoin Bubble Is Caused By The Halo Effect

The #Anecdotal Fallacy And The #Bitcoin Bubble

The Picture Superiority Effect And Financial Markets

Negativity Bias And Financial Markets

Categories
the psychology of successful trading

Women Are Better Traders Than Men

Introduction

There is a good amount of evidence that non-professionally, women are better traders than men. I will outline it here.

This does not mean that female professional traders under-perform male professional traders.  I have not seen a lot of data one way or the other on that point, though apparently there are some indications the female-run hedge funds also outperform.

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

Why Are Women Better Traders than Men?

There are a few interesting reasons as for why this might be.  One is that females are better at “Theory of Mind” than males.  Theory of Mind is the label for how we predict and explain the behaviour of others.  One would expect then that since much of market out-performance is driven by predicting the behaviour of other market participants, that strong Theory of Mind would be possessed by better traders.  And this indeed is what the data show.  Since I don’t believe that anyone has explained Theory of Mind to traders, I also devote an early chapter of the book to that topic.

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The other interesting possibility relates to confidence.  There is a curse of over-confidence that afflicts at least non-professional traders.  They fall in love with their own judgment.  But it is only a fickle love.  In three months, they will be in love with a new idea and a new stock.  This makes traders commit the cardinal error of over-trading.  It is well-known that “buy-and-hold” outperforms as a style over the long term.  The fact is though that many retail trading accounts turn over several times in the course of a year.

Conclusions

It turns out that females are not less over-confident than males in one sense: they also form beliefs which they assert as confidently.  However, it seems that female traders are less likely to act on these beliefs.  So they are protected by this from letting their over-confidence lure them into over-trading.

If you are male, you can improve your trading by waiting longer. Do less than you are doing now.

See Also:

What Is “Theory Of Mind?”

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psychology the psychology of successful trading Trading trading psychology

Problems Unwinding PFI

Introduction

PFI is politically unpopular. For that reason, politicians often announce that they will roll it back. Plenty of projects like hospital construction would be impossible without PFI. Many of the arguments against it fail since they do things like add up 30 years of interest and say that that is the cost of the project. There will moreover be significant problems unwinding PFI due to the bonds issued. I will outline that below.

Who Wants to Unwind PFI?

It was at one point Labour Party policy to unwind PFI. PFI contracts would be reviewed and if necessary, brought back in-house.  The report of that is here:

https://www.theguardian.com/politics/2017/sep/25/john-mcdonnell-labour-would-bring-pfi-contracts-back-in-house

Private investors who have put money into PFI schemes will need compensation.  A spokesman said “a future Labour government would compensate shareholders in PFI companies by swapping their shares for government bonds.” 

That might be acceptable, though equity holders may not be at all happy about being placed in a different part of the capital structure. They would have a completely different risk/reward structure and also have exposure changed to a different entity. 

It would work if they got enough government bonds.  I am not sure how popular a “stuff their mouths with gold” policy to ensure silence (and no lawsuits) will be but we will see.  The real problem however lies elsewhere.

Photo by Pixabay on Pexels.com

How Does PFI Work?

The way PFI works is that the government or an NHS trust signs a contract with a private sector entity, often a consortium the members of which will include prominently construction and financial firms.  The contract, very basically, will say “you agree that we will have a usable hospital between three and thirty years from now” and “we agree to pay you cash amounts for the same period.”  This removes risk from the government because it no longer has to build the hospital — which incidentally it probably cannot afford to do in any case — and any other interruptions to service during the lifetime of the contract. 

This by the way is why it is not an objection to PFI that it costs more: it should cost more because the government has avoided a great deal of risk.  We know that government projects go over-budget all the time. With PFI that risk passes to the private sector. Most critics do not price risk correctly.

The private sector consortium now has a good chance of receiving government cashflows for 30 years, providing it can build the hospital without problems.  These cashflows are excellent for backing bonds: or in the jargon, they are good candidates for securitisation.  Because they are such good candidates, almost all of them will have been.  One reason why they are so good is that there is very strong demand for such long bonds — from everywhere in these low rate times — but especially from pension funds.  Naturally they want long bonds because they have long liabilities.

