Understandingbasic psychology is one of the most important but alsomost neglected 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 also about successfully predicting what other market players will do.And that is a psychological task.
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 to get insights into how they analyse 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.
Alternatively, there are some actual psychologists who write on the topic and are experts in the field of psychology.But be careful about their specialisms.Someone who is a clinical psychologist may be an expertin schizophrenia but not necessarily other aspects of human psychology. And of course the main thing is that these expertsdo not have any serious trading experience, so they also can’t help you improve your trading psychology.
To identify the right sort of person, you need to ask two questions: does this person have significant trading experience and are they qualified in a related field?I am one of these people.
To try 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 —mental shortcuts that are often useful when we want a quick and dirty answer and often very unhelpful when we are trying to get something right.One example is Confirmation Bias, where people look only for evidence that supports what they already believe.There have been manyrobust psychology experiments published,that show time and time again that we do this often and consistently.
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 and 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.
There are two major investment styles which take completely different approaches.They are value investing and momentum investing.The former, also known as contrarianism, seeks to find cheap assets to buy.It is called contrarianism because often it involves looking for assets which are cheap because no one likes them.Momentum investing is simpler.This simply observes that often, assets that have been performing well continue to do so.So investors adopting this style just look for assets which have gone up and hope that they will continue to do so.
I favour value investing.One reason for this is because the problem with momentum investing is that assets which have done well continue to so until they don’t.There is no way to tell when something which has gone up will stop doing so.And we definitely know that nothing will appreciate forever!
The difficulty with value investing is knowing when an asset is cheap.In the early days of investing, the concept of book value was very useful.This is simply the accounting value.If a company owns a factory and some machinery, the book value will be close to the value for which the factory and the machines could be sold. If you can buy a share, or a slice of the company, for less than the book value per share, you should.
Book value is still very useful on many occasions.But modern companies are very complicated, and often much of what they do cannot be valued simply.A lot of their worth might be tied up in software, for example, which is harder to value than a building.Or they might own a lot of IPR — intellectual property which again, is intangible and hard to value.But the effort is worth it.Finding a cheap company to buy is one of the best ways to trade successfully.
I have written a lot about the importance of psychological factors in investing.It is absolutely crucial that you understand these, for two reasons.Knowing about your own psychology will help you understand and improve your decision-making processes. It will be especially valuable to know when cognitive biases are likely to cause you to make errors in evaluating investments.But just as important is knowing how other investors will think — after all, they have the same psychology as you do!And knowing what other investors are likely to think of an asset is the key.Because you want to find an asset which is not just cheap — but unjustifiably so.Then you can expect it to go up sustainably.
I consider the question as to whether The City will suffer a severe impact from the loss of passporting and conclude that it will
Jacob Rees Mogg made the claim below this morning on the Today programme:
“Passporting is mainly retail and UK financial services mainly wholesale.”
This was aimed at supporting the further claim that loss of passporting will not be much of a problem. Passporting is the regulatory feature whereby financial institutions located in any EU member state can offer financial services in any EU member state.
The first thing we need is clarity on the distinction between retail and wholesale banking. This maps approximately on to what we might call “high street banking” and “investment banking.”
The former are retail banks such as for example RBS or HSBC. Their primary lines of business involve dealing with retail customers — i.e. individuals — and their financial needs. They will offer deposit acceptance, interest bearing accounts (often in pre-crisis times with non-zero amounts of interest!) and mortgages.
Investment banks such as Goldman Sachs or will mostly deal with HNWIs and corporate clients. HNWIs are merely very rich individuals, who require additional services such as estate planning and access to hedge funds. Corporate clients will want funding usually. This is provided by investment banks often by issuing bonds for them on the global financial markets. (There are also some banks like Citi who are both retail and investment banks.)
So now we see that the Rees Mogg position is approximately that the passport enables banking across the EU to individuals whereas the City specialises in corporate clients. Rees Mogg is definitely correct that the passport enables retail banking. Basically, the passport means that a banking licence in any EU member state is a banking licence in all EU member states. With that in hand, one can be regulated by the ECB, open a branch anywhere in the EU and start accepting deposits and making loans.
So the key contestable element of the claim becomes the one that one does not need to be an EU bank to conduct business with corporate clients in the EU. One point to bear in mind is that many if not all investment banks which operate in The City will also be banks in Frankfurt. So they will be fine; but of course London could easily lose a lot of high paying jobs and tax revenue.
