Thursday 22 December 2011

The Power of Conformity in Financial Markets - Candid Camera.

The following classic clip is from a 1962 episode of Candid Camera. This video captures a subtle point about human and crowd psychology which is commonplace in the financial markets.

Whilst it is amusing to watch, it's a good demonstration of scenarios commonplace in financial and commodity markets which has enormously powerful effects.

It is this force which creates trends and wild erratic movements in markets as tens of thousands of trades are placed in reaction to news, data,events and price action.

This immensely powerful force, has the ability to distract people and lead them astray from their well thought-out trading plans.



AlphaMind :Helping People Develop an Alpha Mindset for Optimum Performance in Financial Markets.

AlphaMind is a collaboration between market veterans Steven Goldstein and Mark Randall which aims to help people and businesses engaged in the challenging and highly uncertain world of Financial Markets, develop, cultivate and grow optimal mindsets for outstanding performance and more productive behaviour.

Listen to the AlphaMind Podcast on buzzsprout http://alphamind.buzzsprout.com/ or on Itunes at 

Follow Alphamind on TwitterInstagramLinkedin Group.

Newsletter: If you would like to subscribe to our 'AlphaMind' Newletter. - Please signup at this link.



Article by Steven Goldstein

Steven Goldstein is a leading Performance and Executive Coach and managing director at Alpha R Cubed Ltd.

Steven has worked as a coach with traders and investment professionals since 2009 with clients across the world. Steven's focus as a coach is on developing the 'Inner Game' aspects of trading performance.

Prior to becmoing Steven worked for more than 20 years as a traders in Rates and FX at some of the world’s leading investment banks.

See Steven's Full Profile.

Alpha R Cubed work with people and businesses in the financial markets to help them improve and develop behaviours to catalyse stronger and more effective risk performance. Alpha R Cubed run leadership development programmes, coaching programmes for leaders and financial market practitioners, and 'AlphaMind' Mindfitness Programmes.

If you are curious about how we could help you or your business, please email us at info@alpharcubed.com. or call +44 (0)7753 446097.

(c) Copyright AlphaRCubed Ltd, April 2019. Copyright in this blog and any accompanying document created by us is owned by us. Exception are stock images which have been acquired on license. Stephen Hwking image courtesy of Wikipedia.


Thursday 15 December 2011

Seminar: - ‘Developing Excellence in Trading and Investing Performance’

I am delighted to announce that I will be joining renowned market-timing expert Trevor Neil of Betagroup, to present a one-day seminar in Behavioural Finance and Trading Psychology from a neuro-behavioural perspective.

This cutting-edge seminar is aimed at traders, investors, portfolio managers and ‘heads of trading‘ desks and other risk professionals: The aim is to deepen understanding of the psychological, mental and behavioural forces which affect risk professionals and shape markets. It will also introduce behavioural practices and strategies which can help promote a significant edge in personal trading and investing performance.

The seminar will be held in Geneva on the 26th January 2012. Please see the link below for further details and how to book. This seminar is a joint-venture between Betagroup and BGT Edge.

http://www.betagroup.co.uk/Courses/geneva2012.pdf

Kind regards

Steven Goldstein (Group Owner)

Trader Performance Coach
BGT Edge – Enhancing Trader and Investor Performance
www.bgtedge.com
sgoldstein@bgtedge.com
Tel: +44 (0)207 993 5362 / +44 (0)775 344 6097

Tuesday 13 December 2011

Cognitive Dissonance: Where traders start to dig holes for themselves.


‘Cognitive Dissonance’ is a theory which states that we like to seek consistency in our beliefs within our mind. If we hold two conflicting or opposing beliefs we get a feeling of discomfort or unease, as such we attempt to reduce this dissonance in our minds caused by holding these two conflicting beliefs. This dissonance reduction may involve us self-justifying or deceiving ourselves, this includes acquiring or inventing rationales which resolve this internal conflict, or modifying previous held beliefs.

As mentioned, dissonance reduction often takes the form of a self-justification of self-deception. Some examples of this occur all around us, smokers typically display cognitive dissonance, they know it is bad for them, and that it will probably shorten their life, but they’ll reduce the dissonance and justify the smoking by thinking ‘It’s not really as bad as they say otherwise it would be illegal’ or ‘I’ll worry about that when I’m older’, etc.  Dieters will also fall victim to this, they may justify having a chocolate or piece of cake by thinking ‘Its just one, what harm can that do?’ Last year in the UK there was a major scandal involving expenses fraud by Members of Parliament, whilst passing anti-fraud legislation, they had no issue with this contradiction, claiming their expenses were entitlements. Police will often continue to prosecute suspects whilst wilfully ignoring contradicting evidence. Academics have been known to doctor research evidence to suit their arguments, explaining this away by firmly stating their conviction in their beliefs.

Cognitive dissonance is all around us, and is often intertwined with other biases and behavioural traits. In a sense procrastination is only achievable because we enact dissonance reduction. E.g. ‘I’ll do that piece of work later, after all what’s the rush’.

So what and how does these affect traders and investors directly?

I’ll provide some simple examples.

Firstly, assume I have a long position in the SP500 Index future, say I bought some contracts at 1250. I then placed a protective stop at 1240 whilst looking for an upside target at 1280. I have a personal trading rule that I never move a stop further away once it is in place. – Later that day, the SP500 is trading down towards 1242, I sense that my stop is too tight and that this will bounce. I have a cognitive dissonance, my original belief was that if the market traded down to 1240, I was out of this trade, I was not prepared to risk any more on this trade, based off my initial analysis. Now I am thinking that this may trade lower and then bounce, however I will be stopped out before then. My dissonance here is that I need to remove my stop and place it at a lower level, but I never move stops once in place, this is a ‘golden trading rule’ for me. However, I decide in this case that I can break the rule on this one occasion, my though process is ‘just once it won’t hurt, I have a really good feeling about this’.

Hence I move the stop to 1230. The best thing that could happen in this case, is to get stopped out at 1230 immediately, as I would have instantly been penalised, and should thus learn the error of my ways. But assume that instead the SP500 drops to 1235, the stop is not triggered, and the SP500 bounces and rallies to my target. – I will feel that I was justified in moving my stop, and hence will be almost certainly giving me the green light to repeat that. Thus now a sensible rule, put in place as a form of discipline is jettisoned, and a slippery slope has been started, almost certainly with disastrous future consequences for my trading.