What are the Problems Unwinding PFI?

Here’s the problem.  These investors focus on Repayment Risk.  This is the risk that you give them their money back before they were expecting it.  This sounds like good news for the investors, but it isn’t. The pension fund wants interest for 30 years at a rate fixed today. Now you have given them their money back they won’t get that.  This is especially painful for them if rates have declined in the meantime.  The current ultra-low rates environment just underlines this.  Imagine 10 years ago you bought a bond paying you 6% a year for 30 years and now they give it you back and say “go ahead and find another bond that pays you that much…”

Because investors hate this so much, they insist on what is known as a Spens clause.  This basically says that if you repay early, you have to roll up the remaining excess interest payments for the remaining life of the bond and hand that over now.  This will be unimaginably expensive because the excess interest will be calculated primarily from the original rate paid by the bonds and the general rate available.  That difference will be huge in a lot of cases because rates generally are so low.  So you will have to roll up a huge difference for maybe 20 years.

Conclusions: Problems Unwinding PFI Mean You Shouldn’t Do It

Conceivably the government could legislate to take out the Spens clauses.  But that would mean government had intervened radically in contracts agreed between consenting experts in full possession of their faculties…and would destroy the reputation of the City as a secure global marketplace.  We don’t need that ahead of Brexit.  In any case, it would also kill most of the pension funds.  Many of those are foreign, so even if the government were able to lean on the local ones, they would still pick up some fearsome litigation. Problems unwinding PFI are such to make it a bad idea even if PFI was a mistake, which it isn’t.

See Also:

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

Cognitive Biases And How They Affect Stock Markets

Jacob Rees Mogg Is Wrong To Say That Loss of Passporting Will Not Be A Problem For The City

UK Government Spending: Where It Needs To Be Cut And Why

Categories
the psychology of successful trading

Bitcoin Has No Future

Bad Arguments for the Permanence of Bitcoin

I will argue that Bitcoin has no future. I will do that by rebutting various elements of a rather poor article arguing that Bitcoin will be around forever. It appeared here:

https://www.theguardian.com/commentisfree/2017/sep/15/jp-morgan-ceo-wrong-bitcoin-jamie-dimon

The random banker bashing in the headline might give you an initial suspicion about who is likely to be right here.

The first rhetorical question the article asks is “Would Jamie Dimon really sack traders who netted a 1,000% return in less than two years? The bank’s shareholders wouldn’t approve”

The answer to this is definitely yes.  Return alone is an inadequate assessment of trader performance.  We must look at risk-adjusted return. A guaranteed 10% return is better than anything lower than a 50% chance of 20%.  If the trader made his 1000% by betting on a single horse, he took an enormous risk to make his 1000%. The shareholders would certainly approve of Dimon sacking such a trader and in fact would demand it.

Bitcoin Has No Future: Standard “Fake News” Accusation

Next is a ‘fake news’ type criticism aiming to show that Dimon is biased.  He writes “Although JP Morgan was by no means the most leveraged of the banks, it still took bailout money, and, as its CEO, Dimon and bitcoin will inevitably be philosophically opposed.” 

These claims don’t stack up.  Firstly, JP received a bail out post-crisis (fine).  Secondly, Bitcoin is a response to this crisis. I doubt it, but let’s accept this.  Thirdly, JP oppose all crisis responses.  Conclusion: JP opposes Bitcoin forever.  Premise Three is obviously false. It has no defences.

The next section of the article accuses Dimon of not understanding Bitcoin because he says it is a fraud.  The author then admits that the main uses of Bitcoin are for fraudulent and criminal purposes but it is not itself a fraud.  This is parallel to those arguments against gun control which say that guns don’t kill people, people do. This is another obviously stupid argument.

The Weakest Point of the Argument

I will close by criticising a remarkable paragraph which packs in a lot of errors and bad arguments.

“Dimon declares that we will use the technology – blockchain technology – but that bitcoin will be shut down. That’s like saying we will use football pitches, but football players will be banned. One comes with the other. In any case, you can’t just shut bitcoin down. It’s a decentralised, distributed network. That’s the whole point of its design. There is no central point of failure.”

