2012/01/26

Blink and trade

I just finished reading the (highly recommended) book Blink by Malcolm Gladwell. It is about those decisions humans can make instantaneously, without conscious thought. It’s about when this works extremely well, and when it fails, sometimes with horrible consequences. My own decisions are the opposite of snap judgements. I consider everything with extreme care, perhaps too much care. Traders often do not have that luxury, especially not, I think, pit traders. What interests me then, is to what extent traders rely on snap judgements and is this a good thing?

Traders, war games and money

Gladwell relates a tale about General Van Riper, at a time when the US government was conducting very expensive war games. Van Riper thought there was something to be learnt from trading, and so the army played some trading games. What is more, he took some traders to play war games and found that they were very good. They were able to make the rapid assessments under high pressure that were needed. It was clear that the army and traders were “fundamentally engaged in the same business – the only difference being that one group bet on money and the other bet on lives.” George Soros, reportedly, owes much of his success to this kind of instinctive decision-making. His back starts to hurt and he changes his market position.

The good, the bad, the ugly

Blink decisions can be very good. They avoid over-analysis. They allow people to react within the necessary amount of time. And they can, under the right circumstances, be as good or better than decisions made with careful and tiresome deliberation.

The problem, of course, is getting those right circumstances. Snap judgements can fail horribly, such as when a policy officer shoots an unarmed suspect, seeing a gun that was never there. But such snap judgements can also allow you to avoid getting killed. In general, experience and practice, allow for better snap judgements. Is it thus possible for traders to get a feel for the markets based on their experience, a sense, a tingling, that they cannot perhaps explain, that allows them to avoid losses or make profits?

The problem is that markets are so very random. The information a trader sees is peppered with irrelevancies. There is, perhaps, no pattern. Our brains are very good at sifting through information and focussing on what’s really important. But it can also get fooled. I am not sure whether the markets are more likely to fool the brain or not. All the evidence for biases in human decision-making would suggest caution is warranted.

It is usually thought that deliberated decisions should be at least as good as snap judgements. This is often not the case. We can get swamped by information. We make errors because we cannot identify what is truly relevant. We get distracted by things we might be better off not considering. In the markets, more information is not necessarily better. Much of it is irrelevant, meaningless, in any case.

Snap judgements, of course, cannot be scrutinised. The mechanisms behind them are hidden from our conscious minds. We cannot, rationally, justify them. “I had a feeling,” is not a good enough explanation for entering a trade that lost a lot of money. And, even if some traders were good at making such snap decisions, not all of them would be. It might be hard to distinguish them.

Final word

I do not think this is a topic which has been much studied. I can, therefore do little but pose some interesting questions. Are trader snap judgements good? Can they be improved with training or by changing the environment in which those decisions are made (such as limiting the information a trader sees)? Should traders rely more or less on snap judgements?

Reference

Gladwell, M. (2005). Blink. New York: Little, Brown and Company.

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