But to look in more detail, I turn to a report entitled “THE IMPACT OF THE UK’S EXIT FROM THE EU ON THE UK-BASED FINANCIAL SERVICES SECTOR” from Oliver Wyman, commissioned by lobby group TheCityUK. This report considers four aspects of the wholesale financial ecosystem:
Sales and Trading
Sales means buying financial assets such as stocks in bulk for major investors; trading is attempting to make a profit by e.g. predicting future directions of market assets
Wyman suggest that economies of scale mean that:
“banks could move other activities that are not directly restricted into the EU and away from the UK”
This means “clearing.” When there are large volumes of trading — and there is well over £2tn (yes, trillion) of daily foreign exchange trading done in London — there are lots of trades that must be cleared. This means basically moving cash from the bank that bought something to the bank that sold it and changing the documentation accordingly. (Incidentally, this sort of thing is why the blockchain is so interesting. That however, is not a reason to buy Bitcoin: https://timlshort.com/2017/09/16/bad-arguments-for-the-permanence-of-bitcoin/)
Wyman suggest that fragmentation of clearing across jurisdictions will increase costs, and
Due to these inefficiencies, some firms could move their clearing out of the UK
This is managing large investment portfolios for corporate and financial clients such as large EU insurance companies
Wyman note that inefficiencies will arise if sales/trading desks migrate to Frankfurt etc, and so benefits of managing portfolios from the UK could be eroded thus:
leading some companies to manage a greater portion of their assets from within the EU
Corporate and Specialty Insurance
This is the Lloyds market, specialising in writing large bespoke insurance contracts for major corporate clients
Here Wyman suggest:
A loss of depth in the marketplace due to the loss of EU-related activity might lead some insurance firms to relocate outside of the UK
Taking all of this into account, Wyman conclude that no passporting means:
up to 50% of EU-related activity (£20BN in revenue) and an estimated 35,000 jobs could be at risk, along with £5BN of tax revenues per annum
I therefore conclude that some elements of the Rees Mogg claim are true. It is indeed the case that passporting is on the face of it more of a retail matter than a corporate one. But corporate clients are still EU clients in a number of important lines of business. And losing access to those clients from London desks will cause significant impairment to the UK economy.
Wyman confirm this when they estimate the effects of retaining passporting (or some equivalent regulatory arrangement). They say that in this scenario:
revenues are predicted to decline by up to £2BN (2% of total wholesale and international business), 4,000 jobs would be at risk, and tax revenues would fall by less than £0.5BN per annum
This is still bad — there are no positives to Brexit — but less severe. Nevertheless, our overall conclusion must be that loss of passporting is very bad news.
There are correlations between taste preferences and personality (disorders) which are also highly present on the trading floor — so check your tastes to see if you are already likely to be a winner!
Evidence has been reported that there are correlations between liking certain bitter tastes and certain personality factors. Personality as generally understood does not really exist; the belief to the contrary is known as the Fundamental Attribution Error. However, there are some stabilities in character which are or approach being diagnosable as “personality disorders.” These though are very much in the eye of the beholder in terms of whether or not they impair effectiveness. It turns out that these same personality stabilities are highly prevalent in competitive professions, so these people must be doing something right.
Researchers from the University of Innsbruck reported as follows:
Individual differences in bitter taste preferences are associated with antisocial personality traits
Bitter tastes are basically self-explanatory. Marmite and gin and tonic are two obvious examples, but tea or coffee without sugar could be others. One might also start looking at wine types.
The authors found robust correlations between preferences for such bitter tastes and the Dark Tetrad, which is the Dark Triad plus everyday sadism. The Dark Triad is one of the stable factors in personality. It consists of Machiavellianism, psychoticism/psychopathy, and narcissism, at levels below threshold for diagnosis as a personality disorder.
Machiavellianism could also be termed manipulativeness. It reflects how likely someone is to be devious or to manipulate others for their own benefit. Psychosis means susceptibility to delusions. Some false beliefs — especially false positive beliefs about the self — are correlated with individual success.
Some authors in the literature include psychopathic tendencies instead of psychosis. These tendencies come from a wide potential array of behaviours. Some or all of the following may be present:
manipulation of others
lack of remorse and/or guilt
lack of empathy
failure to accept responsibility
lack of realistic life goals
poor behavioral controls
early childhood behaviour problems
Obviously some of these are very unhelpful. But we can imagine that others could be extremely useful.
Narcissism is an extreme level of self-absorption and self-belief. This looks as though it will be really quite useful in terms of allowing people to fail repeatedly with no adverse ego consequences.
We know that the Dark Triad –and presumably also the Dark Tetrad, since that is very similar — are heavily over-represented in certain professions. That is: investment banking, journalism and politics. All of these professions are extremely competitive and perhaps also require a certain amount of ability to exploit others. This can therefore explain why the Dark Triad would often be seen on the trading floor as well.