Another trading example shows how self-deceit rather than self-justification can be the dissonance reduction technique. In this example, assume that a trader was playing the USDJPY carry trade in 2007, and had decided to go long USDJPY on a break over 121, convinced that this was heading higher to 132 and maybe higher. His conviction is built on that the fact that this has been trending higher 2 years, is buoyed by the fact that he is gaining nearly 5% yield pickup on a daily basis, and is boosted by the knowledge that just about every major player is in on this trade. - Briefly the USDJPY rallies to 124, he is making money and feels good, all the stars seem in line, and in his head he is thinking of the future rewards this will bring. But from 124 the USDJPY declines and breaks a key level at 118. Now he is sitting on a loss, and looking at analysis which is indicating a major reversal is underway.

The problem for the trader, in this example, is that he has attached himself to this position; he had in a sense bonded and indentified with it. His evidence firmly suggested that a deeper reversal is underway, but he decides to label this a minor correction. This new analysis had created a cognitive dissonance for him; he resolved the dissonance by trivialising his normal rational analysis and invoking a self-deception; he decided that ‘this time it was different’. (There are a couple of other cognitive biases at play here, - The endowment effect; valuing an asset more highly when we own it, and the previously discussed confirmation bias). Eventually this trade would have suffered a huge loss, USDJPY declined sharply to below 100.   

The problem with ‘dissonance reduction’ techniques is the use of ‘justifying terms’ – such as ‘just once’, or ‘this time its different. Of course we never do something ‘just once’, in fact usually when we break a rule, we tend to repeat breaking it, particularly if we’ve justified it and been proved right on that occasion.

In the Carol Tavris and Elliot Aronson excellent book, ‘Mistakes were made (but not by me)’, they talk about how this process takes hold in the creation of corrupt police practices. A good young highly principled cop sees an older cop plant some evidence. He is angry, confused and conflicted, but the older cop says to him ‘We’re the good guys, these criminals are getting away with crimes that we know they are committing, isn’t it better that when we know something and can not prove it, we make it provable, its not like we do this regularly, but in this case its different, it’s a one-off.’  The young policeman decides to look the other way on this occasion, just once. – A couple of years later, this happens again, but having already justified it previously he convinces himself of the value of this. Eventually some years later, without a hint of conscience, he is repeating this behaviour himself. – He may not necessarily be a corrupt cop, he may be a good cop who has adopted some bad practices, but either way it is quite likely that innocent people are going to prison somewhere, and guilty people are out running free.

Cognitive dissonance can be the loose thread, which slowly pulled over time ends up destroying a whole fabric. In a trading/investing sense this is often what can happen; a sensible reliable trading approach can start to come undone, and as in the first example above, it is not the initial action, but rather what it implies, where the problem often starts. In the second example, the self-deceit can lead to a warped view of the market. From my own experiences working with traders, cognitive dissonance can lead to traders digging themselves deeper and deeper holes and by the time they realise what has happened it may be too late.

Tuesday 6 December 2011

‘Recency Bias’ can distort our decision making and judgmental processes, thus reducing their effectiveness.


Recency bias is the tendency for traders and investors to give a greater weight to more recent trade performance, news and information, rather than taking into account older news, information and performance. This leads to distorted perceptions, decisions and judgments, and as such can seriously undermine overall performance sometimes with very negative results.


Here is a simplified example:
A trading method or system involves taking hundreds of trades per year. The hit rate is distributed fairly evenly, with more wins than losses, but with wins typically being three times the size of the average loss.

For example a typical run would look like this:

Win, Loss, Loss, Loss, Win, Loss, Loss, Loss, Loss, Win, Loss, Loss, Loss, Win, Loss, Loss, Win, Loss, Loss, Loss. 
(In summary 15 Losses, and 5 Wins: With wins performing three times better than losses the net effect is zero.)

Now compare it to this run:

Win, Win, Win, Win, Loss, Loss, Win, Loss, Loss, Loss, Loss, Loss, Loss, Loss, Loss, Loss, Loss, Loss, Loss, Loss.
(In summary 15 Losses, and 5 Wins: With wins also performing three times better than losses, thus again the net effect is zero.)

Whilst the outcomes of the two run of trades are different, the trader may feel differently about his system or method at the end of the second run. The last 10 trades on the second run were all losses, whereas on the first run there were 3 wins out of 10, thus a fairly even distribution. Whilst this example is quite small the effect may nonetheless make the trader start to question his system or method: Is it still valid? Have the rules changed so much that he should alter the (proven) system or method? Should the trader take the next trade? Should the trader lower the risk level on his next trade? – I hope you can see where I am going on this.

In Curtis Faith’s excellent book, ‘The Way of the Turtle’, there is a great example of this: Faith provides a friend, who has begged him to reveal the secrets of his highly successful trading system, with all the details of the system. However the friend rather unfortunately decides to override the system following a string of losses. The relevant paragraph from the book is as follows:

Around February 1999 I (Faith) asked him how he was doing in cocoa since I had noticed that there was a great downward trend. He told me that he did not take the trade because he had lost so much trading cocoa and thought that the trade was too risky’. Curtis noted that prior to the downtrend starting there was a run of 17 losing trades. Collectively these losing trades added up to a loss of nearly $17,000. The subsequent 11 trades, which the trader did not take, contained 4 winning trades and 7 losing trades. The net result of these 11 trades was a profit of around $73,000.

It is worth noting that this ‘recency bias’, also occurs in the way we make many judgments, process information and review news. Investors may shun a share because its recent dividends were poor; however behind the scene the company may have made a significant investment in restructuring and producing new lines which will yield significant future results.

Another effect of recency bias is to alter our state of mind. There is nothing worse than a string of losses to dampen our enthusiasm. It may be that at this point we start to question ourselves and our ability, and that opens the door for self-doubt. Once self-doubt creeps in then we could fall into a viscous circle of doubt and crisis of confidence; we then start expecting poor outcomes, and once this starts happening we then actually then create them.

