A big part of trading is about making decisions with incomplete information in an ambiguous environment and then managing those decisions towards the best possible favorable outcome. I don't mean just trade entries, exits, money management or trailing stops etc. The above applies to all other aspects of trading like market selection, trading research, setups to explore or employ, retrospective analysis etc.
Given the prevalence of decision making in trading/investing and our great ability to sabotage our decision making with psychological biases, I think having few structured techniques in our toolbox for good decision making is highly useful.
The purpose of this post is to put forth the idea of utilizing structured decision making techniques available in other fields in trading and to present an overview of 5 simple and effective decision making techniques.
Showing posts with label Decision Making. Show all posts
Showing posts with label Decision Making. Show all posts
A fascinating presentation (10 minutes) on Mirror neurons by Neuroscientist V Ramachandran. Only recently discovered, these neurons allow us to learn complex social behaviors, some of which formed the foundations of human civilization as we know it.
Does it mean traders who work in banks and prop firms with opportunity to watch veteran traders has an advantage from psychological side over retail traders?
In daily life we are often exposed to one-sided information about various issues, disputes etc involving multiple parties. The same applies for trading. This study by Amos Tversky et.al is about how people jump to conclusions based on limited information even knowing well what the information they have represents only one-sided information.
It is generally considered as standard that roughly it takes 10000 hours to develop expertise in any field. May be it is. I have some doubts/questions on the usefulness of this 10000 hour rule though like:
- Do we learn by number of hours spent or is it by number of decisions we make and reflect?
- Given large part of trading is making quality decisions, between these two cases who would have likely developed better trading expertise - A trader who spends 10000 hours (learning, analyzing etc..) but made only 1000 trades (decisions) or a trader who spent 8000 hours but made 5000 trades (decisions)?
- If it is latter, i.e., number of decisions (made and reflected) is better criteria for trader expertise then shouldn't the rule be in terms of number of decisions (and not in hours)?
- Would the same apply for other performance activities like music/sports etc?
I don't have expertise in Psychology/learning field to figure good answers to above questions. Hence the dilemma. Please let me know your thoughts on above questions.
This post probably will be skipped by most in search of something more intellectually stimulating on understanding market behavior/our own minds. On other hand, a big part of trading involves developing new habits that enable us act in our own best interest.
So how do we develop a new habit? Following is a simple and powerful methodology for new habit development that I came across:
So how do we develop a new habit? Following is a simple and powerful methodology for new habit development that I came across:
- First, make a decision clearly that you are going to begin acting in a specific way and spell it out clearly.
- Second, till it becomes a habit (like first 3 weeks) don't make excuses or rationalizations. Don’t let yourself off the hook.
- Third, visualize yourself performing/acting this behavior. The more often you imagine yourself as if you already had the new habit, the more rapidly this new habit will be accepted by your subconscious mind and become automatic.
- Fourth, create an affirmation that you repeat over and over to yourself. This repetition dramatically increases the speed at which you develop the new habit.
- Fifth, resolve to persist in the new behavior until it is so automatic and easy that you actually feel uncomfortable when you do not do what you have decided to do.
- Sixth, give yourself a reward of some kind for practicing in the new behavior. Each time you reward yourself, you reaffirm and reinforce the behavior.
Motivation is what gets you started. Habit is what keeps you going. ~Jim Ryun
Ambiguity aversion is basically an aversion to uncertainty - like preference for security over uncertainty, known risk over unknown risk etc. It is one of the major causes of a trader's under-performance. We all have this aversion with the levels varying from person to person unless you are from Mars. If so, curious to hear your perspective as well.
The basic idea is when a trader is not comfortable with ambiguity, the trader tends to seek more data than necessary.
The basic idea is when a trader is not comfortable with ambiguity, the trader tends to seek more data than necessary.
A simple exercise to determine ambiguity aversion quotient in your trading:
- Count the number of inputs you considered in your back testing to initiate & manage a trade. Assumption: Reader has a method/plan that was back tested via automated, sim or live trading.
- Now count the number of inputs you considered in last 10-15 trades. Or all the inputs you would consider for your next trade.
- Now calculate the difference (i.e., subtract 2 from 1) and multiply by 5%. Result is the ambiguity aversion quotient in your trading.
Two questions to ponder:
- If the extra inputs you consider in live trading are really needed and improving the performance, then why is it not included in the trading plan?
- If those extra inputs are not improving the performance then why are you considering them and making your trading complicated?
Obviously I am not a psychology expert. So treat above as fun. Who knows the exercise might trigger some other insight that might also prove useful.
Note: If you are a not a trader then just use "decision making" as proxy for trading.
Trading is an art of uncertainty and science of probability.
A large part of trading is about making quality decisions with incomplete or ambiguous information and then managing it to favorable outcome. So as a trader, I felt it is useful to learn more about decision making. My current plan is to learn little bit each week, share via journal and seek comments and perspectives.
Outline
This week I will share different categories of decision making strategies at high level and go deeper into recognition primed decision making model.
Decision making categories:
I think on a large scale there are 4 main decision making categories
- Rational
- Intuitive
- Recognition primed
- Other
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