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The Market's Illusions & The Human Brain

  • #1
  • First Post: Edited Mar 16, 2015 3:26pm Mar 13, 2015 11:22am | Edited Mar 16, 2015 3:26pm
This thread is going to be an ongoing gathering of information in regards to perception & the human brain and how this affects our decisions in the market. The first post is going to be short & sweet with 2 videos but there is a wealth of information to be learned from it.

Is The Market Long or Short?


Is price Bullish or Bearish, & is there even a difference? As you watch this video image you are looking at a chart and trying to determine if it is up and down.

Inserted Video


"Illusions are so powerful that our brains can be fooled by them, even when we know how they work."

You see, the market is always bullish & always bearish. it is all relative to the shadow you are seeing.

Lets talk about Shadows.
Can the market have a shadow and if so, How does the market cast a shadow?
Moving averages. What are moving averages? In my opinion they are the shadow price leaves behind as it moves depending on the light source(size of MA) you choose to use.

Now take a look at how these shadows drastically change our perspective of the movement of price if we are using improper light sources.

Inserted Video


Notice how the changing of the shadow appears to drastically change the movement of the ball, even though the movement of the ball is not what is changing, it's the shadow.

Shadows can be cast if you have a light source in any direction, just like a shadow of price can be cast using any size of MA. If you are not using the proper light source, the movement of the ball is completely different than what it actually is. The key is to use the light source that every one else is looking at, for example the sun. In the case of price, it is to use the time windows most people trade. Daily, 4 Hour and 60 Minute Candles. Your moving averages should represent the time frames every one else is using. They should not be random and curve fitting as this will mask the true movement of the ball or market with false shadows.

sis.
  • #2
  • Mar 13, 2015 11:26pm Mar 13, 2015 11:26pm
The human brain and it's method of evaluating patterns is a great topic.

You may be aware of Troxler Fading.

Attached Image


This illustrates one of the many ways in which the subjective content of conscious awareness can be manipulated. Stare intently at the central cross. After a few seconds, some of the dots should vanish, then return at random moments. The objective stimulus is constant (being the pattern) but it's subjective interpretation in the brain keeps changing.

This example above illustrates what is referred to as conscious access. It is the way our brain decides what is important and what is not. We should be aware of how our brain interprets patterns as it can be questionnable. That's why it is best to leave it to mathematics to pry through the objective domain.

It is why some people see patterns that other people do not. It's why trend traders draw different lines to determine what their brain decides is a trend and so on and so forth. This is where indicators and statistical models can actually help in ensuring a standard definition to a pattern is obtained.
  • #3
  • Mar 15, 2015 10:58am Mar 15, 2015 10:58am
Your Brain is a Lazy Twat!

Attached Image


Your brain is lazy. It is always taking as many short cuts as it can to paint what you know as reality. Most people who read the picture above will say it reads "New York In The Spring." Most peoples brains wont notice that there is two "the"s in the sentence. This is because their brain uses past experiences of reading and safely assumes that the is only presented one time because it almost never would be back to back in a sentence like it is. Your brain taking these little shortcuts affects your ability to notice mistakes, or realize when something isnt right.

Now the question is, how often do these little shortcuts affect our trading causing us to over look little mistakes & errors in our setups?

sis
  • #4
  • Mar 15, 2015 11:00am Mar 15, 2015 11:00am
Quoting Copernicus
The human brain and it's method of evaluating patterns is a great topic. You may be aware of Troxler Fading. {image} This illustrates one of the many ways in which the subjective content of conscious awareness can be manipulated. Stare intently at the central cross. After a few seconds, some of the dots should vanish, then return at random moments. The objective stimulus is constant (being the pattern) but it's subjective interpretation in the brain keeps changing. This example above...

Great share Copernicus. That is another great example to demonstrate how our perception works & how it affects everyone differently even though we are looking at the same thing.

Its a known fact witness testimony is the least reliable source of information in a court of law. This is because every one sees everything different.
  • #5
  • Mar 15, 2015 5:55pm Mar 15, 2015 5:55pm
Quoting Sis.yphus
Your Brain is a Lazy Twat! {image} Your brain is lazy. It is always taking as many short cuts as it can to paint what you know as reality. Most people who read the picture above will say it reads "New York In The Spring." Most peoples brains wont notice that there is two "the"s in the sentence. This is because their brain uses past experiences of reading and safely assumes that the is only presented one time because it almost never would be back to back in a sentence like it is. Your brain taking these little shortcuts affects your ability to notice...