I would also like to add that though these examples focus on negative recency bias effects. However positive recency bias effects can also throw us out. – In the earlier example, a string of recent wins could have caused the opposite effect, making the trader less cautious and far too overconfident, thus leading them to take too much risk, with eventual disastrous consequences.

So what is happening for us to be affected by recency bias? – Well to one degree this is a natural occurrence, in the real world, recent events are much easier to recall. Our working memory, which is part of our conscious mind used for learning new activities, it has only limited resources, and as such is only able to hold a limited number of ideas and memories at any one time. As such older memories get put to the back of our mind, into our long-term memory: Whilst the storage in long-term memory is infinite, the ability to accurately recall this information and to have it at hand is difficult. Thus we have a much clearer recollection of recent events, and as such we end up with a distorted view of reality.

So what should one do to avoid the effects of ‘recency bias’?

1) Awareness of the problem is always the first step. – But rather like recency bias it-self, any memory you have of this article you are reading now is likely to be lost into your long-term memory before long, and will not easily be recalled. I would suggest make a note of this and other biases (Preferably in a journal), reminding your-self of how it may affect your trading and judgement. – It is essential to re-visit this periodically to remind yourself with regard to this and other biases and how they may affect your judgement.

2) Try and ‘develop a habit’ of tracking the record of your trades, or other relevant data you may be watching. – Here again a journal is highly valuable. – When you do hit an extended run of data or news, try and look back at it in perspective of the bigger picture.

3) Set-up rules, guidelines and criteria for trading and analysis. Check yourself regularly to ensure you are abiding by these criteria. Once again, our old friend the journal is an excellent place to note these rules, guidelines and criteria.

4)) Manage your-self: The more stressed and anxious one is, the more one is likely to veer from common-sense, and good practice. Euphoria, over-confidence, despair, self-doubt, and many other stated all have the ability to throw us off course, and lead us to abandon our usual work mode. Try and make obtaining and maintaining balance and perspective part of who you are and how you work. – Once again maintaining and reviewing a journal is an excellent tool to use as part of this process, along with a healthy life-style, exercise, work/home/social balance, etc.

We are as humans all prone to recency bias, however as traders, we have to ensure that somehow we do not let this affect our ability to perform and make sensible decisions and judgments.

Friday 2 December 2011

Leverage – Your best friend but also your worst enemy.


The summary which follows is in response to work I have been doing with a recent coaching client. The client, no names mentioned, has given me permission to re-produce this short summary of one aspect of his issue.

The client, lets call him Bob, had been working for many years as an investment manager for a private investment house. His investments, though conservative, had always performed well, and his own private investment portfolio had also reflected his success at investing. He felt that given his knowledge and background that he would chance his arm at trading, though much more short-term, many of the principles involved were quite similar, and his investments had always been pretty short-term in nature. He had also been spread-bet trading for the past couple of years, with some decent results.

Thus he decided that the time was ripe for him to chance his arm at trading, the investment world had been good to him, but trading would give him a chance to magnify his performance through the use of leverage, which was not available to him when investing.

Unfortunately, after two barren years however, things had not been going well, in fact he deemed it a spectacular failure, and could not see anyway to turn it around. This was despite making some decent calls on the market, and his performance with his investments, which he has continued to do in the background though in very small size only, had remained solid.

Bob was put in touch with me through a mutual friend. After listening to Bob it was clear he had made one crucial mistake. He was misunderstanding the effect of leverage on his performance. Bob had set aside a trading pool of money of around £100,000. He was using leverage of 10 to 1. Thus this gave him a £1,000,000 trading fund. Bob was fully aware that a 10% hit would wipe him out, so he traded with a maximum drawdown of 2% of his trading fund (£20,000). This would of course wipe out 20% of his capital, and thus reduce his trading fund by 20%.

Bob’s trading style, which had its source in his investment approach, relied on leaving long stops, and holding trades for at least a few days. However, whereas before when he had placed a trade, he would remain calm, he was now fearful and slowly but surely this fear started driving his trading. On many occasions he would plan a trade and then do completely the opposite, he would end up taking small profits, and cutting losing trades before they hit the pre-defined stop, which sometimes they would never actually hit. Overall he was not sticking to his trading plan or his strategy.  

The source of the problem was in the level of leverage, but the problem had now taken on a psychological dimension. Bob was now fearful of trading, his fear had damaged his trading, his confidence was suffering and his self-belief was diminishing. This usually confident, bright and extremely clever person, had slowly got sucked into the fear/negative mindset/self-doubt loop.   

As a coach, I don’t tell someone how to trade, but I try to help facilitate a better or more appropriate approach. Typically the client possesses the solution themselves, almost certainly a better solution than I may come up with, however it is usually buried deep inside their mind, and due to their problems they are rarely clear-headed enough to be able to access it. Thus my job as coach is to help the client coax the solution of out of themself.

Bob, trusted his system and his approach, however he did not trust himself. His root cause of the distrust was his fear of losing too much to continue, this was driving his trading, and fear is such a strong emotion. At the core of this distrust was incongruence between his trading style/system, personality (Bob had a conservative nature and hated uncertainty) and the amount of leverage he was taking onboard.

Bob was adamant he was not going to change his approach and style, this had always worked for him, and it was what he knew. But he was aware that the leverage levels on a method which would require some potential hefty drawdowns meant he could not possibly continue as it was.  We went through a few scenarios, and although Bob was not originally in favour of this approach, he decided to try a nil leverage approach for a couple of weeks. In other words he would just trade his original capital. The idea at that point was more about restoring his self-confidence and breaking the negative loop cycle, than generating income. – After a slow start, Bob started making money, and after a month of this was feeling a lot better about himself. – After this he decided he would trade the second month on 2 times leverage, once again this worked out well, and Bob’s confidence was really being restored.

It is now 6 months since he first went back to nil leverage. Bob has had five very successful months, with one month suffering a slight drawdown, which he was very comfortable with. – He has been using 3x leverage the past 3 months, and is preparing to move to 4x, where he thinks the right level will be for him. – I will continue to coach Bob through this process. I do not know the right level of leverage; I think only the person trading can ever know that; it is a very personal thing. He has decided that 10x leverage is almost certainly going to be incompatible with his style and method. But that he was going to try and move to a higher level of leverage, find his comfort zone, and then slowly try and push that a little further.

