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the psychology of successful trading

Trading Psychology: Optimise Your Performance

Why is Trading Psychology Important?

Understanding trading psychology is one of the most important but also less often done tasks for investors.  Of course, everyone realises that they need to analyse the investments they are considering buying.  But many traders do not realise that winning in investment is mostly about successfully predicting what other market players will do.  Before they do it. And that is a psychological task.

https://timlshort.com/wp-content/uploads/2018/01/tradingpsychology.mp4

Most of the advice on the internet is not really psychology.  It is quasi-psychology.  You might get famous traders telling you things like “I always played tennis in the morning before my best trades to make sure I felt good.”  This is useless.  By all means, study what these guys do. You may get insights into how they look at opportunities and maybe any tricks they have for bouncing back from a loss.  But famous traders don’t have any specific training in psychology. So, if you are specifically wanting to improve your own trading psychology, adopting their tips (such as the tennis one above) won’t really help you in achieving that goal.

What you need to look at is the psychological literature. This is published in the academic journals. You also need to do that having spent a decade on the trading floor. Fortunately, you don’t need to do that yourself since I have done it for you. So all you need to do is read the book.

The other sort of person who cannot help you is someone merely described as a psychologist. That’s better than nothing. But they need to be the right sort of psychologist, as I will set out in the next section.

Is that the right sort of psychology?

There are some actual psychologists who write on the topic and are experts in the field.  But be careful about their specialisms.  Someone who is a clinical psychologist may be an expert in schizophrenia. They may however not necessarily know any other aspects of human psychology.  And of course these experts do not have any serious trading experience. So they definitely can’t help you improve your trading psychology. Unless you have schizophrenia. But in that case, you have more pressing issues to attend to than the performance of your portfolio.

There are also a lot of completely unqualified people who write on these topics. They don’t know any psychology and they don’t know anything about trading. These individuals are all over the internet. But you should not waste any of your time on them.

The right sort of psychology is actually called Theory of Mind. This is the label for the way we predict and explain the behaviour of others. This is exactly the area in which I specialise. You can check that out in my first book: https://www.amazon.co.uk/Simulation-Theory-psychological-philosophical-consideration-ebook/dp/B00S1DDMKI

To identify the right sort of person, you need to ask two questions. Does this person have significant trading experience? Are they qualified in a related field?  I am one of these people.

How To Optimise Your Psychology

To convince you of this, I will outline my ideas on how to optimise your trading psychology.  The first thing to know about is that we have a lot of cognitive biases. (Here’s a list on Wikipedia: there are hundreds! https://en.wikipedia.org/wiki/List_of_cognitive_biases )

These are mental shortcuts that are often useful when we want a quick and dirty answer. However, they are often very unhelpful when we are trying to get something right.  One example is Confirmation Bias. This is where people look only for evidence that supports what they already believe.  There have been many robust psychology experiments published, that show time and time again that we do this often.

This isn’t something which is optional. Cognitive biases are a fundamental part of our wiring. More intelligence does not make you immune to biases. At least if you know about them though you have a chance to counteract them.

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The first thing to note here is that if you use this bias when making your own trading decisions, you will make bad decisions.  Every time!  So you will definitely not be optimising your trading psychology.  But here’s the key point: everyone else in the markets will be doing it too.

So what does that mean?  It means you need to know about Confirmation Bias. You need to think about it in a market context.  Look out for it in yourself and be careful.  Expect it in other market players and trade accordingly.  

That’s how you stand the best chance of optimising your trading psychology. 

See Also: The Illusory Truth Effect And Financial Markets

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
psychology

US Defeat In Vietnam: Systematic Theory Of Mind Error

Introduction

Many theories have been proposed to explain the US Defeat in Vietnam. I will suggest a novel one. One cause was a Theory of Mind error made at the top levels of US political leadership.

It is clear that the US possessed much more in the way of conventional military assets in the conflict with North Vietnam than the opposing forces.  This point is widely accepted so I will not spend much time arguing for it.  For example, the US had tanks while the Viet Cong had no anti-tank weapons.*  US forces had “superb artillery and air support” (Sheehan, p. 447, 1988) which enabled any US troops facing locally superior odds to succeed.  

