To function and exist in society, we as human beings operate under a social paradigm or level of social conditioning that allows this to occur relatively smoothly for the vast majority. As traders and active investors in the markets however, these same paradigms can often be detrimental to our success and profitability. The decisions we make in society ‘usually’ conform to a general set of criteria or guidelines that serve in these social environments. These include such concepts as being right, not wanting to be a loser, going with the flow, accepting the decisions of ‘experts’, and a wide variety of other societal norms. These decision making processes have quite the opposite effect when applied to the markets. Adjustments need to be made in order to accept such market paradigms as being a loser (sometimes quite often), buying high and selling higher, cutting losing positions and many others. Implementing a decision making process that is empathetic with the market takes time and effort to learn and apply, and many of these decisions will be contra to what we have learnt as acceptable from a societal perspective.
So, how do we arrive at the decisions we make? What are the thought patterns we establish, the influences we take on board?
The following excerpts are taken from a modern psychology book on the subject of human decision making. The book is “Psychology, Themes and Variations” by Wayne Weiten, 2001, Wadsworth.com.
“Most people try to be systematic and rational in their decision making. Most traditional theorists in economics assumed that people made rational choices to maximise their economic gains. Herbert Simon, winner of the Nobel Prize for Economics in 1978, demonstrated that people have a limited ability to process and evaluate information on numerous facets of possible alternatives. Thus, Simon’s theory of bounded rationality asserts that people tend to use simple strategies in decision making that focus on only a few facets of available options and often result in irrational decisions that are less than optimal.”
“Many decisions involve choices about preferences. In selecting alternatives that reflect preferences, people generally weigh known outcomes (apartment A will require a long commute to campus, car B will get 30 miles to the gallon, and so forth). In contrast, risky decision making involves making choices under conditions of uncertainty. Uncertainty exists when people don’t know what will happen. At best they know the probability that a particular event will occur.”
Wayne Weiten also says:
• “The availability heuristic involves basing the estimated probabilities of an event on the ease with which relevant instances come to mind.”
• “The human mind is wired to think in terms of raw frequencies rather than base rates and probabilities.”
• “Evolutionary theorists also argue that the human mind is wired to count the frequency of whole objects, actions and events rather than parts.”
From a trading perspective this means that traders easily identify with accumulating counts of events, such as “I had six losses out of 10 trades”. This will have far more significance to a trader who has not yet conditioned his/her mind to think like a trader. Add to this the fact that the human mind is hard-wired to avoid emotional pain. Conditioned by living in society for many years, the trader associates losing trades with emotional pain. Six losses out of 10 will cause immense psychological conflict. Resolving this so that such a situation no longer causes conflict but indeed is perceived as a natural occurrence, requires a transition process that changes the current wiring of your mind.
Traders with unconditioned minds will have even more difficulty comprehending the role different size winning trades and different size losing trades play in their potential for success. This is because people who think like a trader are required to think in terms of the parts rather than the whole. They must combine the parts of winnings and the parts of losses with the actual count of the winners and losers to determine whether they have odds in their favour of winning on an ongoing basis. This requires thinking in parts on two dimensions.
And as these psychological researchers have found this is unnatural for human beings and hence requires much effort and learning to change.