I have used Bob’s example to highlight how excessive leverage can and does come back to affect you in other ways. Some people can cope with it better than others, and some trading system methods are better able to cope with leverage than others. I want to make one more point clear; this is real leverage here which is being talked about, trading capital verses real capital, and not margin risk, which is often many times higher.

Tuesday 29 November 2011

Procrastination: A bad habit which affects many traders.

In my coaching work with traders, there have been many cases where I have found occurrences of procrastination.  Procrastination takes on many forms, the classic definition is ‘putting off to tomorrow what we can do today’, however I tend to see it the way Piers Steel, author of ‘The Procrastination Equation’, describes it; ‘one procrastinates when one delays beginning’. – In a trading sense this manifests itself in many ways; failure to plan, failure to stick to a plan, perfectionism – waiting for the perfect set-up and hence not acting, hesitancy in pulling the trigger, choosing the safer option by continuing to analyse and watch the market rather than place the trade, which often leads to the cry –‘I knew that was going to happen’, or something along those lines. – One of my favourite quotes on trading is by Warren Buffett: – ‘Predicting rain doesn’t count, buildings arks does’.

Procrastination is a deeply entrenched habit.
The problem for many is that procrastination is a deeply ingrained habit; it is something we have learned to do throughout our life. – I have often harped on about ‘the 10,000 hour rule’, and how practice makes perfect, well during our lives it is quite possible we have spent many thousands of hours practicing at procrastinating, as such this has formed into a well entrenched and fully automated habit. Fortunately there is help at hand, and that helps involves developing new habits, habits which override and usurp that bad habits which are part of procrastination. Unfortunately for many procrastinators, it takes time, commitment, planning, effort and application, and as we know that is one thing which many procrastinators are not good at.
I will reference a couple of articles which explain a little more about procrastination, some of the causes of procrastination, and steps we can take to start overcoming procrastination. Before I do however I want to introduce the following excerpt by Daniel Goleman, in ‘Leadership: The Power of Emotional Intelligence – Selected Writings’ where he talks about trying to from new habits as a way of usurping old habits.

‘Doing the wrong thing is a habit that you have become an Olympic level master at—your neural wiring has made it a default option, what you do automatically. The neural connectivity for that is strong. When you start to form the new, better habit you essentially are creating new circuitry that competes with your old habit in a kind of neural Darwinism. To make the new habit strong enough, you have to use the power of neuroplasticity—you have to do it over and over again.

If you persist in the better habit, that new circuitry will connect and become more and more powerful, until one day you’ll do the right thing in the right way without a second thought. That means the circuitry has become so connected and thick that this is the brain’s new default option. With that change in the brain, the better habit will become your automatic choice.’


Procrastinators will always be recovering procrastinators.

‘Old habits don’t die, they merely hibernate’: It only takes a stimulus from the old days to return for the dormant pattern to re-assert itself. This is why no one is ever considered cured of alcoholism; instead it is drummed into them by Alcoholics Anonymous that they will always be recovering alcoholics, this mindset helps keep them on guard against returning to the habit. This is something we all have to guard against when trying to form a new habit, hence it is useful to try and adopt a mindset that helps us to overcome these issues. Of course, procrastination does not have the same level of gravitas as ‘alcoholism’, and hence we are not likely to carry this around with us in our mindset to the same degree, also we cannot avoid the environment of work, like we can a pub or bar. However, we can take actions to try and keep it at the forefront of our minds; after all it is almost certainly serious enough to make a major dent in your earnings from trading, or even to be a cause of trading failure. I suggest placing small reminders around which are intended to jog our memory of the beneficial habit and thus avoiding returning to the destructive habit. Maintaining a journal, and placing reminders prominently in the journal are useful, also small physical reminders and inspirations are useful around your work place, and perhaps well located in your home.

Links to articles about procrastination and steps to overcome it.

The following link is to an article from the 'Psych Central’ website. It discusses some of the causes of Procrastination, included in these are Irrational beliefs, Perfectionism, Fear, and Disorganization, some or all of which are aspects which traders should be able to identify with.

http://psychcentral.com/library/procrastination.html

The second link attached is the follow-up to this, it includes how to tackle procrastination and how to take greater control of your ‘self’, which I believe should help lead to ‘better trading’. Amongst one of the steps recommended is keeping my old friend ‘the journal’, something which I strongly advocate to all traders.

http://psychcentral.com/library/procrastination.html

And finally, I shall finish with a humourous quote by Gloria Pitzer -

“Procrastination is my sin. It brings me naught but sorrow. I know that I should stop it. In fact, I will--tomorrow”

Sunday 27 November 2011

AUDUSD 3 Peaks pattern - Update 28th Nov 11

The AUDUSD continues to follow the idealised '3 Peaks and a Domed House'(3PDH) pattern. The recent retrace to 107 a few weeks back was greater than I thought, however it did not violate the pattern and appears since then to vindicated it if anything. - My previous post on this can be seen here, I have posted a number of articles on this pattern on the AUDUSD over the past 6 months, with the initial posting in May first suggesting the possibility of this formation, even before it had hit a peak (can be seen here).

Here is the latest update of the AUDUSD and the 3PDH pattern. - The update is at the foot of this image, the top part of the image is the idealised 3PDH, with the middle part, the update from 13th October.
Note I have a minimum target of around 0.8000 with a maximum target close to 0.6000, with target possibly to be hit in 2012.


Further to this I have looked back a little further at the AUDUSD on the longer-term charts, and it appears as this 3PDH may be a fractal of a larger 3PDH. - With the current pattern formed since 2008 representing the second half of the pattern 'The Domed House', and the period representing 2003 -2008 representing 'the 3 Peaks'. - I will revisit this bigger pattern over the next few weeks, however this pattern seems to explain the and allow for the AUDUSD to visit both targets I have mentioned; the less aggressive target in the low 80s followed by a sharp correction back to around par and then a deeper correction towards around 0.6000 some time during 2012 or 2013. - This chart can be seen below. 

My usual caveat applies; 'patterns work until they don't'.

