Decision-Making

The following excerpts are from Stephen Jay Gould's Full House.

People under assault, and hopelessly overmatched, often do the opposite of what propriety might suggest: they dig in when they ought to accommodate. We call this behavior siege mentality. Davy Crockett, Jim Bowie, and Co. won posthumous immortality by their intransigence at the Alamo, but an honorable surrender (given their hopeless situation and the certainty of carnage with continued fighting) might have secured the more worldly privilege of telling good war stories over a beer at a Texan bar (for independence from Mexico would have been won in any case) some twenty years later. The embattled traditionalist [buy and holder] must therefore stand his ground on the right tail of his natural habitat. He must adopt a siege mentality and dig in to protect his own restricted turf. The right tail, he must now admit may be small and merely consequential. But grant me, he pleads, this last potential natural comfort: 'May I not at least be a king in my own restricted castle?' Give me, then, at least, this one remaining solace in a parody of a fine old song: 'It had to be me, wonderful me; it had to be me.' Let me, in short, live like Pio Nono (the nineteenth-century Pope Pius IX). My predecessors held temporal power over much of Europe. I once ruled a good part of Italy, though I am now confined to a tiny principal - Vatican City - within Rome. But at least my rule here is absolute and I can proclaim my infallibility!
Stephen Jay Gould

TurtleTrader comment: Gould makes the clear point on human psychology: Most people do not want to reach outside their knowledge area (or comfort zone). What most people want (at often the expense of their best interest) is their own little kingdom. Not a good way to be if you desire to profit from the market.

Human Culture

A potential for inherent progress provides no guarantee of realization in actuality. The radical contingency of all history can intervene in a thousand potential ways. A capacity for technological accumulation does not guarantee that all cultures will avail themselves of this potentially mixed blessing. In fact, several great societies have made conscious decisions not to pursue technological progress to the inevitable destruction of an old order. At a crucial point in the history of human life, imperial China decided to scrap the technology of interoceanic shipping and navigation that, if pursued, might well have converted the central historical theme of European westward expansion to an alternative tale of Oriental eastward exploration in the New World. In the early 1640s, after a century of relative openness to Western inventions, especially to the musketry that permitted their assumption and consolidation of power, Japan's ruling Tokugawa shogunate severed all future accumulation and banned most of what had been imported. So complete and sudden was the cutoff that Japanese inhabitants of various trading cities established abroad were not even allowed to return home. All Western trade was reduced to the merest trickle. Only two Dutch ships could arrive each year. They could dock only at Nagasaki, and all Dutch traders had to live on the artificial island of Dejima, connected to the rest of Nagasaki by a narrow and easily guarded causeway.
Stephen Jay Gould

TurtleTrader comment: There are many reasons when people are faced with better opportunities (or strategies) they run the other direction. Good traders take advantage of that weakness. Even if you think you are avoiding the fight, you still lose. The fact that one doesn't want to face reality doesn't make reality go away.

Read Gould's Full House.

Clayton Christensen

The Innovator's Dilemma by Clayton M. Christensen is a great read for Trend Followers. Christensen recently offered in an interview:

They were looking at the book [Innovator's Dilemma] for answers rather than for understanding. They were saying 'tell me what to do' as opposed to 'help me understand so I can decide what to do.'...[Wall Street analysts] are theory-free investors. All they can do is react to the numbers. But the numbers they react to are measures of past performance, not future performance. That's why they go in big herds. Wall Street professionals and business consultants have enshrined as a virtue the notion that you should be data-driven. That's at the root of the inability of companies to take action in a timely way.

Christensen clearly outlines a key tenet of the Trend Following mindset. Trend Following is never based on having all the data. It's based on odds and reaction. Think about it. If you look at a stock such as Yahoo and witness its great rise and decline you can say 'you should have bought here and sold there'. But isn't that 20/20 hindsight? No, you simply needed a trading plan of attack before the great rise up and great decline down.

What Christensen is driving at is the notion that you must be able to make decisions in the face of not knowing how the trend will look when it's all over. You must have a plan to act early before trend direction is obvious to the masses. You must be set and ready to go (and entered) long before the CNBC watchers decide the trend is underway and jump on. Those people are always a day late and a dollar short. Those people are the herds Christensen alludes to. Those people don't make the money, they lose it. And given that trading is a zero-sum game, the money that those people lose goes directly to the other people with the plans of attack designed to win their losses.