The entire US army fought with the doctrine of “superior firepower” (Sheehan, p. 243, 1988).  The financial resources that the US was able to apply also hugely outweighed those of its opponents in a largely peasant guerrilla army.  Sheehan (p. 624, 1988) writes that commodity aid to South Vietnam reached the staggering figure of $650m in 1966.

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This last point is decisive.  It has been wisely observed that:

“Most wars have been wars of attrition, settled by which side had more staying power through the ability to apply men and materiel.” **

The GDP of North Vietnam in 1965 was $6.0bn in 2015 dollars.  The GDP of the US in 1965 was $4.1tn in 2009 dollars. That is, 683x larger. This makes it very hard to understand the US defeat in Vietnam.

US Defeat in Vietnam: How Is This Possible Given the Resource Mismatch?

Consider the following highly insightful quotation.

“When McNamara wants to know what Ho Chi Minh is thinking, he interviews himself.” ***

Robert McNamara was the Secretary of Defense at the time, and so crucial to  managing the war effort.  It is clearly important to know what the enemy is thinking.  McNamara’s error was to do this in the way that most people do.  This is where we come to Theory of Mind.

Theory of Mind is the label in psychology for the way we predict and explain the behaviour of others.  We all do this all the time.  There is a vibrant debate in psychology as to how we do it.  The mainstream view is “Theory Theory.” This holds that children as young as five, who already have a serviceable Theory of Mind, have formed it by learning a theory of other people. Children do this in a scientific fashion. They propose hypotheses and then confirm or disconfirm them empirically. This is what psychologists think but I think it is implausible.

Simulation Theory

I support the opposing view, which is known as Simulation Theory.**** This suggests that we run our Theory of Mind by putting ourselves in the position of others and seeing what we would do.  This, according to the quotations, is exactly what McNamara did.  And it is why he was wrong and why the US lost.

We can see this same factor in action with another quote from a significant protagonist in Vietnam. Green Beret Colonel Kurtz who makes the following  observation on realising that the Viet Cong have removed the arms of all the children in a village who were vaccinated against Polio by US forces.

And then I realized… like I was shot… like I was shot with a diamond… a diamond bullet right through my forehead. And I thought, my God… the genius of that! The genius! The will to do that!

Col. Kurtz, Apocalypse Now

Theory of Mind Errors

The surprise of the Colonel is again an illustration of Theory of Mind error.  This goes to the heart of the US defeat in Vietnam.

If his simulation of the Viet Cong had been more accurate, he would have been able to predict their action here.  That he was not, and that he was able to see how effective, if inhuman, this strategy was, shows that he was perhaps able to adjust and improve his Theory of Mind more than McNamara was.

It also illustrates the type of Theory of Mind error we should expect.  McNamara was a company man. He had experience from his time running Ford in systems analysis and data handling.  So when he simulated Ho Chi Minh, he drew conclusions along the lines of “I am faced with overwhelming odds; all of the analysis says that overwhelming odds always win; I therefore cannot win. So I should give up.” But that is not what happened.

This forgets the “Blut und Boden” point hinted at by Kurtz.  It misses out the will to fight on one’s own soil irrespective of the prospects of success.  Also missed out is the will to enlist the entire male and female population in the war effort, with many women driving supplies down the Ho Chi Minh trail at night without lights under largely ineffective yet heavy US bombing.  It misses out what the French missed at Dien Bien Phu: the will to disassemble artillery pieces and carry them up jungled mountains by hand.

Institute for Defense Analyses Library
IDA Library

Alexandria, VA 22311 United States

 

You can also buy a copy at the link below if you want to know more about Theory of Mind. ****

Conclusions on US Defeat in Vietnam

We have now seen several types of relevant Theory of Mind error. We can conclude that this played an important role in the US Defeat in Vietnam.

References

* Sheehan, N. (1988)   A Bright Shining Lie: John Paul Vann and America in Vietnam.  Vintage Books

** “The other side has a vote”, The Economist, Oct 14 2017

***  This quotation is from James Willbanks, an army strategist.  It is written up in The Economist, “Buried Ordnance,” in the issue of Sep 14 2017.  The piece is a review of “The Vietnam War,” a TV documentary by Burns and Novick.