__________________________________________________________________________
RIP - Gary Speed - One of the premiership's finest.

Friday 11 November 2011

Understanding our natural and developed human tendencies can help improve trading performance

One of the most common mistakes we all make as traders and investors is to think that we really have 'free-will'. There is a saying which is often quoted by traders - 'You pays your money, you takes your choice'. - The underlying message being that we are totally in charge of our own choices. Having been a trader for 25 years, and now as a trading coach, I believe that is a dangerous illusion which derails many if not most traders and investors. At the core of this is my belief that traders and investors are affected by a wide range of psychological, philosophical, physiological and sociological affects which affects and limits their ability to think and act rationally when it comes to making their trading decisions.

All people suffer from natural and learned biases, traits and habits, which for the sake of this article I collectively term as tendencies. Many of these tendencies have evolved over millions of years, they are part of our natural make-up and have aided our survival and have helped us thrive in the natural environment. - A few thousand years of domestication versus millions of years of evolution have not been enough for us to lose these natural tendencies which are really our basic instincts. We also pick-up many tendencies as we grow and develop, these are shaped by our environment, our education, our upbringing, social factors, culture and belief systems, and help to instill certain ways of thinking.

These tendencies are either part of our natural make-up or have been influenced and shaped as we have grown and developed. They enable us to make decisions quickly and reasonably, they have helped us to learn and develop, and to fit in and adapt. As a result of these we are able to filter information quickly, to learn rapidly, and to move forward in the complex world we live in. However as a result we also do not truly receive and recall information in an objective sense, but colour it in any number of ways in order to match our preferences. Thus often we 'see what we want to see' and 'hear what we want to hear', we make decisions which are comfortable for us, that help to reduce anxiety and keeping us feeling safe and secure.

In the natural world we evolved in over millions of years, and in the social world we grow up into, these tendencies are often perfectly rational and beneficial. However in the somewhat unnatural world of the financial markets, these same tendencies can sway people's (traders and investors) decisions, choices, and behaviours in unfavourable directions. As a consequence traders and investors often display limits to their rationality, lack the necessary self-control required, and will become heavily influenced by social factors and their environment.
In the world of trading and investing there tendencies often lead traders and investors astray, sending them on false paths, and exposing them to 'decision traps'. I believe that increasing knowledge and understanding of these behavioural tendencies could make an invaluable contribution towards improving traders and investors’ self-awareness and increasing their knowledge base of themselves, others, and markets in general. Elimination of these tendencies is not a realistic goal; one cannot fight basic human nature and expect to win. However, by deepening one's understanding of who they are and how they work, one can provide important information which can help them modify their behaviours and strategies, in order to pursue a more optimal approach towards trading. 

Many of the world’s most successful traders incorporate strategies into their trading and their approach to trading, which have helped them, overcome these natural tendencies. By following these successful strategies they get closer to exercising free-will in their trading, free-will to choose a trade, free-will to execute entry and exit, free-will to correctly exercise appropriate risk and money management, free-will in being able to objectively analyze data, news and information. 


Thursday 10 November 2011

AUDUSD 3 Peaks and Domed House is still on, as is the SP500 pattern.

The 3 Peaks and a Domed House pattern which I have been following since May, still appears to be valid, despite the larger than expected rally to 1.07 last week. - Here is the link to my previous post on the AUD 3PDH. And here is the previous chart and the updated chart.

US equities (As defined by the SP500) are also continuing to trace out its respective pattern. He is the link to me previous (and extremely long-winded) post on this.

And here is the SP500 weekly chart at last nights close.
 
Firstly - My usual, I don't want egg allover my face, caveat: Patterns are not written in stone, and even the best of them can fail at times. (In fact failed patterns can be wonderful trading opportunities.) . Nonetheless both the SP500 and AUDUSD 3PDH patterns are tracing out really well, and confirming each-other. - IF this continues to follow through as per the typical 3PDH pattern, then this may be on the cusp of a very large ande volumous decline. - In terms of the SP500 we may be looking to a move towards 950ish. - It could surpass that, but right now that is where the indications are this may be heading.

Trading Biases - Ambiguity Aversion - Loss aversion's companion,

Ambiguity aversion is an aversion to uncertainty. This is a tendency to favour a known risk over and unknown risk, or security over insecurity, and quite frankly, who wouldn't. This attitude is central to much of what we do and how we behave, it is written into the fabric of our lives in so many ways, think of the many phrases and sayings which have become a major part of our language; 'better to be safe than sorry', 'a bird in the hand is better than two in the bush', 'better the devil you know, than the devil you don't', and so forth.

People generally hate uncertainty, though as with all personal characteristics, the aversion to uncertainty varies from person to person. - The higher value a person places on certainty and security, in relation to other values, the more likely they will be affected by ambiguity aversion.

How does this manifest itself in trading: One of the side affects is that people are unwilling to stay with risks. I have often seen traders take small profits on potentially winning trades in order to reduce uncertainty in outcomes, only to regret this later (I include myself at this, and often come to regret it). Ambiguity aversion is also a major cause of cutting trades preemptively rather than awaiting a predefined stop to be hit (Hello - another guilty trait). - I have also seen traders close positions just because the suspense was killing them, even though the trade had neither made a significant profit nor a major loss.

Together with loss aversion, 'ambiguity aversion' is one of the major causes of trader under-performance. - It is easy to understand why we possess these characteristics; in the natural world, where we have spent millions of years evolving, taking risks with uncertain outcomes could have been fatal. It was far safer to eat the berries of trees one would be familiar with than eat the berries and fruits of trees we do not know. That very attitude was a sensible and safe option and has become hard-wired into our thinking. However, that very same thinking in the financial markets has the ability to seriously derail a trading strategy; there is a price to pay for reducing uncertainty (loss of potential gains and cost of insurance).

Many of the most successful traders have developed strategies which work in their favour and against loss aversion; they have found ways to overcome this natural tendency. If one is to take their trading forward, this is one of the hurdles one must face and overcome.  

Monday 7 November 2011

Beware the Inner Reptile.

