Trading Are You Too Smart?

Tate on Trading - Are You Too Smart?

I've often thought that trading is the world’s most equal opportunity employer. This wonderful fact comes about because the market neither knows nor cares about you. Therefore by extension it doesn’t care about your age, race, religion, sex or education.
The fact that you may have an MBA from the Wharton School of Business or a PhD in computational finance is a complete irrelevancy to the market and, by extension, your chances of success. Whilst these academic endeavours are undoubtedly very rigorous, there is no way to convince the market of your academic prowess because the market doesn’t know you exist.

To date my view has merely been based upon my anecdotal observations of people as they embarked upon their trading careers. One observation that struck me quite early on was that there seemed to be no correlation between my perceptions of a person’s intelligence and their ability to trade. More often than not the brighter I perceived a person to be, the more they struggled with the trading process. This opinion has been enhanced by my observations of graduates of my Mentor Program.
I have witnessed some very bright people struggle with the mundane nature of trading. Their natural curiosity has driven them to tinker and generally fiddle with various trading systems. Undoubtedly they believe there is a better way. Curiosity and self-reflection are good traits to have as a trader and all trading systems need revision. However, eventually there is a need to settle and begin the production line process of trading, and it is with this settling down that I think people have trouble.

Peter Bossearts from the California Institute of Technology has offered a different and very interesting slant on this problem. In a series of studies he has found that trading success did not seem to correlate with mathematical ability which is often used as an indicator of intelligence. Rather, it seemed to require an ability to understand the intentions of others. This is sometimes called having empathy or theory of mind. It is the capacity to understand that others may have different intentions, beliefs and views to you. My reading of this is that such people have an innate ability to lock into the current predominant group think. As such they may be more natural trend followers as opposed to individuals who are resistant to group think and who will pursue an individual agenda - often to their detriment.
These traders would have what I would term a high illusion of control – successful traders have a low illusion of control. That is, they are willing to surrender to the trend rather than cling to a point of view that is opposite to what is actually occurring.
Such a point of view ties in with work done by Terrence Odean who looked at overconfidence as a predictor of trading performance. His work looked at differences in confidence between men and women and then reviewed this data as a function of returns from brokerage accounts. The overconfidence models said that men would be more confident (overconfident) in their ability than women and this would be reflected in differing investment returns. On a risk adjusted basis men traded 45% more but earned 1.4% less.

This is not to suggest that people who struggle with the trading process lack empathy or are dangerously overconfident but rather that they have an inability to conceive of the market as an aggregation of differing beliefs which oscillate from bullish to bearish. Hence they are always clashing with the predominant group because its world view does not tally with their own.
This is undoubtedly a disadvantage since trading is simply about having the ability to decide who is in charge, the bulls or the bears, and then following the appropriate strategy that reflects this understanding.

Whilst the reasons why traders struggle with the trading process are no doubt many and varied and cannot be ascribed to a single feature, it is essential that traders realise that they do not act in isolation.
What the group or herd think is more important than what the individual thinks.
- Chris Tate

 

Nice post Tropo!

Therefore, in the current environment, if I were to take that idea and elaborate it a bit: It doesn't matter if I know for a fact that the ASX is still fair value and that the China expansion is going to continue and even if the US goes into recession the fact that China is buying ore to build local infrastructure and not exports to the US means that the ASX and Shanghai exchanges will remain strong. What matters is what everyone else thinks. So, if fear is ruling the world on the back of the sub-prime fall-out in the US, it makes sense to "group-think" this fear and run for the hills with all the other bears. Let the markets have their tumble and then buy back in after the train wreck.

Mind you, I could have that completely wrong. Maybe everybody thinks the world is OK and there's only an educated few that think this sub-prime issue could have serious ramifications...

So, if I'm going to stay at the head of the hurd I need to know what everyone else is thinking, so, is the ASX still bullish or is it turning bearish?

Cheers,
Michael.

PS I think the answer to the question posed in that article is: Yes, I sometimes am too "smart" for my own good. Typical alpha male who thinks he can stay ahead of the markets because he "knows better". Pride before the fall perhaps...

 

This is my exact problem. I am intelligent as measured by tests and games (Mensa member) and very confident in my abilities as inculcated by my military training and background but I never was able to trade well. Buy and hold has served me way better cos it has simple rules.

I always thought I knew better than the average person doing the same thing. When in reality I needed to be average enough to know what they were doing or even of below average intelligence so I could have faith in a system and just act on the signals.

My intelligence is also the reason I struggle having faith in anything I cannot understand or see.