That illustration had me going. Despite recognising that the image would have some deceptive illusory trick I still fell for it with the double 'THE'.

I love pattern recognition and recognise the brain's shortcomings in faithfully interpreting patterns (it's fidelity of translating) but on the other hand, it's propensity to fill in the blanks to achieve coherence is an amazing quality in itself. For example I am actually intrigued by the capacity of the brain to make sense of apparrent gobbledygook. This is illustrated by the urban myth called typoglycemia.

"I cdn'uolt blveiee taht I cluod aulaclty uesdnatnrd waht I was rdanieg: the phaonmneel pweor of the hmuan mnid. Aoccdrnig to a rseearch taem at Cmabrigde Uinervtisy, it deosn't mttaer in waht oredr the ltteers in a wrod are, the olny iprmoatnt tihng is taht the frist and lsat ltteer be in the rghit pclae. The rset can be a taotl mses and you can sitll raed it wouthit a porbelm. Tihs is bcuseae the huamn mnid deos not raed ervey lteter by istlef, but the wrod as a wlohe. Scuh a cdonition is arppoiatrely cllaed Typoglycemia.

The brain naturally seeks to reorder and reshape information received to relate that information to past experiences held in memory. A continual process of receiving informatiion and then comparing that input to a benchmark (memory itself). For the example above provided that the position of the first and last letter of each word are faithfully preserved, the brain can fill in the gaps quickly and rearrange the content.

Once again....thanks greatly for this thread Sis.yphus as it is exceptionally relevant to trading. :-)
  • #6
  • Mar 15, 2015 10:41pm Mar 15, 2015 10:41pm
Quoting Copernicus
{quote} That illustration had me going. Despite recognising that the image would have some deceptive illusory trick I still fell for it with the double 'THE'. I love pattern recognition and recognise the brain's shortcomings in faithfully interpreting patterns (it's fidelity of translating) but on the other hand, it's propensity to fill in the blanks to achieve coherence is an amazing quality in itself. For example I am actually intrigued by the capacity of the brain to make sense of apparrent gobbledygook. This is illustrated by the urban myth...
Im glad you are enjoying the thread Copernicus & keep on sharing!

It is truly amazing what the human brain is capable of doing. Just like stitching together that whole entire paragraph with only 2 letters being correct in each word. These shortcuts our brains take are catch 22s Some of them provide us amazing benefits and others leave us looking foolish. Great find and read Copernicus!
  • #7
  • Mar 16, 2015 3:12pm Mar 16, 2015 3:12pm
The Herd(Do You Know What Direction Your Going to Trade Before You Are Aware Of It?)

Inserted Video


In the experiment, the participants are asked to say a tool and color after they answer a question in under 10 seconds. 80% of the people who do this survey will answer with a red hammer. The Herd. This is because our brains tendency to take short cuts. Our memory is a system of shortcuts we use to store ideas and information. It stores this data in categories like "colors, tools & furniture. Each of these categories has its best example. These examples allow your brain to quickly and efficiently find what it needs with out having to dig through everything you know." The best example of a tool & color for most people is, you guessed it, a red hammer. This is why 80% of the people polled will answer with this.

You can expect 80% of the people to answer with red hammer before you even ask them the question because this is the most common "best example" amongst people.

So how does this relate to our trading?

Well we know around 80%+ of people trading lose. The Herd.
If we want to be profitable we must trade against The Herd.

Now lets take a look at the Pin Bar. The classic price action pattern every one knows & loves. Our Brains "best example" of what a pin bar leads to is likely something like this.

Attached Image


This is what we all know as the picture perfect pin bar. This is the "best example" our brain goes to when ever one appears on the chart.
This is because this is what we all have been taught by every single price action guru on the internet for decades making it the most common "best example" amongst traders...

This applies to all of the classic charting practices preached by a Guru near you.