A very interesting article on some of the work of Andrew Lo by Gillian Tett: MIT finance professor Andrew Lo's market theories draw on research from the fields of neuroscience, evolution, and econometrics

In an article called 'Beware the Inner Reptile', Tett describes Lo's interesting angle and contribution to the field of behavioural finance, in particular he suggests that humans behave in a perfectly rational way in “normal” times, but will resort to their animalistic behaviours during times of panic. He link his work to earlier evolutionary development studies of the 'Triune Brain' by Paul MacLean. 

Thus when markets go awry and things start to go 'bump in the night', traders and investors start to resort more on using both their mammalian brain and their reptilian brain. However, previous experience of markets has been confined to using and utilising the Hominoid part of the brain. One point of interest within the article is an interesting spin on the debate over the effectiveness of the EMH. The article can be seen here.

Monday 31 October 2011

Trading Biases - Loss Aversion - The Biggie.

One of the most common mistakes we all make as traders is to think that we really have 'free-will'. There is a saying which is often quoted by traders - 'You pays your money, you takes your choice'. - The underlying message being that we are totally in charge of our own choices and essentially we have free-will when it comes to decision making. Having been a trader for 25 years, and now as a trading coach, I actually think that this is a dangerous illusion which derails many if not most traders. At the core of this is the belief that traders are affected by a wide range of psychological, philosophical, physiological and sociological affects which influence their ability to think and act rationally when it comes to making their trading decisions.

All people suffer from natural biases and traits. These biases and traits have evolved over millions of years, they are part of our natural make-up and have aided our survival and have helped us thrive in the natural environment. - A few thousand years of domestication versus millions of years of evolution have however not been enough for us to lose these biases and traits which are really our basic instincts. In the trading environment many of these 'basis instincts' can severely impair our ability to read the markets objectively and make good trading decisions. - The first step I implore traders to take in order to help mitigate the destructive affect of biases on their trading is to try and understand these biases, and to become fully aware of them. Below, is a description of what I believe is the main destructive bias to impact one's trading. 

LOSS AVERSION BIAS.
Over the past couple of decades the fields of behavioural economics and finance have shed a huge light on the way we as humans make our decisions in relation to financial matters. Probably the most significant advance in that time was work by Amos Tversky and Daniel Kahneman on 'Prospect Theory' for which Kahneman was awarded the Nobel Prize in Economics in 2002. One of the central elements of this was 'Loss Aversion' bias, which states that people have a psychological tendency to handle equivalent gains and losses differently; a loss almost always feels more painful or detrimental than an equivalent gain.

An example of this would be the pain that losing an amount (say $50) is worse than the equivalent joy from gaining an equivalent amount. This bias manifests itself in all sorts of ways in trading and investing. - Often when a trade starts losing money, there is a tendency for traders to hold on in the hope that the trade will recoup its losses, rather than cutting the losing trade early. In many cases the trade continues losing money, and the trader is faced with much larger losses. This is exasperated by many traders only taking a very small profit (or even cutting out flat) on the occasions the trades do come back. -- This creates a dangerously asymmetric risk/return profile. 

There has been much research into the 'Loss Aversion' bias: In one study it was found that people tend to view losses as having around 2.5 times as much negative impact as a gain of a similar magnitude. In other words a $100 loss has an equivalent impact (in negative terms) as a $250 gain (in positive terms). There is an old trading adage that traders 'should run their profits and cut their losses', often however traders tend to do the opposite, they act in a way that is psychologically comforting to them, but is actually detrimental to their performance. In my early days, quite some years ago, I was told by other traders 'that no one went broke taking a profit', if ever there was poor advice, then that was it! - I have seen far too many people go broke over the years because they took small profits and ran their losses. Though it was only occasionally that those losses would seriously deteriorate, when they did happen they would run and run, and it only has to happen once or twice to completely ruin someone.

Awareness of our tendency towards 'Loss Aversion' is a starting point, though on its own awareness is not going to help overcome the tendency. Traders have to ensure that their strategy and approach to trading is correct and able to offset this as well as many other all destructive biases. - I will talk about this in future articles, however it worth noting what successful traders tend to say around the subject of 'Loss aversion'. Veteran trader and hedge fund manager Peter Lynch is quoted as saying: 'Some stocks go up 20-30 percent and they get rid of it and they hold onto the dogs. And it's sort of like watering the weeds and cutting out the flowers. You want to let the winners run.'


Wednesday 26 October 2011

Linkedin Group - Trader Trading & Risk Psychology,

I would just like to advise regular readers of this blog, that I run a Linkedin Group called 'Trader, Trading & Risk Psychology'. 

Group members are able to join discussions, share thoughts, post opinions and distribute articles on the many psychological and behavioural aspects of trading and investing, including
• Trader & Market Psychology.
• Trader Performance & Development.
• Behavioural Finance related to Trading. 
• Sociological aspects of Trading and Markets. 
• The Psychology of Risk.
• The Psychology behind Technical Analysis.
And any other subject within the broad context of trading psychology.
 
I try and keep the group free from commercial/promotional material and spam in order that it can fulfill its objectives as a forum for discussion and learning on the key topics around trading psychology.

I also ask members to keep discussions within the broad context of Trader, Trading & Risk Psychology, and as such away from posting market forecasts and opinions .

The group already has close to 900 members and has been running just a few months. Members come from a wide range of disciplines, including Professional and Private Trading, Research, Analysis, Academia, and many other associated fields. 

To join the group, click on the following the link ; - http://www.linkedin.com/groups/Trader-Trading-Risk-Psychology-3863963?mostPopular=&gid=3863963 ' Then hit the 'Join Group' button.

All are welcome to join: 

Warm regards

Steven Goldstein

Monday 17 October 2011

3 peaks & a Domed House on the SP500 ??

Over the past few months, I have focused on how the AUDUSD, itself a good proxy for the risk-on v  risk-off trade. - I have been following what appeared to be a rare formation known as a '3 Peaks and a Domed House' (3PDH). This rare formation was the concept of George Lindsey, a brilliant but little known (until very recently) technical analyst who dies in August 1987.

I first touched on the possibility of this 3PDH pattern developing in May of this year on the AUDUSD, the posting can be seen here http://hometraderuk.blogspot.com/2011/05/aud-highly-speculative-view.html

I have maintained regular updates of this, including a posting over the weekend, which suggested a strong risk  that the AUDUSD may be at of close to a final rebound a long and sharp drop.  (Initial stop over 105).

