More Market Psychology - The Roulette argument.

Whilst the market awaits the slew of data and news of the next week, trading seems to be slowing to a grind. The data releases start today with the first release of the US third quarter GDP, in light of the debate within the FOMC regarding QE, this could prove to have even greater significance than usual: At least in the minds of market participants, even though the first release will probably bear little or no resemblance to the final revision. - I am not going to get drawn on market direction today, as I think we face too many variables heading into next week.

I would instead like to comeback to my posting from last Friday on the issue of 'Trading Psychology and needing a Strategy'. As part of that post (which can be viewed here) I suggested that for many traders their flawed strategy or perhaps lack of strategy, was analogous to walking into a casino and playing roulette, a game where mathematically it is impossible to beat the house over the long-term. This actually caused quite a bit of debate with some friends and ex-colleagues who refused to accept that the house could not be beaten at roulette.

These are people who are extremely successful and highly intelligent (almost certainly more so than me) and yet they refuse to agree that the house can not be beaten. One argument that is put forward (by more than a few people) goes something like this: Assuming the payout is 35:1 and the chances of winning are 36:1 (European game), then lets say the numbers 1 and 2 both come up twice, each in four consecutive spins, then the odds of these two numbers coming up again is highly unlikely, thus the odds are now closer to 34:1 whilst the payout is still 35:1, thus shifting the odds in the favour of the player over the casino. This is a common misconception, even if in the example given, the number '1' came up for four times in a row, there is still as much chance of the ball dropping on the number '1' as any other number on the next spin. They also tend to quote examples of times when this has occurred to them, as proof of their argument.

The argument proposed here panders to one our own human biases. As humans we all like to think we are rational, however we are in fact often far from rational, for example if we own something we tend to believe it has more value or worth than if we do not own it. – It is these common biases and misconceptions in peoples thinking which drive markets and lead to traders making basic mistakes. By the way if we all did think rationally then the game of roulette would not exist nor most probably would markets, but life would also be a damn-sight less colourful. – I will cover biases another time in more detail, as understanding them is necessary in understanding markets and ourselves.



I am keeping today's posting brief, partly because I have am a touch jaded after one Guinness too many last night...




Before I go: - Something for the weekend. --- Something mellow in fact --- One of my favourite bands of all time singing one of my favourite songs of all time. The Kinks - Waterloo Sunset.