Artice from Trading Game Newsletter - June 2006 (http://www.tradinggame.com.au)
Tate on Trading
I've just finished reading an intriguing book on trading. In fact, it's one of the better trading related books I've encountered. The most interesting feature of this book is its title - 'On the Psychology of Military Incompetence' by Norman Dixon. As you would expect, this book doesn't mention trading at all. Its aim is to look at some of the various catastrophes brought about by some of the most incompetent military minds in history. Men whose idiocy is on a galactic scale and whose follies resulted in an extraordinarily tragic waste of life.
In analysing each of these failures and the psychology of those responsible for them Dixon has come up with a set of characteristics that are strikingly similar to the characteristics found in poor traders. He found fourteen common characteristics in these individuals and, as you would expect, he found these characteristics lacking in successful military commanders.
Whilst I reject the notion that trading is akin to war, despite this being an analogy that many people falsely cling to, Dixon's profile is extremely instructive.
In looking at the things he found, I will use his terms and see how they might also apply to trading.
1. A serious wastage of human resources and a failure to observe one of the first principles of war - economy of force.
"If I buy 1,000 of XYZ that's good, but if I buy 10,000 of XYZ that will be ten times better". On the whole, traders fail to understand the nature of engaging the market on prudent practical grounds. Position sizing and the related notions of diversification, in many ways, are designed to insulate us from this folly. The lack of acceptance of this notion is evidenced by the fact that the majority of Australia's six million shareowners have all their capital in one stock. Bad luck for most of them that it is Telstra.
2. A fundamental conservatism and clinging to outmoded traditions.
This is an interesting notion since it highlights the desire in all of us to resist change and to cling to the past either real or imagined. I have often seen this manifest itself in traders via their refusal to adopt new ways of thinking about such techniques as stops. The majority of traders still refuse to use stops. The excuse I generally get is "I know I should take my stops but the last time I did I lost money and then the stock rebounded so therefore it is wrong to use stops".
3. A tendency to reject or ignore information that is unpalatable.
This is known as 'cognitive dissonance' or 'information cherry picking'. Traders will select only that information which confirms an existing viewpoint and will reject any information that conflicts with the original point of view. Interestingly traders will also assign greater weight to information that confirms their viewpoint. Sources that confirm their view become gurus and by definition they think of themselves in those terms. This is idiocy by association.
4. A tendency to underestimate the enemy and to overestimate the capabilities of one's own side.
In trading it would initially seem that we don't have an enemy. We can't compete with the market and we don't really compete with other traders. In this respect trading is most like golf. In golf you don't really compete against the course since it is only the environment you play within. Also you don't compete against other golfers, since their activities do not directly impact upon your play.
However, we have a silent enemy - our own subconscious and our inability to deal with its influence upon us when we trade. Within many there is a strong fear of success for whatever reason, be it family or ethnic background. There may be a feeling of not deserving what might come from success or simple inability to conceive of a different future. Whatever the reason it highlights the notion that trading is a psychological endeavour and success or failure rests upon that and not which moving average you use.
Traders also have a stunning opinion of their own ability - particularly traders who have never traded. Those who have played with back testing engines tend to be in a class all of their own. Consider for a moment the notion of intra day trading currencies. The evidence both anecdotal and quantitative indicates that the failure rate among such traders is as high as 95%. Yet everyday traders are drawn to the FX market in the belief that they are somehow special and that these statistics do not apply to them. Consider this, if the next time you crossed the road and you only had a 5% chance of making it to the other side alive would you not reconsider your crossing?
5. Indecisiveness and a tendency to abdicate the role of decision-making.
Most people are, by design or choice, 'order takers'. They await instruction particularly from what they regard as a 'higher authority'. In trading this manifests itself as the inability to take the first signal. The common excuse is that they need to wait for some form of confirmation, whatever that may be. As the old saying goes - nobody rings a bell at the bottom or the top of the market.
In an intriguing paradox, confirmation for these traders generally comes in the form of a signal in the opposite direction and then they take the signal in the original direction.
In addition to these there is the need to seek outside counsel from what is perceived to be a higher authority such as a broker, fund manager or the like.
6. An obstinate persistence in a task despite evidence to the contrary.
Need I say any more about stops and their importance? If you don't get it then you never will.
7. A failure to exploit a situation gained and a tendency to pull punches rather than press home an attack.
Trading is a difficult endeavour and traders look for any excuse to either not take a signal or to pre-emptively leave a position. We often console ourselves with comfort phrases such as "you can never go broke taking a profit" or that "you should leave some on the table". (It's almost as if trading were some form of charity where you were judged by how generous you were to the person next to you).
All trading systems must seek to exploit extended moves since they are much less common than traders imagine. This is generally done via pyramiding, either by buying additional stock or by building a surrogate position via derivatives. When a position is going in your direction you should not take profits. You should buy more and keep buying more until the movement reverses. As George Soros is famously quoted as saying after giving the Bank of England a serious touch up - "You need to know when to be a pig."
8. A failure to make adequate reconnaissance.
Me: Why the hell did you buy these?