At the end of the last posting, I highlighted a similar pattern on the SP500. - I have decided to update that, with the analysis boosted by having read a superb new book on George Lindsey and his work, written by Ed Carlson. The book is 'George Lindsay and the Art of Technical Analysis', was named 'Stock Traders Almanac' - 'Best Investment Book of the Year'.

The charts below are quite wordy so I will sum the main points, in line with some of the main supporting factors from Ed Carlson's book:

1) The pattern seems to conform (almost to a perfect pattern), it is rare (almost impossible) to get a perfect representation, but this is a pretty good version, with the main exception possibly explained away by one of Lindsey's principles.

2) The pattern suggests we may be close to a serious steep decline taking us rapidly to around 963 (minimum 1010, quite possibly deeper).  

3) The biggest discrepancy between this pattern and the ideal pattern is the wide-ranging consolidation over the past 2 months. This represents the 'roof of the first-floor' on the pattern and typically occurs during the ascending side of the 'Domed House' pattern, not the descending side. On the other hand the ascending side had a shorter correction in Oct 2010 which should have occurred where this one occurred. ( I hope you follow, because I'm struggling and I'm writing it). - Lindsey explains this with his principle of equalization. - [Though I have to give consideration to the possibility that this is a serious departure, and if it does not resolve favourably soon, it may null and void the pattern.]

4) The AUDUSD, which has a very high visible correlation with US equities over the past few years, does not have this discrepency, it has everything in the right order. (With the exception of an irregular top on the 'Domed-House'.

5) My usual Caveat. - Which I am happy to state since I am physically short of the position in AUDUSD, not merely analyzing this, is that as with all chart patterns and price action, it is a probability call and not written into the future.


The first chart shows the SP500 and the idealised pattern. - With desciptions of the various stages.



Below, I have tried to use the 2 day chart to try and explain the anamoly of the 'First-Floor Wall'.


And for good order sake, here is the AUDUSD chart I mentioned, as per Friday's close.

Friday 14 October 2011

UPDATE - TO AUDUSD - 3 Peak and Domed house Patternn

To update the AUDUSD 3 Peaks and a Domed House pattern.

This AUDUSD has followed the script incredibly well since I first started following it in April/May time. -- Once again we are at a critical juncture. -- 103ish -- If this fails soon in the 103/104 area, it could spell the beginning of a very sharp drop towards .8000 area in next few months. -- I will allow for a short-lived extension to 105, but really any prolonged time over 103/104 I think may start to question this pattern and lead me to thinking that its not going to continue following through.....

Here us my update. With the previous update from September , then the update version at the current price.., - I have also included the SP500 chart below, highlighting that this too has followed a similar evolution to the AUDUSD.

Monday 10 October 2011

Wham Bham - My two opposing views seem to be reconciling.

Over recent weeks, I have followed 2 trades.

1) The possible top (or temporary top) forming in the Bund (Suggesting a pause in risk aversion).
2) The possible collapse of the AUDUSD towards low 90s/high 80s. (Suggesting risk aversion).

Clearly these two things could not happen together. One had to win out. - The past 2/3 days had suggested that 1) the bund was likely to win. - I now believe we may see a deeper retrace on the bund towards the low 130s. (I favour around 131).   - I also think we may see AUDUSD rally toward 102/103. --- In these volatile conditions, I would not expect either journey to be without some sharp corrections, and possible strong overshoots.

I also think that this may settle the question of how the AUDUSD 3 Peaks pattern was unfolding, (See posting of 12th September), it would favour the pattern now unfolding as Option 1....  - And may set-up a great shorting opportunity around the 102/103 area. ---(Once again with the caveat that this may not turn out to be a true '3 Peaks and DH' pattern.)

FWIW - Ed Carlson, who has just brought out a brilliant book about George Lindsey, the person behind this elusive pattern, says that the '3 Peaks and DH' pattern was intended to be used on equities-only. And although that wouldn't stop one from using it on currencies, it should not to be used in isolation, rather as part of an integrated approach using all of Lindsay's methods. Without those other methods, 3PDh doesn't provide enough info to be certain of its forecast. )

Tuesday 4 October 2011

Update on Bund and AUDUSD

Bund never made the break on heavy volume needed, in order to drop sharply... The strong rebound seems to have switched attention away from any drop, as markets seek a FTQ... - If stock markets can hold in, then start rebounding, then this are will still remain in focus.... For now though the analysis on the bund below is invalidated,,, though any topping around 138/139 could still create a triple-top/Head & shoulder type formation.

The short-lived AUDUSD rebound did turn out to be just that, and failure to break over 100 sent this on its continuation lower.  - My original analysis was for a move towards 90 HIgh 80s area, and there seems little to stand in the way of this right now....

Tuesday 27 September 2011

Bund - Interesting set-up could suggest deeper correction ahead.

The Bund (German 10 Year future) rally may be petering out, the past few days has seen a sharp correction from last weeks high. There are indeed signs that it may be preparing for a deeper correction. (Which would presumably favour further risk-on activity). - Before I outline my thinking, this is counter to a very strong trend, and may merely be a pause within that trend, however, there is much to suggest that a deeper correction is a good possibility.

The Chart below shows the Daily Continuation Bund Future.
Here are the technical signals:
1) Major trendline break.(Yesterday)
2) Bearish 3 Crows Pattern.  (Past 3 days). - (Follows a similar pattern 2 weeks ago)
3) Potential Double Top Pattern (Needs a high volume break of 135.12 to confirm)
4) Strong Bearish Divergence on momentum. (Triple divergence on RSI, Double on MACD).

The Double-Top Pattern is not yet confirmed, but if it was, it would also be the first significant lower low since April and would strongly suggest that the trend has turned for now. - Note, unless and until it is broken, then the trend is higher still, and the current price action is a consolidation.

AUDUSD - the bounce.