Good article. I had a feeling this was an issue but never took the time to articulate it.

 

Yay, another post on InvestEd! And only 45 minutes between posts!!

But I agree completely. That's why I think buy and hold accounting for the long term macro trends is a far better approach for my style than trying to become a day trader. I believe that understanding the macro environment will pay dividends long term as the "emotion" of the markets becomes irrelevant in the face of facts.

I think Warren Buffet was a bit of a value buyer, and I like to think that this is the way to go. I like looking for asset categories that are under-priced relative to other categories and leveraging long into that category. For now, I'm still bullish on the ASX and Shanghai indices. I think the Australian residential property market is still set to under-perform over the medium term but is improving in value daily. I think Brisbane and Melbourne will out-perform over the short term, with Sydney firming in a year or two. Affordability still limits that market's potential in the short term.

So, for now, I'll stay long ASX and look potentially to diversify and take a position on Asian equities. I'll continue plodding away with my Sydney multi-unit development on the Northern Beaches as I'm locked into that now and see solid profit margin's based on my gross realisation projections. If Sydney firms in a few years time then those margins will be even better.

Day trading or stock picking is not for me. Just which market, and how to take a leveraged long position. For the ASX I'm using a managed fund (you all know which one) and for residential property I'm just buying direct.

All good fun.

Cheers,
Michael.

 

Simon,
Your intelligence or military training has nothing to do with successful trading.
One of the things that sets successful traders apart from the losers is that they (successful traders) understand their motives for trading.

As Ch.T. said – ‘trading is simply about having the ability to decide who is in charge, the bulls or the bears, and then following the appropriate strategy that reflects this understanding’.
Some people have ability to play golf well, sing, dance and others to trade.


Michael,
It’s up to you to decide if market is still bullish or is turning bearish.
J.P. Morgan said once, when the local shoe-shine boys begin to talk about their share portfolios it is time to sell.

 

I've often pondered in the broader investment context...not just trading about two things:

1) can being smart actually be a disadvantage?
2) do you need to have experienced great adversity to really have the drive to take great risks to succeed in a big way? What I mean is there's lots of our richest Australians who've been penniless migrants or come from disadvantaged backgrounds.

Just some Friday philosophications

Cheers
N.

 

Nigel,

I tend to agree with this one. It seems adversity builds the drive and resilience to take the appropriate risks required to be truly financially free.

I consider myself to be quite risk tollerant so am gearing up now despite all the media doom and gloom. As someone said to me in a PM recently: "Well done Michael, you seem to be playing the game to win, not playing it not to lose". That actually started me thinking and I tend to agree with that observation. I haven't gone into capital preservation mode, I'm still largely in wealth generation mode. I'm using gearing to accelerate my growth even in this current environment.

Just more thoughts for the mix...

Cheers,
Michael.

 

Whilst adversity is in no way a prerequisite I do think it does motivate a strong individual to go on and achieve.

Some "Battlers" will never rise above their lot in life and almost wear their badge with pride.

Other middle class people (perhaps me) have plenty for their day to day living and sit fat dumb and happy.

What is the type of person who can go from very little to achieving great success?

I mean I have the capital that he would dream of using yet I have lots of lazy equity as I wait for the market to collapse as forecasted then wait for it to strengthen again .....

Some interesting ideas here but I think there is nothing new in what I write.

 

I think that can apply in particular to "highly" paid professionals (lawyers, doctors, accountants etc). They do get paid somewhat more than average...and to use your words "have plenty" [and some] "for their day to day living"...but really don't have the lifestyle freedom of choice of the truly rich. There's a real smugness amongst some around their perceived status as "a doctor" etc.

I've hardly ever heard someone's Mum proudly talking about "her son, he's a property developer" but often hear people talking proudly about their daughter "she's a lawyer you know...".

Anyway just some musings...I think we can sometimes outsmart ourselves in investing.

Cheers
N.

 

I'm smart. In the top 95% of my class.

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At least thats better than being in the bottom 5% Matt

 

Great News

I'm not too smart, so should be fine



The above has been confirmed..I looked at FMG when they were around $7, $11, $26 and thought "Nope, thats about their peak"

 

Core principles

I both agree and disagree with this. I am certainly playing to win, but to do so requires capital preservation. It is not a mode, but a maxim -Capital preservation is more important than capital appreciation. No matter the stategy employed in the trades (and investments are just trades entered and not yet exited), to be in the game requires capital. Be it shares, Funds, Futures or Forex, the principles are the same, money management, risk management and a defined strategy. You must have capital for it to appreciate, thus capital preservation should be the one absolute for any investor/trader.