Dec

30

Memory, from Duncan Coker

December 30, 2010 |

 The Chair offers a meal in the ideas of forgetting and trying to start fresh in trading every day, week, month. In my case I tend to remember and overweight the large losses and not the average gains. This leads to trading too infrequently and then being subject to adverse selection. Sometimes forgetting is a good thing. This past year it would be hard to forget the intra hour move of 10% in May, or intra month move of 25% in Oct 2008. Though they deserve some consideration, their likelihood of occurring again is probably overweighted for me. I am reading a book called Waves where it documents a 1700 foot wave that hit Lituya Bay Alaska in 1958. How many fishermen would ever venture out if they dwelled on the past too much? I have found in tennis, I often play better after a period of not playing, as I forget my bad habits. For some reason I manage to remember the core fundamentals. This affect unfortunately wears off when the dreaded reversion to the mean takes hold.

Ralph Vince comments: 

Interesting observation Duncan. I am of a similar mindset, have been working with the idea the past 12 months and have drawn the conclusion therefrom that "expectation," the probability-weighted sum of possible outcomes, aka "Mathematical Expectation," of what might happen, is not only NOT how human beings asses risk-opportunities, and rightly so. If we did, the analogy I like to use is, we would never board a flight.

But we DO board a flight, knowing there is an incredibly small probability of never arriving at our destination. Why? Because we "expect" to arrive at our destination.

In fact, the notion of Mathematical expectation is really a mere proxy (and a poor one at that) for assessing risk-opportunities compared to what we should use.

Thinking about writing a book on this. The problem is it ties into everything else I have ever worked on, and a lot of it would be redundant.

George Coyle writes:

I too suffer from this problem. This is obviously tough for those trading with casino logic which requires the "house" to play all games (subject to size limits). There is a concept in psychology known as systematic desensitization (http://en.wikipedia.org/wiki/Systematic_desensitization) which attempts to stop responses to fear and anxiety. It might be useful for trading, but presumably one would have to incur many losses to get the benefit. Also, if we check the opposite end of the spectrum (the bank traders who take large risk because they can just jump ship and move to the firm across the street if they lose) it would appear having nothing to lose personally, and thus an asymmetric risk profile, would also result in eventual disaster. So there must be some optimal level of fear/greed/caring/indifference, the efficient frontier of trading emotions. It is difficult to think of how it might be measured and then used.

Craig Mee comments:

This seems to be a catch twenty two here, how individuals receive risk, and how the market does.. As everyone is boarding different flights at different times, surely fear and greed , or lack of …fifo's each other out. 

Ralph Vince adds: 

Put another way, what the casino "expects," and what you, the solitary individual "expects," are not mirror images of each other.

George Coyle adds:

The casino expects a slight positive expected return over the course of time (by virtue of the odds of the games). The only real exception is blackjack in which a player has an edge provided s/he can split aces and double down on split aces. The speculator using a casino approach would expect the same. Basically the central limit theorem says that over a large enough sample the distribution of outcomes will be approximately normal. In this instance both speculators and casinos using this logic assume a slightly positive mean (expectation) to the distribution. So they do expect the same, a profit over time by virtue of the laws above. The amount of said profit varies as markets are not governed by the statistical laws of casino games. So they aren't mirrored, but they have the same trajectory. Both experience runs against the expectation, the goal is to manage emotions such that a big loss does not prevent a speculator from playing the next game which may cause the positive average to be realized. The casino does have the benefit of odds remaining in their favor over infinite time.


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3 Comments so far

  1. Matthew on December 30, 2010 2:44 pm

    Well done, Mr. Duncan. Nice post and thread. I feel like the drunk who gets slapped straight.

    Happy New Year to all here on this wonderful website.

  2. tom on December 30, 2010 3:03 pm

    Given the subject of memory, that photo that accompanies the piece may be one of the more elliptical yet direct literary allusions that I’ve seen in some time.

    There is poem called “Elosia to Abelard” written by Alexander Pope almost 300 years ago which deals with an ill-starred romance.

    The gentleman involved suffered a particularly cruel fate, though not while playing soccer. Ironically, one would imagine, he now found himself liberated.

    While the lady sought solace in forgetfulness.

    http://en.wikipedia.org/wiki/Eloisa_to_Abelard

  3. Sam on December 31, 2010 3:50 pm

    At first reading I assumed “1700 foot wave” was a typo or decimal-point error. But it isn’t. Holy cow! http://www.wired.com/thisdayintech/2009/07/dayintech_0709/

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