My brother-in-law: Because the bloke in the pub said they were going to $10.00
Me: Idiot
9. A predilection for frontal assaults often against the enemies strongest point.
If you have a look at any chart of an instrument that is trending down and you plot volume against it you will notice that there is activity all the way down. The intriguing thing is that there are lunatics out there who throw themselves in front of an instrument that is clearly trending in the opposite direction to which they believe it should be going as if by force of positive thinking they can reverse the trend.
When I used to work in broking I often spent a lot of time on the old Melbourne trading floor. On the floor I used to watch a curious spectacle among the various male operators/brokers. They would stick their hands in their pockets, grab hold of whatever was in there, thrust their hips forward and begin buying stocks that were clearly falling. As if somehow a show of testosterone and gonad grabbing would reverse the fall.
10. A belief in brute force rather than a ruse.
See above
11. A failure to make use of surprise or deception.
Whilst we cannot deceive the market we can, through use of a trading plan, deceive our subconscious. The subconscious cannot tell reality from fantasy, therefore, it can be programmed to behave in a way that is conducive to aiding us instead of hindering us.
12. An undue readiness to find scapegoats for military set backs.
My broker/shares magazine/that peanut on the TV made me do it.
13. A suppression or distortion of news from the front usually rationalised as necessary for morale or security.
In many ways this relates to the earlier point about the weighting of information that supports an original point of view. However it may also apply to the notion of simply ignoring stocks that have moved strongly against you. Traders will simply stop looking at positions that have gone bad in the belief that if you cant see it then it no longer exists. If you have ever played hide and seek with a three year old, they have the same view - if they can't see you then you can't see them.
14. A belief in mystical forces.
Magical thinking is one of the banes of the late 20th century and early 21st century. Some 300 years after the Age of Enlightenment fuzzy or magical thinking still preoccupies people. It raises its head in the form of such nonsense as Gann, astrology and phases of the moon. It even appears in trading journals and magazines where people bang on about problems caused by Uranus. This is despite overwhelming evidence that such concepts are nonsense.
In my opinion such thinking cannot be quarantined from day to day activity since it demonstrates a world-view that is no different from that of a peasant farmer circa 500AD. If you cannot think logically in all forms of endeavour then you will not be able to think logically about trading.
It shouldn't be a surprise that failure in an area such as the military displays such parallels with failures in trading. Human psychology and the capacity for incompetence are inescapable in all ventures. We cannot divorce the way we behave from the activities we undertake as we don't have a set psychological make up for differing environments - we have a single set of programming that we need to somehow learn to optimise to avoid failure.
- Chris Tate
Tate on Trading
I've just finished reading an intriguing book on trading. In fact, it's one of the better trading related books I've encountered. The most interesting feature of this book is its title - 'On the Psychology of Military Incompetence' by Norman Dixon. As you would expect, this book doesn't mention trading at all. Its aim is to look at some of the various catastrophes brought about by some of the most incompetent military minds in history. Men whose idiocy is on a galactic scale and whose follies resulted in an extraordinarily tragic waste of life.
In analysing each of these failures and the psychology of those responsible for them Dixon has come up with a set of characteristics that are strikingly similar to the characteristics found in poor traders. He found fourteen common characteristics in these individuals and, as you would expect, he found these characteristics lacking in successful military commanders.
Whilst I reject the notion that trading is akin to war, despite this being an analogy that many people falsely cling to, Dixon's profile is extremely instructive.
In looking at the things he found, I will use his terms and see how they might also apply to trading.
1. A serious wastage of human resources and a failure to observe one of the first principles of war - economy of force.
"If I buy 1,000 of XYZ that's good, but if I buy 10,000 of XYZ that will be ten times better". On the whole, traders fail to understand the nature of engaging the market on prudent practical grounds. Position sizing and the related notions of diversification, in many ways, are designed to insulate us from this folly. The lack of acceptance of this notion is evidenced by the fact that the majority of Australia's six million shareowners have all their capital in one stock. Bad luck for most of them that it is Telstra.
2. A fundamental conservatism and clinging to outmoded traditions.
This is an interesting notion since it highlights the desire in all of us to resist change and to cling to the past either real or imagined. I have often seen this manifest itself in traders via their refusal to adopt new ways of thinking about such techniques as stops. The majority of traders still refuse to use stops. The excuse I generally get is "I know I should take my stops but the last time I did I lost money and then the stock rebounded so therefore it is wrong to use stops".
3. A tendency to reject or ignore information that is unpalatable.
This is known as 'cognitive dissonance' or 'information cherry picking'. Traders will select only that information which confirms an existing viewpoint and will reject any information that conflicts with the original point of view. Interestingly traders will also assign greater weight to information that confirms their viewpoint. Sources that confirm their view become gurus and by definition they think of themselves in those terms. This is idiocy by association.
4. A tendency to underestimate the enemy and to overestimate the capabilities of one's own side.
In trading it would initially seem that we don't have an enemy. We can't compete with the market and we don't really compete with other traders. In this respect trading is most like golf. In golf you don't really compete against the course since it is only the environment you play within. Also you don't compete against other golfers, since their activities do not directly impact upon your play.
