#Brexit Is A Disaster, But @DavidDavisMP Is Right About The 57 Documents

Attacking SecState DEXEU by using an easily foiled challenge does not aid the cause of those seeking soft or no Brexit. I will outline why the HMG position on the 57 documents is coherent and plausible, contrary to widespread opinion

Everyone seems to be struggling with the government’s stated position on these documents, claiming that there have been obvious inconsistencies.  I will argue that on this sole point, there have been no inconsistencies and in fact, the position of HMG is economically correct.

By “everyone,” I mean the Financial Times and noted QCs as well as the entire Twitter commentariat.  So that really is everyone.

The general position seems to be something approximating to the following. “Davis said HMG had done a lot of work (“57 documents”) on the economic impact of Brexit but then when he was asked to provide it, changed his position to the diametrically opposed one of “there are no documents.” ”  If he had said that, he would clearly be inconsistent and incompetent.  But, he did not say that.

The key to this is understanding the formal definition of an Impact Assessment.  According to Davis (and which I accept):

An Impact Assessment must include a “quantitative forecast of economic outcome”

This means that for an Impact Assessment to have been produced, a team of economists and sector experts has produced a complicated spreadsheet modelling cashflows.  Efforts have been made to see what the effect of tariffs on a particular sector would be.  Finally, and critically, assumptions have been made as to exactly what percentage of trade will be lost, to what extent this will be offset by other factors, and what the levels of various key parameters will be, such as GDP growth in the UK and the EU, CPI in various locations, and the level of employment and the flexibility of workers.  If a document does not have such a “quantitative forecast of economic outcome,” it is not an Impact Assessment.

Davis admits that no Impact Assessments have been made.  There has been, though, a great deal of assessment of the economic impact of Brexit.  These are the 57 documents.  Note also that these documents can have detailed numerical underpinning but still not meet the formal definition of being an Impact Assessment.  Just because something considers the impact of Brexit economically does not make it an Impact Assessment.  We see this when Davis says that the fact that a document contains the word impact is not sufficient to make it an Impact Assessment.

Should HMG do Impact Assessments?  No.  They are, again as Davis says, of limited value.  This is because we have little idea of what CPI or GDP are next year, and we have absolutely no idea over the 30 year horizon of relevance here.   I discuss such difficulties of forecasting in a precise way in my new book (see for example pp. 79-80):

https://timlshort.com/the-psychology-of-successful-trading-behavioural-strategies-for-profitability/

So, it is now clear that there is no inconsistency in the position taken by SecState DEXEU and it is in fact economically appropriate.

 

The Picture Superiority Effect And Financial Markets

The Picture Superiority Effect is one of a large number of cognitive biases that affect how we think and act. It is important to know about these biases in the context of financial markets because they can impair our decision making but also inform traders on how other market participants may react

As in previous posts featuring on this blog  ( https://timlshort.com) I will first outline a cognitive bias drawing from the relevant psychological literature and then describe how that plays out in financial markets.  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 and assessing whether they have resulted in an optimal decision, with specific relevance here to trading decisions.  Secondly, since no-one is free of these biases, traders can expect that other market players will be influenced by them and trade accordingly.

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.  In my view, the effect is likely to be explained by our preference for the vivid and concrete over the dull and abstract; 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 particular in the age of social media, as pictures are shared more widely on social media than text (and so we might surmise that there is also a Video Superiority Effect which is even stronger).

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.

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.  The example is the photos and video with which we are all familiar of people who had been fired from Lehman Bros. after it collapsed in the crisis.  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 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.

It is probably wise to set aside the limited information value represented by imagery and focus on the data — which may of course be presented graphically without being just a photo.  If you want to discuss these and other concepts mentioned in the book, or for more information about the book, you can Send Mail

Negativity Bias And Financial Markets

Negativity Bias is one of the powerful and ineradicable aspects of human psychology, which has important effects on the performance of stock market investors

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 is reflected in the finding 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 that operate in people who are depressed or anxious, such that they 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 can be seen as 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.

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.

This was measured by experimental social psychologists in financial terms using sums of money.  It was 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.  In other other words, losing something is much, much worse than gaining the same amount.

The Negativity Bias then will have huge impacts on our risk aversion, and that, it is well known, 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.

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 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.

I discuss in much more detail the important effects in financial markets of Cognitive Biases like Negativity Bias in my new book:

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

If you want to discuss these and other concepts mentioned in the book, or for more information about the book, you can Send Mail

 

 

 

Attentional Biases And Financial Markets

Attentional Biases are operative in everyone’s psychology; they can affect performance in financial markets because they control what information sources we consider

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

One of the most important Cognitive Biases is known as 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 can be expected to have 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.

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 market participants to be depressed when trading.