Of course, this shows correlation rather than causation. However, since we have a plausible explanation as well as a correlation — it seems likely that being a Dark Triad person will be valuable when trading. And now, since we have observed correlations* with bitter taste preferences, there is an easy way to check!
Getting your trading psychology right and understanding that of others are both essential prerequisites to successful trading in financial markets. I discuss the most important elements of trading psychology in my new book.
Buy the book here:
Thanks to Karine Sawan and film crew for video production.
One of the causes of the Bitcoin bubble is a cognitive bias known as the Halo Effect. I will explain how this works and how it is going to prove very expensive for holders of Bitcoin
The Halo Effect occurs when people judge the overall quality of an item or person by considering only a single property of that item. This can lead to dramatic errors; most obviously when all of the other qualities of the item are negative or highly questionable. This I will argue here is one causal factor among several which have caused novice investors to buy Bitcoin. When it crashes, they will lose all of their money. They will be unable to exit the market because the power of the cognitive bias is too strong.
In this post, I will briefly set out the cognitive biases which are in play here before describing the Halo Effect and how it is another feature of human psychology which leads people to mistakenly buy Bitcoin.
The Halo Effect is not the only causal factor operative among the novice investors who are buying Bitcoin. I have already argued:
We can see that as a two variants of the Dunning Kruger effect. Here, people who lack competence are unable to detect such lack of competence. This makes intuitive sense since people who lack competence and are aware of it would presumably either take steps to address that lack or avoid activity requiring the relevant competence.
A corollary of that is seen in another variant of the Dunning Kruger effect: people are unable to detect true expertise. We can see this when:
— someone is able to publish a book on Bitcoin when it is quite apparent that they do not have even a basic understanding of it. For readers of this book, it must be impossible to recognise and benefit from well sourced, properly constructed arguments, for example in the mainstream media.
I turn now to the Halo Effect. This was first seen in data about personality assessment in the military. It was found that officers asked to rate their subordinates would in fact rely on a single criterion, and then assume that all other relevant factors were correlated with that one criterion. This is obviously dramatically false unless all of the other variables are correlated with the one assessed. And that is highly unlikely to be true.
Many people are unable to distinguish Bitcoin from the blockchain. This leads many of the novice investors who are buying Bitcoin to fail to distinguish between the two claims “I am buying Bitcoin” and “I am investing in blockchain technology.”
The blockchain is a distributed ledger system which offers transparent recording of transactions (or any data) without the backing of any central authority. It is an extremely interesting technology which holds great promise. It could, for example, be used to create corruption-resistant property ledgers. That would be of great benefit, not least in combatting money laundering.
Bitcoin is termed a “cryptocurrency” even though it does not fulfil the roles of a currency in that it is not readily convertible and it is not a stable store of value. It is used to reward the miners who maintain the blockchain on a widely dispersed set of servers. However, it is clear that the blockchain and Bitcoin are not identical.
An objection has been attempted here by a Bitcoin proponent that it is not possible to have a blockchain without a cryptocurrency. There are a number of readings of that, but on the obvious two, the claim is either false, or true but misleading. If the claim is read as “you cannot run blockchain code without also generating a cryptocurrency” then it is false. There is no reason why the blockchain code could not be run with the cryptocurrency elements redacted.
If the claim is read as “it is necessary to compensate the miners, ” then it is true. However, the miners could be paid in $. Or the blockchain could run in the cloud, or in many clouds. That would carry some costs, but this is not a problem. It would even be possible to compensate the miners in a cryptocurrency which was pegged against the $. There is no need for the cryptocurrency to appreciate and definitely not to gyrate wildly. I therefore conclude that the objection fails.
There is one positive property that Bitcoin possesses. It is true that it is generated using the blockchain technology. It is also true that the blockchain technology is extremely interesting, and being pursued widely by a number of serious players. By contrast, no professional, experienced or institutional investor is holding Bitcoin. Novice investors fall prey to the Halo Effect when they think that the one positive quality of Bitcoin is a measure of its overall quality, when in fact it has no other redeeming features at all. This will prove to be a very expensive cognitive bias when the Bitcoin crash comes.
One common feature shared by both groups is distrust of experts
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 when Bitcoin crashes, Trump voters will experience most of the losses. In this post, I will consider only the distrust of experts feature.
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:
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 and Galaxy Investments
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
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.
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:
— but that isn’t one of them.
Bill Gates and the future
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 Gates thinks the blockchain is the (part of) the future and is not holding any sizeable numbers of Bitcoin. 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.
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. I discussed here:
— some really bad arguments. What is remarkable here though is not the quality of the arguments — they are all very poor — but that this is someone who has somehow managed to publish a book on Bitcoin while clearly not understanding it at all.
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.