However, we have a silent enemy - our own subconscious and our inability to deal with its influence upon us when we trade. Within many there is a strong fear of success for whatever reason, be it family or ethnic background. There may be a feeling of not deserving what might come from success or simple inability to conceive of a different future. Whatever the reason it highlights the notion that trading is a psychological endeavour and success or failure rests upon that and not which moving average you use.
Traders also have a stunning opinion of their own ability - particularly traders who have never traded. Those who have played with back testing engines tend to be in a class all of their own. Consider for a moment the notion of intra day trading currencies. The evidence both anecdotal and quantitative indicates that the failure rate among such traders is as high as 95%. Yet everyday traders are drawn to the FX market in the belief that they are somehow special and that these statistics do not apply to them. Consider this, if the next time you crossed the road and you only had a 5% chance of making it to the other side alive would you not reconsider your crossing?
5. Indecisiveness and a tendency to abdicate the role of decision-making.
Most people are, by design or choice, 'order takers'. They await instruction particularly from what they regard as a 'higher authority'. In trading this manifests itself as the inability to take the first signal. The common excuse is that they need to wait for some form of confirmation, whatever that may be. As the old saying goes - nobody rings a bell at the bottom or the top of the market.
In an intriguing paradox, confirmation for these traders generally comes in the form of a signal in the opposite direction and then they take the signal in the original direction.
In addition to these there is the need to seek outside counsel from what is perceived to be a higher authority such as a broker, fund manager or the like.
6. An obstinate persistence in a task despite evidence to the contrary.
Need I say any more about stops and their importance? If you don't get it then you never will.
7. A failure to exploit a situation gained and a tendency to pull punches rather than press home an attack.
Trading is a difficult endeavour and traders look for any excuse to either not take a signal or to pre-emptively leave a position. We often console ourselves with comfort phrases such as "you can never go broke taking a profit" or that "you should leave some on the table". (It's almost as if trading were some form of charity where you were judged by how generous you were to the person next to you).
All trading systems must seek to exploit extended moves since they are much less common than traders imagine. This is generally done via pyramiding, either by buying additional stock or by building a surrogate position via derivatives. When a position is going in your direction you should not take profits. You should buy more and keep buying more until the movement reverses. As George Soros is famously quoted as saying after giving the Bank of England a serious touch up - "You need to know when to be a pig."
8. A failure to make adequate reconnaissance.
Me: Why the hell did you buy these?
My brother-in-law: Because the bloke in the pub said they were going to $10.00
Me: Idiot
9. A predilection for frontal assaults often against the enemies strongest point.
If you have a look at any chart of an instrument that is trending down and you plot volume against it you will notice that there is activity all the way down. The intriguing thing is that there are lunatics out there who throw themselves in front of an instrument that is clearly trending in the opposite direction to which they believe it should be going as if by force of positive thinking they can reverse the trend.
When I used to work in broking I often spent a lot of time on the old Melbourne trading floor. On the floor I used to watch a curious spectacle among the various male operators/brokers. They would stick their hands in their pockets, grab hold of whatever was in there, thrust their hips forward and begin buying stocks that were clearly falling. As if somehow a show of testosterone and gonad grabbing would reverse the fall.
10. A belief in brute force rather than a ruse.
See above
11. A failure to make use of surprise or deception.
Whilst we cannot deceive the market we can, through use of a trading plan, deceive our subconscious. The subconscious cannot tell reality from fantasy, therefore, it can be programmed to behave in a way that is conducive to aiding us instead of hindering us.
12. An undue readiness to find scapegoats for military set backs.
My broker/shares magazine/that peanut on the TV made me do it.
13. A suppression or distortion of news from the front usually rationalised as necessary for morale or security.
In many ways this relates to the earlier point about the weighting of information that supports an original point of view. However it may also apply to the notion of simply ignoring stocks that have moved strongly against you. Traders will simply stop looking at positions that have gone bad in the belief that if you cant see it then it no longer exists. If you have ever played hide and seek with a three year old, they have the same view - if they can't see you then you can't see them.
14. A belief in mystical forces.
Magical thinking is one of the banes of the late 20th century and early 21st century. Some 300 years after the Age of Enlightenment fuzzy or magical thinking still preoccupies people. It raises its head in the form of such nonsense as Gann, astrology and phases of the moon. It even appears in trading journals and magazines where people bang on about problems caused by Uranus. This is despite overwhelming evidence that such concepts are nonsense.
In my opinion such thinking cannot be quarantined from day to day activity since it demonstrates a world-view that is no different from that of a peasant farmer circa 500AD. If you cannot think logically in all forms of endeavour then you will not be able to think logically about trading.
It shouldn't be a surprise that failure in an area such as the military displays such parallels with failures in trading. Human psychology and the capacity for incompetence are inescapable in all ventures. We cannot divorce the way we behave from the activities we undertake as we don't have a set psychological make up for differing environments - we have a single set of programming that we need to somehow learn to optimise to avoid failure.
- Chris Tate