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 time it took for subjects to press the button was recorded.  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 what is known in psychology as an RT spike — or 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, day-trading is best avoided as 85% of day traders lose money.  (Day-trading is popular among people new to investing.  It is called that because 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.  What effects of Attentional Bias should such individuals be aware of?

If one is episodically depressed or anxious, then these are not times to be trading.  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; what is clear is that such a decision should be made 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 someone is permanently depressed or anxious, then treatment should be sought and one should abstain from trading until an improvement is seen.  If no such improvement can be achieved, 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.

I discuss in much more detail the important effects in financial markets of Cognitive Biases like Attentional Bias in my new book:

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

Email me at shorttim1@gmail.com:

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Opposition to Gun Control is not “Superstition” 

There have been suggestions recently that some voters are immune to evidence and argument. They rely instead on gut feelings and instinct. These individuals are described as being “intuitionists” or “superstitious.”  I will suggest that while this is the correct direction of travel, that we can in fact be more precise and locate the issue as a consequence of cognitive bias known as Status Quo Bias.

The Onion puts the strangeness of the gun control debate best with its satirical headline: “No Way to Prevent This, Says Only Country Where This Regularly Happens.” To rational observers, it seems obvious that if you have 310m guns in a country and 93 people a day are killed by them, you should reduce the second number by reducing the first. Almost every other country in the world does this and it works. Yet a majority of Republicans and even 25% of Democrats disagree. This is ignoring data on a massive and deadly scale.

I think this is not best explained by appealing to superstition as The Economist did recently. Superstitious beliefs, to be sure, are not based on data and do not often result in true claims. If they do, it is a coincidence: superstition is not a reliable method of arriving at true claims. There is no such thing as bad luck and walking under a ladder wil not bring it. Opponents of gun control do not believe that firearms are lucky charms.

The appeal to intuition, by contrast, can I think throw light on the topic if precisified in the right way. I would understand intuition as being a collection of cognitive biases. These operate to slant and indeed direct our decision making, largely unbeknownst to us.

The Bias I have in mind here is called Status Quo Bias. For my U.K. readers, I should immediately clarify that this has nothing to do with Francis Rossi. The Bias is also known as the familiarity effect. I will introduce it by asking you to make a quick choice.

Would you prefer to meet a friend for lunch somewhere you have been before or would you rather go to see a stranger to pursue a novel activity in an unknown location?  Most people most of the time would choose the first option.

As with all Biases, this one has its origins in being valuable. Most of the time, it will produce the right result. This is because of a very approximate risk assessment heuristic. We assume that things we have done before which have not harmed us visibly are safe activities. This is wrong but better than nothing. It is in fact I believe an outgrowth of another Bias called the Availabilty Heuristic, but I will set that aside for now.

Status Quo Bias though can be rephrased as the idea that any change is more risky. This can produce conclusions which are as uncongenial to the left as to the right. It is not true, for example, that because countries have borrowed heavily in the past, they can continue to to do indefinitely. As to the topic at hand, for the “intuitionists,” changing to a scenario of tighter gun control is risky because it is new, rather than safer because all of the countries that do it are safer.

If you are wondering what this means practically, I suppose that depends on whether Cognitive Biases are hardwired in to us. That’s unclear, but I think it is at least a start for me to list the mental subroutines we are running. If they are hardwired, then they will be impervious to data, which would explain why the debate is sterile: proponents of gun control continue to say “if we changed this fewer people would die because that is what happens when you have gun control” and opponents would continue not to listen.  If they are not hardwired, then telling people they have these biases might be a start in the direction of changing them.

My new book focusses on these biases and their effects in financial markets:

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

I recommend it if you want to be aware of the subconscious processes which guide your behaviour in markets and elsewhere and if you want to become less dependent on your own autopilot which will not be optimising your outcomes.

Narcissism and Unexpected Behaviour – Tim Short – Medium

There are claims that Narcissism explains unexpected behaviour like electing Trump. This cannot be formally and exactly true, but there are ways to construe the claim so that it makes sense

https://medium.com/@timlshort/narcissism-and-unexpected-behaviour-f083862a3317

In Financial Markets, Relying on the “Wisdom of Crowds” Can Be Very Risky

We all tend to do what everyone else does. This saves time and effort on many occasions, but it can cost you a lot of money in financial markets

 

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 (see link below).

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, but in reality they were actors who were going to behave in a specific way suggested by Asch.

A line of a certain length was drawn on the left side blackboard.  Some other reference lines of different lengths were drawn on the right hand side.  One of them was clearly the same length as the reference line and 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 even though the answer was obviously and clearly wrong.  Amazingly, Asch found that most people gave an obviously wrong answer some of the time and also that 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 where the answers are much less clear cut and much ambiguous and conflicting data must be weighed.

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.

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

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