Frisby
Photo by Worldspectrum on Pexels.com

Objections to the Football Analogy

This is very strange.  Take the football analogy first.  There are two major problems with it.  As a parallel, it may or may not work.  Assume it works.  Let’s be generous. 

There are alternative uses for football pitches.  Other sports exists. They became holding centres post-Katrina.  Other uses are possible.  We could land helicopters on them.  So even if Bitcoin ls like playing football and the blockchain is like a football pitch, we can do other things with football pitches and we could do other things with the blockchain.  Strikingly in fact, this is where much of the excitement exists.  There are many potential extremely useful applications of a distributed ledger technology such as property registers and shareholder transaction records.  These would be interesting because they would be highly transparent and resistant to corruption and bureaucratic sloth.

Bitcoin Has No Future: You Can Have a Blockchain Without Bitcoin

The claim that you can’t have a blockchain without bitcoin is false. You do need to pay the miners. But you could pay them dollars. Moreover, that argument needs the blockchain to be useful. That is possible but the jury is still out. So that argument does not work against the claim that Bitcoin has no future.

The second argument in here is equally poor.  It claims Bitcoin is impossible to shut down because it is decentralised.  What this means is that you cannot shut down the servers behind Bitcoin because they are decentralised.  But that isn’t what Dimon says.  He says that “There will be no currency that gets around government controls.” What if governments made Bitcoin possession and use illegal and banned its use in any transactions?  They could do that and then what Dimon has pointed out is true. But no-one has to go around shutting down distributed servers.

Conclusions

I conclude that the author has done nothing to show that Dimon is wrong. So we can be clear that Bitcoin has no future.

See also:

The #Bitcoin Bubble Is Caused By The Halo Effect

The Forthcoming #Bitcoin Crash Will Kill The #Trump Demographic

The #Anecdotal Fallacy And The #Bitcoin Bubble

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

Categories
the psychology of successful trading

Hindsight Bias In Financial Markets

Introduction

Recently, Lloyd Blankfein of Goldman highlighted an important feature of psychology that has impacts on financial markets: Hindsight Bias.

Photo by Suneo1999 on Pexels.com

He is discussing whether we are in a bubble comparable to Tulip Mania.  The key point he makes for our purposes today is:

“But, of course, you never really know until you know,” he said. “When something happens, 80 percent of the world will remember knowing it … in hindsight.”

https://www.cnbc.com/2017/09/06/lloyd-blankfein-sees-something-that-unnerves-him.html

What is Hindsight Bias?

In psychology, this is Hindsight Bias.  People falsely believe that they predicted events that have now occurred.  I suspect that this is due to another sort of idea much discussed in philosophy.  The common idea of time uses a ‘moving block’ theory. While the future is still open and fluid, the past is fixed. 

The fixed block moves forward as time does.  So, since the past is now fixed, it begins to look like everything that happened had to happen.  And since it was inevitable, we must have predicted it, right?

Wrong.  The canonical experiment on this asks people to assess the probability of events from a story of a war between two countries.  The build up is described and people are asked to assess the probability of war breaking out.  The story is in fact an actual description of the period leading up to a conflict between two Asian powers.  It really happened.

Some months later, people decide that since it did in fact happen, they must have predicted it. It was inevitable, so how could they have missed it?  They claim now that they gave a much higher estimate of probability than they actually did.

How Will Hindsight Bias Affect Your Trading?

What does this mean in financial markets?  A great deal.  Think about what you are

likely to do now if you suffer from this bias, as everyone does.  You will overestimate the probability that you gave to past events. Then, you will over-estimate the probability of your future forecasts being right.  This will make you over-confident at the wrong times and will kill your market performance.

See Also:

The Illusory Truth Effect And Financial Markets

Categories
the psychology of successful trading

UK Deficit Had Been Handled by 2015

Introduction

In 2015, controversy existed over whether the UK deficit had been handled by 2015. This matters now because the situation post-COVID will get much worse again. It shows that it was possible to handle the deficit after the global financial crisis of 2008. After COVID has been managed, we can do it again.