You can assume that around 80% of people who will be looking at a pin bar in the future, will trade in the direction of the pin bar because this is what we have all been taught, and it is what has been preached for decades. The Herd.

We know around 80%+ of people trading are wrong. The Herd.
If we want to be profitable we must trade against The Herd.

Attached Image

(most of them don't work.)

So is your mind made on which way you are going trade before your setup even presents itself? 80% of peoples are...

sis.
  • #8
  • Mar 16, 2015 3:28pm Mar 16, 2015 3:28pm
hey I have to admit with back testing of chart patterns, from hammers,morning stars, dokis, evening star etc etc
I found they work roughly 50% of the time. Some would say random
Learn, a forex trader must, unlearn and relearn he will.
  • #9
  • Mar 16, 2015 3:34pm Mar 16, 2015 3:34pm
Quoting COGSx86
hey I have to admit with back testing of chart patterns, from hammers,morning stars, dokis, evening star etc etc I found they work roughly 50% of the time. Some would say random
It is hard to say, and even I my self cant say with a sure fact, what % of the time they work because the extent to how often they work will change due to TP and SL placements.
  • #10
  • Edited 7:40pm Mar 16, 2015 7:21pm | Edited 7:40pm
The points you make are exceptionally valid guys. Here is a post from my reading of David Aronson's "Evidence-Based Technical Analysis" who used the scientific method to put to bed views on 6,400 binary buy/sell rules on the S&P 500 using 25 years of historic data. The 6,400 rules capture almost every chart pattern under the sun.

There is hope in there, but it is slamming regarding the use of predictive entry patterns. Of course there are going to be ardent critics but from my own testing over the years this is as clear as crystal. C

http://www.forexfactory.com/showthre...90#post7982490
  • #11
  • Edited 8:14pm Mar 16, 2015 7:56pm | Edited 8:14pm
Sis.yphus, I was reading a post of yours regarding 'Levy Flight' which was a term I was not familiar with but in further investigation, I was extremely interested in the principle. While there is no definitive pattern that can be predicted from this market mechanism, the principle behind it I believe also is reflected by the term 'market drift' that is particularly relevent to trend traders who bias there technique towards the longer term timeframes.

A bias to random walk - Levy Flight
Attached Image



Trade clusters in an otherwise random market seperated in time serve to provide a probabilistic edge that a trend trader can capture in their technique, not through their entry method but simply based on the notion that a probabilistic bias is incorporated in the data from collective action of participants. This principle can be harvested not in prediction itself but in simply riding the wave of price action.

A very small favourable bias through this mechanism will be hard to define in a single instrument but collectively will be magnified through diversification and further magnified through leverage associated with a positive bias. This to me is the exact same principle that is applied to any market action in which trends of significant duration exist.
  • #12
  • Mar 16, 2015 8:10pm Mar 16, 2015 8:10pm
Quoting Copernicus
The points you make are exceptionally valid guys. Here is a post from my reading of David Aronson's "Evidence-Based Technical Analysis" who used the scientific method to put to bed views on 6,400 binary buy/sell rules on the S&P 500 using 25 years of historic data. The 6,400 rules capture almost every chart pattern under the sun. There is hope in there, but it is slamming regarding the use of predictive entry patterns. Of course there are going to be ardent critics but from my own testing over the years this is as clear as crystal. C http://www.forexfactory.com/showthre...90#post7982490...

Great post C! Love reading the information you are sharing and what was said I agree with 100%.

The Levy Flight that is present is the fiscal policy, geopolitical risk, etc just like David Aronson mentioned. This creates times to profit from the market, or the levy flight.

Quoting Copernicus
Trade clusters in an otherwise random market separeted in time serve to provide a probabilistic edge that a trend trader can capture in their technique, not through their entry method but simply based on the notion that a probabilistic bias is incorporated in the data from collective action of participants. This principle can be harvested not in prediction itself but in simply riding the wave of price action.
Exactly. the levy flight bias does not predict future outcomes, but it does provide an insight into which way the bias is tilted. There is always a levy flight. even when the market is most random if that makes sense.

Even when the market is in its most random state, it is not a perfectly balanced system that is truly random and certain sequences are always favored over others. This does not mean it will always happen this way, but this does mean that if you bet accordingly you will beat the market just like Joseph Jagger beat the monte carlo roulette wheels.

