Archives of “Decision theory” tag

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Objectivity in Trading -Anirudh Sethi

  
Analysis, Education
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Image result for Objectivity in tradingTrading is a very interesting field, and also a highly challenging one. Being faced with changing prices, other traders’ actions, and your expectation and hope of making the right decision, is certainly not an ideal situation to make objective choices. Many a time traders feel the stress and tension of it all to be too heavy on their minds, and as a result, their judgement is clouded. They either act too rashly, or are way too slow and cautious.

So we can all agree that for a trader to be objective is definitely no easy feat. However, an objective mindset is indispensable for a successful trader. The market is going to be offering the trader all kinds of information and data, as well as suggestions and comments being made by fellow traders. A trader needs to learn how to be objective as well as have the flexibility to use that information so as to act upon it objectively. This is however easier said than done.

In reality most traders enter the market with many notions and mindsets, as well as certain biases. The goal is to try to make the best possible trading decision, but due to these aspects it is not always the case. All human beings have an innate tendency of trying to be quite certain about a decision they make, and so they sort of seek confirmation for their actions. However in trading you cannot always be fully certain of your choices, and in the vast majority of the cases you will not be. The best you can do is to acquire information so as to make well informed decisions and as a result minimize risk. Speculating in the financial markets is normal, but no matter how much you try to speculate, you can never be completely certain. (more…)

Mauboussin: Three Steps to Effective Decision Making (Video )

  
Education, Video
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Making an important decision is never easy, but making the right decision is even more challenging. Effective decision-making isn’t just about accumulating information and going with what seems to make the most sense. Sometimes, internal biases can impact the way we seek out and process information, polluting the conclusions we reach in the process. It’s critical to be conscious of those tendencies and to accumulate the sort of fact-based and unbiased inputs that will result in the highest likelihood that a decision actually leads to the desired outcome. In this video, Michael Mauboussin, Credit Suisse’s Head of Financial Strategies, lays out three steps that can help focus a decision-maker’s thinking.

Make the Right Choice: Three Steps to Effective Decision Making 

5 fundamental truths For Traders

  
Analysis, Education
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Five fundamental truthsTo eliminate the emotional risk of trading, you have to neutralize your expectations about what the market will or will not do at any given moment or in any given situation. You can do this by being willing to think from the markets perspective. Remember, the market is always communicating in probabilities. At the collective level, your edge may look perfect in every respect; but at the individual level, every trader who has the potential to act as a force on price movement can negate the positive outcome of that edge. To think in probabilities, you have to create a mental framework or mind-set that is consistent with the underlying principles of a probabilistic environment. A probabilistic mind-set pertaining to trading consists of five fundamental truths.

Five fundamental truths

  1. Anything can happen.
  2. You don’t need to know what is going to happen next in order to make money.
  3. There is a random distribution between wins and losses for any given set of variables that define an edge.
  4. An edge is nothing more than an indication of a higher probability of one thing happening over another.
  5. Every moment in the market is unique.

Risk intelligence – How to live with uncertainty -One of Best Book on Behavioural finance.

  
  Education
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Risk Intelligence is a special kind of intelligence for dealing with risk and uncertainty. It doesn’t correlate with IQ, and most psychologists failed to spot it because it is found in such a disparate, rag-tag group of people – American weather-forecasters, professional gamblers, and hedge-fund managers, for example.
Dylan Evans PhD, and former senior lecturer in Behavioural Science in the School of Medicine at University of Cork, has written about his work in researching risk intelligence in ‘Risk Intelligence – How to Live with Uncertainty‘. Evans asserts that people in positions which require high risk intelligence – doctors, financial regulators and bankers, for instance – seem unable to navigate what Evans calls the “darkened room”, the domain of doubt and uncertainty.
Risk Intelligence is a traveller’s guide to the twilight zone of probabilities and speculation. Evans shows us how risk intelligence is vital to making good decisions, from dealing with climate change to combating terrorism. He argues that we can all learn a lot from expert gamblers, not just about money, but about how to make decisions in all aspects of our lives. 
I read it once, and re-read it a second time. It is in my opinion, the best, yet least known book, on behavioural finance. 

Succeeding At Trading By Not Trading

  
  Education
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One important performance variable that isn’t tracked often is the variability in a trader’s risk-taking. Opportunities are not distributed perfectly evenly over time: some markets offer more opportunity, some less. As a result, the skilled trader will vary risk-taking as a function of the opportunity set: sometimes trading actively and in size, other times pulling back from trading. What traders refer to as “overtrading” is the result of an inability to regulate decision-making by opportunity set: taking risk when rewards are quite uncertain.

“When are you mostly out of markets?” is a question I like to ask. The ability to not trade is itself a performance edge when it helps traders hang onto their gains during times of market uncertainty. This is yet another area where having a full and rich personal life becomes important to trading success. If all you have to sustain you psychologically is your trading, it is going to be difficult to not trade. If you have a full and rich life outside of trading, then it is much easier to take risk when rewards justify the effort—and put trading aside otherwise.

It’s great to have a passion for trading; better to have a passion for successful trading. And sometimes that means engaging in other passions and refraining from marginal trades.

HUMAN MISJUDGMENT- 22 Points

  
  Education
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1.  Under-recognition of the power of what psychologists call ‘reinforcement’ and economists call ‘incentives.’

2. Simple psychological denial.

3. Incentive-cause bias, both in one’s own mind and that of ones trusted advisor, where it creates what economists call ‘agency costs.’

4. This is a superpower in error-causing psychological tendency: bias from consistency and commitment tendency, including the tendency to avoid or promptly resolve cognitive dissonance. Includes the self-confirmation tendency of all conclusions, particularly expressed conclusions, and with a special persistence for conclusions that are hard-won.

5. Bias from Pavlovian association, misconstruing past correlation as a reliable basis for decision-making.

6. Bias from reciprocation tendency, including the tendency of one on a roll to act as other persons expect.

7.  Now this is a lollapalooza, and Henry Kaufman wisely talked about this: bias from over-influence by social proof — that is, the conclusions of others, particularly under conditions of natural uncertainty and stress. (more…)

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