Background

The Conservative claim was that the UK deficit had “halved.” The objection was based on the observation that £91bn is not half of £153bn:

http://www.theguardian.com/politics/2015/jan/02/david-cameron-launch-election-campaign-deficit-claim-conservatives

As the Conservatives correctly argued, the most natural way of considering the deficit is a proportion of the size of the economy.  On this measure, they said it has indeed halved.  I will offer a couple of brief arguments as to why the Conservatives were right to say this.  They could have gone further and argued that the problem was over.  (They may have chosen not to do this because they considered it would be valuable in the election as a way of harming other more spendthrift parties.)

1).  The deficit as a proportion of GDP is the way the bond markets look at deficits.  This is the correct perspective to take, because it is the bond markets who are funding the deficit.  They look at debt to GDP (%) and the deficit is the rate of change of debt to GDP (also %).

2).  Relatedly, looking at the absolute number makes no sense.  If I ask you whether a £5,000 overdraft is a problem, you will ask me what the person who has the overdraft makes in a year. With no income, it’s a big problem.  If they make £80,000 a year, it is no problem at all.

Now I will look at what they could have said.

Budget Deficits

Now I will look at what they could have said.

Photo by Karolina Grabowska on Pexels.com

The UK budget balance as a % of GDP was -4.5% of GDP.  (All of my numbers are going to come from the table on p. 96 of the 13 December 2014 issue of The Economist.  They caveat their number as being either from “The Economist poll or an Economist Intelligence Unit estimate/forecast.”  We do not need to worry about this as the number is about right. They were just allowing for the fact that they are making an estimate for the whole of 2014 slightly before it ends.

We now need to know the trajectory.  The first benchmark is the Maastricht criterion.  Although the UK was not looking to join the Euro, that is a relevant benchmark of UK peers.  It requires the deficit to be 3% or less of GDP.  (Again, note that we state the criterion as a % of GDP because that is the only sensible way to look at it. It’s on that basis that we can conclude that the UK Deficit Had Been Handled by 2015)

I saw estimates before the 2010 election that the previous administration was looking to borrow 15% of GDP p.a.  That was terrifying, not least because 1.15^5 = 2.01 i.e. 15% a year doubles debt to GDP in a single parliament.  That is a doubling of the national debt before you get another chance to intervene. That’s a reason for COVID caution.

GDP Percentages Show that UK Deficit Had Been Handled by 2015

Now, perhaps that 15% estimate was political.  More neutrally, all sides agreed that the deficit had reduced from around 10%.  Let us take that number.  Now consider this: you can run a deficit at the same level as your nominal GDP growth without changing your debt to GDP number.  Since that is what bond markets care about, it should be what you care about as well.  GDP growth for 2014 is 3.0%.  So imagine we want to get from 10% to 3%, then the distance we want to travel is 7.0%.  We have actually moved from 10% to 4.5% i.e. a distance of 5.5%.  5.5% divided by 7.0% = 79% i.e. we really only have another 20% of the distance to go.

Why You Can’t Borrow for any Purpose

Now I was the first to think we should continue to bear down on the deficit. In particular it is a really bad idea to fund OpEx with debt rather that Capex. This means you can borrow to fund actual investments in actual pieces of infrastructure which pay you actual GDP benefits but you cannot sensibly borrow to keep the lights on or to pay benefits. That won’t work. However, a lot of the work was complete.  I would at that stage like to have seen the deficit number reduce only slightly but shift spending into sectors which will produce a GDP return.

Two ideas: the Germans lend EUR16bn a year to their famed SME sector.  The Israelis generated a globally successful tech start-up  industry by `pouring money into elite universities and creating a clever system to attract venture capital’ (The Economist again, p. 76). So you can spend wisely. It just doesn’t happen very often.

Conclusion: UK Deficit Had Been Handled by 2015

The UK Deficit Had Been Handled by 2015 but it is going to be a problem again after 2020.

See Also:

Scotland Has no Feasible Currency Options on Independence