Watch the video I posted in this post: http://www.forexfactory.com/showthre...08#post8138908

All though the market is random, just like human flipped light switches are random, it is not a truly random sequence because certain sequences are favored over others. The market will always be decisions made based on humans bidding(even HFT algos are coded to make the decisions of a human mind), therefore it will always be like the random light switch controlled by the human, favoring certain sequences over others.


A little more information on this can found here: http://www.forexfactory.com/showthre...31#post8135531
  • #13
  • Mar 16, 2015 8:17pm Mar 16, 2015 8:17pm
That's great Sis. Thanks for the references. I will devour them tonight. Thanks for bringing these to my attention. This thread is certainly crystallising my viewpoint and I really appreciate it. :-) C
  • #14
  • Edited 1:02am Mar 17, 2015 12:10am | Edited 1:02am
Sis you might like this website from an expert in the field of managed futures trading.

In a nutshell, the research dispels a hell of a lot of myths in the market. It is not simply heresay but backed up with significant empirical testing.

In a nutshell the website features the trend following techniques employed by the most successful hedge fund managers in the world and it is clear from the analysis contained therein if you spend some time in it, that it is diversification that counts as opposed to the technique itself.

In his book which is a great read he examines two very simple trend following strategies across a spectrum of commodity sectors that have an extensive back-test history and clearly demonstrates how sustainable and profitable trading actually works. These two strategies (one in the market at all times) versus a Donchian Breakout strategy clearly reflect that the choice of strategy or the entry is not the reason for the success. In fact have a look at this simple strategy that demonstrates this viewpoint. Note that no rules have been placed for stops in this simple strategy but this is attributed to the fact that with a large diversified portfolio, their use becomes an obstacle for performance. Without the prerequisite diversification however (and I am talking significant diversification here on say 50 plus instruments) with say 0.5% capital risk per trade, having stops in place is essential.

The chief determinant of sustainability is the diversification across instruments working with a very small positive bias that we have been discussing in this thread. The reason for this is that on a single instrument, over the course of history you are likely to receive drawdowns of up to 50-60% to achieve consistant returns of +20% per annum. All traders should look at this carefully and see how far out of whack the general consensus on sites such as this are. By having a diversified range of instruments, the composite result allows for this regular significant drawdown on a single instrument but across non-correlated instruments, the result is dramatically diluted (provided the positive correlation is not excessive).

It is exceedingly hard to get neutral correlation as the global market place is progressively becoming more correlated so the aim in diversification is to reduce positive correlation as much as possible to dilute the impact of poor trading periods for trend traders.

I have found the same result in the back-testing I have done on my approach which only has 27 months of testing under it's belt.

Red flags to a bull (that go against the statistical empirical evidence) for a seasoned statistician are the following statements you frequently hear made by traders:

  1. Don't trade a particular session and only trade these particular sessions;
  2. Only trade this technique on the following instruments;
  3. Only trade a single instrument as it is essential that you get to know this instrument;
  4. This pattern predicts this outcome;
  5. It is the entries that are the chief determinant of success in any trading strategy
  6. etc, etc, etc...........

As you and I know it is essential that you treat these style of statements with a grain of salt and ensure that you spend the time to validate wheher or not such statements are legitimate.