Corrective bounce. Leads me to question this call for a large downmove similar to the EUR, as per the previous graph. ---

I am watching to see how this unfolds. - Would have expected a bounce after last weeks sell-off, to be a spike bounce,,,, i.e. sharp down, sharp bounce , then quick sell-off.... -- So far I know its only been a couple of days, so early yet, but lets see how this unfolds, but it does not appear to be a spike bounce, which is what concerns me ....

-- Obviously 1.0050 area will be resistance.... I think over there and we could be looking back to 1.0400 or even higher..  - will see how this unfolds over next couple of days.

Wednesday 21 September 2011

AUDUSD possible overlay v EURUSD 2009-2010

Here is an interesting overlay of the AUDUSD over the past year+ versus the EURUSD in 2009/2011.

Overlays, always should be handled carefully, firstly because there is the possiblity that they are merely co-incidental, and secondly even where they do follow similar paths, the tmeptation to take them down to the micro-level, which nearly always ends in failure.

What is interesting about this overlay however, is how it accords with the '3 Peaks' pattern outlined in my previous post. - Note, the EURUSD was not part of a 3 peaks pattern, so I am purely focusing on the second half of the 3 peaks pattern here for the AUDUSD compared to a different bigger picture move for the EURUSD,

Monday 12 September 2011

AUDUSD 3 Peaks pattern revisitied

Back in May I wrote a piece about a highly speculative view on the AUDUSD (Link to posting) about how the currency pair may be close to creating a rare '3 Peaks and Domed House' Pattern. - Since then the price action has gone a long way towards adding credibility to this view.

Before I continue, the technical analyst who first recognized this particular formation was a chap by the name of George Lindsey. Recently an excellent book has been published by Ed Carlson about the work of George Lindsey called 'George Lindsay and the Art of Technical Analysis'.

Back to the AUDUSD here is the original comparison of the AUDUSD and the overlay of the pattern.

And here is the updated version - Note I have added 2 options, as the 'double top' does not quite conform to the traditional pattern. - It is also possible, that the 'double top' could be indicative that applying the 3 peaks to the AUDUSD is incorrect, and that this could follow a very different path. - I am fine with that, markets prices action is never determined in advance, however I do feel it follows certain behaviours to various degrees of probability. - However, markets are chaotic systems, and though chaotic systems do follow patterns, they are incredibly hard to determine, and any number of variables can change the formation of the patterns.

Tuesday 6 September 2011

Friday 2 September 2011

Re: The Euro - Clearly the answer was no.

I will update in the next few days. But after some frustrating calls on the Euro recently...( See recent posts ) I sense this may have turned down properly... 

Wednesday 24 August 2011

Is the Euro close to breaking out?

The Euro has traded in a wide sideways band for up to four months now. Trying to predict direction has been somewhat difficult in the recent turmoil of the past few months. I am sensing a possibility that we may be close to breaking out on the upside. - The next two charts will highlight my reasoning. - It is worth viewing this in the context of my previous couple of postings .

The first chart shows EURUSD weekly candles.

The second chart shows the EURUSD with a possible 'Cup & Handle' continuation pattern formed over recent weeks. - I am a touch cautious on the validity of this pattern for reasons stated on the chart, but I still feel that it should be given some consideration.


Below is a pictorial representation of an idealized 'Cup and Handle' pattern, or click on this link for further description.:

Monday 15 August 2011

RE:EURO WEEKLY CHART - A dangerous omission

It has been pointed out to me by a good friend, that my commentary and chart of the Weekly EURUSD failed to include a bullish option. (Typically I include both a bullish and bearish options). - Perhaps that omission by me was a sign of that I (like many others) is only looking for the bearish outcome. - This omission, whether accidental or deliberate may be a signal in itself, that the market is too focused on the bearish case. If so, could this actually be a good reversal indicator in itself.  - A market overly bearish, where fear of a drop is the only option being considered.- In a similar way to the Stock market in early 2009.  Since I published that chart on Thursday, the EURUSD has done a big about turn, and right now is knocking on the door of 1.4400.


I will post a chart which considers the bullish option, which I really should have included last week.

Below is the weekly EURUSD bullish option. - A large  'Bull Flag' pattern, which has consolidated the major bull flag monthly breakout of the 2008/2011 pattern. (UPPER chart is the weekly/LOWER chart is the monthly). On a sustained breakout over 1.4440 this suggests a potential to around 1.6500 -




Monday 8 August 2011

Big Monday

Today's and tomorrow's market reaction to the downgrade will be crucial in establishing price action for next few weeks.. - Overnight futures on the S&P made a mild new low after gapping lower on the open, the gap has remained significant until now... However it will be what happens in the US hours which will be crucial. - The cash low on Friday at 1168 was a fraction above the 61.8% retrace of the 2010-2011 rally. - I guess this level will be significant and crucial in the short-term.

Friday 5 August 2011

1174? -Perhaps a pause here..

If a week is a long time in politics, its a lifetiem in trading... - When a departed for a weeks vacation the S+P500 was nestling in the low 1300s having rejected 1350 the previous week... Now it sits at 1200 and the futures have been lower....

I will be brief.. I think a major bear market lasting through next year is highly likely....with a possible return to 2009 lows.

But for now - I am wondering if a temporary bottom may soon loom. Fear seems overwhelming at present and it will be very hard to actualy nail a low....- but I think a temporary low could be close... SP500 cash - 1174 is a big level for me....WHY 1174


  • It was big support in q4 last year..
  • It was also the rebound level after the flash crash..
  • And guess where the 'Fibonacci extension' of the May top / June Bottom / and Jul rebound top is ?? 1174.4...
Further to this we ranged for a while between 1170 and 1230 in q4 before the big rally,, so that zone could offer some support..
1180/1220 was major resistance area Apr top last year... 
1190 is 50% correction of July 2010 to May 2011 Rally,,,
Also 1166 if 61.8% correction of Sep 2010 rally..

So if any sort of rebound was to occur it would be in my mind from 1170/1190 - with 1174 being the main area,,,,

AUDUSD has moved back down to 1.04 where major support held over recent months....- Certainly worth banking some profit there if you were short (I think) ..

AlphaMind podcast #107 A US Navy Seal Commander, A Mindfulness Expert, and Self-Compassion

In the brutal world of trading and markets, we can often turn in on ourselves, and end up becoming our biggest problem. The ability to stay ...