**** Short, T L 2015  Simulation Theory: a Psychological and Philosophical Consideration.  Abingdon: Routledge.  URL: https://www.routledge.com/Simulation-Theory-A-psychological-and-philosophical-consideration/Short/p/book/9781138294349

See Also:

#Proust: An Argument For #SimulationTheory

What Is “Theory Of Mind?”

Simulation Theory: A psychological and philosophical consideration

Cognitive Biases And How They Affect Stock Markets

The #Bitcoin Bubble Is Caused By The Halo Effect

Categories
Trading

Gun Control Opponents Are Wrong, But It Is Not “Superstition” 

Introduction

The gun control “debate” involves pro-gun advocates who have very bad arguments. 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 “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 is 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.

This is not superstition. The Economist called it that recently.

https://www.economist.com/united-states/2017/10/05/superstition-helps-explain-how-people-think-about-gun-laws

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.

Status Quo Bias

The Bias I have in mind here is Status Quo Bias. For my U.K. readers, I should immediately clarify that this has nothing to do with Francis Rossi. Another name is 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 related to another Bias called the Availability Heuristic, but I will set that aside for now.

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Status Quo Bias is 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.

Practical Implications for Gun Control

What this means practically 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 are impervious to data. That explains 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.

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.

See Also:

What Is “Theory Of Mind?”

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

The Illusory Truth Effect And Financial Markets

Do Human Rights Do Too Much?

51.496565-0.142472
Categories
Trading

Empathy Is Not All Good

Introduction

People love empathy. But it’s not always positive and is often dangerous.

I have recently seen an interview with a poker champion in which he claims that “empathy” is one of the strengths of his game.  I will suggest this is false for a couple of reasons.  Firstly, we don’t know what it is.  Secondly, what is more likely to be useful is the related but distinct concept of “Theory of Mind.”  I think there are many parallels between poker and financial markets, so my position amounts to an argument that you

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don’t want empathy to make your stock portfolio perform.

What is Empathy?

There are many things that empathy might be. I list several possibilities below. There are many more.

  • Feeling the same emotion as you
  • Being able to say what emotion it is that you are feeling
  • Feeling a similar emotion to you
  • Feeling a weakened form of the emotion that you feel
  • “Sympathising” with your situation
  • Imagining what I would feel in your situation

Certainly, this is already complicated enough, without asking difficult philosophical questions like “what does ‘same’ mean here?” or “what is the effect of similar?”  And we haven’t got on to the main point yet.

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In poker and in markets, what you want to be able to do is predict and explain the behaviour of others.  That is what is known in psychology as a Theory of Mind task.  I have argued in my first book that the way we do this is by simulating others.  We imagine that we are in the situation that the others are in and see how we would feel.  We then predict that they will behave the same way as we would given the resulting emotions.  Note that this does not fit neatly into any of the categories above.

Here’s some philosophical analysis asking what empathy is and criticising it:

https://onlinelibrary.wiley.com/doi/abs/10.1111/j.2041-6962.2011.00069.x

Why Empathy Is Not All Good

This then shows the first problem with claiming that empathy is good for performance.  However, this isn’t a useful piece of advice without defining what empathy actually is.  And secondly, think about what it would do if you felt people’s emotions.  Do you want a surgeon who is about to operate on you to be paralysed with fear because you are?  Do you want a pilot to experience the emotions of passengers as he wrestles with the controls in a storm?

So I think that when it comes down to it, what you want is actually a good Theory of Mind.  In fact, as I discuss in my book, there is experimental evidence that better traders have better Theory of Mind.  For that reason, I spend an early chapter explaining how we think Theory of Mind works.  It can be improved I think by taking account of cognitive biases and that will lead to better trading performance.  It will therefore improve your poker game too!

What Is “Theory Of Mind?”

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

#Narcissism and #Unexpected Behaviour

Can Individual Choices Produce Unacceptable Inequality?