  • #15
  • Mar 17, 2015 4:17am Mar 17, 2015 4:17am
Quoting Sis.yphus
Watch the video I posted in this post: http://www.forexfactory.com/showthre...08#post8138908 All though the market is random, just like human flipped light switches are random, it is not a truly random sequence because certain sequences are favored over others. The market will always be decisions made based on humans bidding(even HFT algos are coded to make the decisions of a human mind), therefore it will always be like the random light switch controlled by the human, favoring certain sequences over others. A
Great video demonstration Sis. This thread is nailing it for me and allows me to rid myself of those damn human biases. I am going to say ta-ta to my Support/Resistance lines in my approach as they just muddy the water, delay my entry into some great trends and I have always been suspicious that I read to much into them. Fartist nailed it for me as well in one of his threads. :-)
  • #16
  • Mar 17, 2015 5:26am Mar 17, 2015 5:26am
Quoting Sis.yphus
Watch the video I posted in this post: http://www.forexfactory.com/showthre...08#post8138908 All though the market is random, just like human flipped light switches are random, it is not a truly random sequence because certain sequences are favored over others. The market will always be decisions made based on humans bidding(even HFT algos are coded to make the decisions of a human mind), therefore it will always be like the random light switch controlled by the human, favoring certain sequences over others. A little more information...
That's absolutely true! In a Market we can observe a similar non-uniform distribution of the sequences of price action which proves that the market is not truely an efficient random system. A Gaussian distribution is the closest model to fit to the price-changes, though.
Trading is the hardest way to make easy money...
  • #17
  • Mar 17, 2015 5:51am Mar 17, 2015 5:51am
Quoting MathTrader7
{quote} That's absolutely true! In a Market we can observe a similar non-uniform distribution of the sequences of price action which proves that the market is not truely an efficient random system. A Gaussian distribution is the closest model to fit to the price-changes, though.
Thanks for that MathTrader7. More info for those inclined in relation to Fat-Tailed Distributions. :-)
  • #18
  • Mar 17, 2015 6:56am Mar 17, 2015 6:56am
Thanks sis.yphus for the interesting stuff. Loving it.
Make everything as simple as possible, but not simpler.
  • #19
  • Mar 17, 2015 8:15am Mar 17, 2015 8:15am
Quoting Copernicus
Sis you might like this website from an expert in the field of managed futures trading. In a nutshell, the research dispels a hell of a lot of myths in the market. It is not simply heresay but backed up with significant empirical testing. In a nutshell the website features the trend following techniques employed by the most successful hedge fund managers in the world and it is clear from the analysis contained therein if you spend some time in it, that it is diversification...

Thank you for bringing this guy to my attention C, I was up late last night reading all of the stuff you were linking me.

Very interesting reads. It is always fascinating to see proof of how keeping it simple can really create a solid equity curve. I also can not thank you enough for bringing the idea of diversification to my attention. It is amazing to see how much it smoothed out the equity curve compared to each of the individual instruments. I have always thought it was better to trade more pairs than less as to not "marry the stock" so to say and it is nice to see some proof that this will help cover the draw down from the other instruments.

I too have started to notice that a lot of the stuff you hear preached on the internet, is the opposite of what you want to do. One of my favorite of the myths is that a trader should size out when the trend is moving in his favor... This is CRAZY! lol

My other favorite is the one you said, "the most important part is the entry". Entries don't make any money, exits do.

Quoting Copernicus
{quote} Great video demonstration Sis. This thread is nailing it for me and allows me to rid myself of those damn human biases. I am going to say ta-ta to my Support/Resistance lines in my approach as they just muddy the water, delay my entry into some great trends and I have always been suspicious that I read to much into them. Fartist nailed it for me as well in one of his threads. :-)
Im glad you you are liking the thread and want to thank you for participating in it with me. I like that video a lot too because it is a great way to demonstrate the difference between truly random sequences, and human controlled "random" sequences. a Coin Flip vs the Market.

I was reading his thread last night since you linked it to me and really liked his approach. It seems like he gets the idea of keeping it simple. And its always good to see another trader realizing that S/R levels, Fibs, etc are no different than random horizontal lines on the chart. It amazes me how much faith some people will put into these things when they are really 50/50 at best.

sis.
  • #20
  • Mar 17, 2015 8:48am Mar 17, 2015 8:48am
Trend or Counter Trend?(Is The Market Long or Short? - Continued)
Quoting Sis.yphus
Is The Market Long or Short? https://www.youtube.com/watch?v=XGG01xTYSoo
Is this trade with the Trend, or Counter Trend?
Again does it matter??

2 Trades From This Morning(About 30 Minutes Ago).

Trend Entry(+33.9 Pips)

Attached Image


Counter Trend Entry(+19.8 Pips)

Attached Image


Whether you entering with or against the trend makes no difference. What makes all the difference is if you exit with a profit or a loss. This is because trends, like shadows, are relative to the time it is contained in(light source). A Counter trend trade on the 5 Minute chart is likely a trend trade on the tick. It is all relative.

sis.
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