Obey Price

We know that prices move up and down. They always have and they always will. My theory is that behind these major movements is an irresistible force. That is all one needs to know. It is not well to be too curious about all the reasons behind price movements. You risk the danger of clouding your mind with non-essentials. Just recognize that the movement is there and take advantage of it by steering your speculative ship along with the tide. Do not argue with the condition, and most of all, do not try to combat it.

Jesse Livermore

The market reflects all the jobber knows about the condition of the textile trade; all the banker knows about the money market, all that the best-informed president knows of his own business, together with his knowledge of other businesses; it sees the general condition of transportation in a way that the president of no single railroad can ever see. It is better information on crops than the farmer or even the Dept of Ariculture. In fact, the market reduces to a bloodless verdict [THE PRICE] all knowledge based on finances, both domestic and foreign.
Charles Dow

In response to questions concerning his opinion on where individual markets may be headed:

I don't know nor do I care. The system that we use at Chesapeake is about the market knowing where it's going.

Jerry Parker

What interests me is the question of how humans learn to live with uncertainty. Before the scientific revolution determinism was a strong ideal. Religion brought about a denial of uncertainty, and many people knew that their kin or their race was exactly the one that God had favored. They also thought they were entitled to get rid of competing ideas and the people that propagated them. How does a society change from this condition into one in which we understand that there is this fundamental uncertainty? How do we avoid the illusion of certainty to produce the understanding that everything, whether it be a medical test or deciding on the best cure for a particular kind of cancer, has a fundamental element of uncertainty?
Gerd Gigerenzer
Edge.org

Read Full Article Here ...

Commentary that addresses heuristics:

...we often get the recurring question: why is your method successful? This is especially the case when there is so much fundamental information available to use in making decisions. We think that our success has been based on simplicity; nevertheless, there often is a bias by some investors away from the simple manager in favor of those who discuss and try to account for the complexity of markets. To some, simple means unsophisticated; but there is a growing body of research work which suggests that simple methods of decision-making actually outperform their more complex alternatives. This certainly may seem counter-intuitive; but in a complex world where decisions have to be made with limited information and face real world time constraints, there may not be the ability to optimize over all possible alternatives. Under the real life situations faced by a trading firm, there is a premium on "fast and frugal" decision-making or heuristics. Fast decision-making is often based on just a few cues or inputs that may seem relevant. There is actually value in not using too much information. Researchers have found through testing that simple decision rules often can perform as well or better than more sophisticated forms of decision-making - especially when there is a high degree of uncertainty.
Market Commentary

There is a constant barrage of information; but often this information can be conflicting and, in some cases, does not come out with the frequency that we would like. For example, monetary policy can serve as a simple case. There are only a limited number of Fed meetings a year; however, this is supposed to help us infer the direction of interest rates and help us manage risk on a daily basis. How do you manage risk in markets that move 24 hours a day, when the fundamental inputs do not come frequently? In the grain markets, crop reports are fairly limited, and demand information comes with significant lags, if at all. How can this information be best incorporated in the daily price action? Under these types of conditions, simple approaches, such as following prices, may be better. In reality, our desire for effective decision-making is based on a simpler cue. Is the market going up or down? Has each position lost a predetermined amount of capital on a trade? We do not worry about trying to decipher all of the particulars of the market when action is required. In that case, the trend may be more than sufficient as a cue of what to do. It may actually be preferred to other information. Something to think about the next time you listen to a manager talking about the complexity of his thought processes as the indicator of his expertise as a manager. Signals are built into the market price...
Market Commentary

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Why Important?
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The biggest secret about success is that there isn't any big secret about it, or if there is, then it's a secret from me, too. The idea of searching for some secret for trading success misses the point.
Ed Seykota

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One of the common struggles in new and experienced traders is outlined in this excerpt:
We also prefer the complex and artificial to the simple and unadorned. We are certain that investment success requires an incredibly complex ability to judge a host of variables correctly and ...

The ability to make decisions when faced with an assortment of opportunities and choices is central to Trend Following success. The following links must be read by all:

1. Example Heuristics (PDF)

2. Smart Heuristics by Gerd Gigerenzer

We have long posted decision-making links for trading. The following excerpts from The New York Times continues that tradition:

When Justine Henin-Hardenne rips a cross-court forehand at the Australian Open or Tom Brady, the ...

Last year Moneyball introduced statistical thinking for baseball to the masses. Now Wayne Winston and Jeff Sagarin are applying "numbers" to basketball in a way people will not expect:

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