Thinking about Thinking and the Why not the How.

”Thinking about thinking is known as metacognition; and while the ”how” of what to do is what everyone always wants to know, you need to thoroughly understand the ”why” first. If you don’t you won’t believe in it; and if you don’t believe it, you can’t feel it; and if you can’t feel it, you won’t – and actually can not do it. Oh, it might look like you do- for some time period equivalent to the average success on a diet, say- but soon, you will be in search of a new answer, strategy, or miracle.”

From ”Market Mind Games” by Denise Shull

The Novice Trader and the Professional Gambler

PG: For most people the word gambling has negative connotations with the word betting slightly less negative, risk taking lesser still and the word trading by comparison can sound perfectly respectable. Trading however is just another form of risk taking where you speculate on the outcome of price movement, rather than the toss of a coin or the result of a horse race.

NT: Hold on, trading is a skill that can be learnt and there are many examples of successful traders.

PG: Well, there are several examples of successful horse race gamblers as well.

NT: Everyone knows most gamblers lose and some ruin their lives through it.

PG: Tell me that isn’t the same for traders?

NT: Ok, well you can’t win on a coin toss game.

PG: You may be able to if you were offered 3 to 1 on heads.

NT: Anyone could win with those odds.

PG: Not necessarily.

NT: What d’you mean?

PG: Check the maths below*1.



PG: If you want a better understanding of what staking strategies could do to your bottom line, have a look at this experiment of the results of betting on a biased coin by a group of finance graduates.

PG: If a high fraction of quantitatively sophisticated, financially trained individuals have so much difficulty in playing a simple game with a biased coin, what should we expect when it comes to the rest of us.

NT: Ok I get it, so all I need to do now is learn how to trade, now I know to keep my risk in check.

PG: Maybe you would be best starting out with the why you do what you do, rather than how to do it.

NT: What d’you mean?

Enhancing performance with inhibition training.

I’ve always found it hard to take on an idea and use it, if it sounds like it may cause some discomfort, even if the idea is touted by those I respect and I know it makes sense. I need something else to give me the nudge I need to take it forward.

Recently in episode 47 of Rob Booker’s trader radio  Rob revisited the day trading tactic, of letting your first trade go and taking your second trade first. Makes sense but that fear of missing out on that first good trade, created enough discomfort for me to disregard the idea in the past.

Researchers from Universities of Exeter and Cardiff published an article June 14 2012 in the journal ‘Psychological Science,’ looking into how people can train their brains to become less impulsive, resulting in less risk-taking during gambling.

Participants in one experiment were asked to repeatedly enter bets selecting between low odds (high probability-low return) and high odds (low probability-high return) bets. They made their selections by pressing a key on a computer keyboard.

At certain times the gambling tasks were combined with an ”inhibition task.” Participants had to refrain from making a choice when presented with a stop signal, which forced them to not press the key on the keyboard.

It was found that when participants had to occasionally hold back from making a selection, they slowed down and became more cautious in the amount of money they bet, suggesting that becoming more cautious about pressing the keys on the keyboard led to greater caution in risk taking.

In other experiments they examined whether training people to stop hand responses to arbitrary signals on the computer screen would have longer-term effects on risk-taking. They found that this inhibition training was able to reduce risk-taking in gambling by 10-15% a significant amount and this effect lasted for at least 2 hours.

Dr Chris Chambers of Cardiff University’s School of Psychology says, ”These results suggest that our impulses are controlled by highly connected brain systems. Inhibition training reduces risk-taking during gambling.”

So I now have a reason why letting my first trade go may actually enhance my performance in the future, slowing me down and making me less impulsive for at least a few hours. Add this to the elimination of the first likely over impulsive poor trade and also the training my  mindset would get as I learn to control my emotions against the fear of missing out of the first trade, I now have three why’s and not just one, why I should implement this tactic into my trading.

Cognitive Distortions

Gamblers have been found to misjudge their chances of winning due to errors in thinking called cognitive distortions.

Near misses appear to make a gambler play more even though it is just another loss. Having a run of events like several reds on roulette makes people think that black is due. This is called the ”Gambler’s Fallacy.” Opposing this we have what is known as the ”Hot Hand Fallacy” where in games of skill a run of good results makes competitors believe their luck is in and will continue. There is evidence that problem gamblers are particularly prone to these errors, but even so at times, all gamblers may become more vulnerable especially after a run of losers, or other external emotional or environmental reasons.

Dr Luke Clarke of the University of Cambridge April 2014 published research that used several patients with different brain injuries in an experiment to determine which part of the brain was responsible for these distortions. He used  gambling games in the research. 1: A slot machine that delivered wins and near misses and 2: A roulette game involving red or black. He used a control group of healthy patients and was able to report that all groups were effected by near misses and the gamblers fallacy except for the insula brain damaged group. So we know that a part of our brain ”the insula” is responsible for these distortions and that they occurred in the healthy control group as well. This part of the brain was already known to have a key role in our emotions and so any adverse emotional stimuli may make a person more vulnerable to these fallacies.

At the same time in April 2014 Juemin Xu and Nigel Harvey, researchers at University College London released a study into the effects of winning and losing streaks on the chances of future success in online sports gambling. They sampled 569,915 bets from 776 online gamblers and looked at how previous winning streaks or losing streaks affected the probability of a win in the future. Overall the bets taken in the GBP currency, there were 48% winning bets made and 52% losing bets.

After a single winner the winning percentage rose to 49% on the next bet, After 2 consecutive winners the winning % rose to 57%. After 3 it rose to 67%, and 4 was 72% and 5 was 76% and finally after 6 consecutive wins we arrived at 76%. What was found was the increase in win % appeared to validate the hot hand, however what was happening was after winning the bettors became more cautious with their selections, choosing lower odds selections but risking more money on them. The gamblers fallacy actually appeared to create the hot hand.

After consecutive losers the opposite happened and the next selections kept losing more and more. The gamblers fallacy that was suppose to reverse the fortune did not occur because the losers started selecting riskier higher odds selections with less money staked upon them. They were reverting to hope and luck to reverse their fortunes rather than expecting the gamblers fallacy to prevail and reduced stakes presumably after their pot of money had been reduced by losses

Taking a look at the controlled results on the charts  you will notice that the probabilities of winning appear to diverge from the norm after 2 consecutive wins or losses and even more so after 3. This would suggest that we need to take special care after 2 consecutive losses or 2 consecutive wins and even more care after 3 and that we don’t subconsciously without thinking, change our trading approach because of those streaks. In fact it may be a good idea at this stage to either walk away or do some sort of mindfulness training, or both, to bring back our insula back to a normal state so we can continue thinking without thinking in our most productive state.

Ratus at Vegas

Research published earlier this year in the Journal of Neuroscience by researchers at the University of British Columbia shows that rats behave like problem gamblers when sound and light cues were added to a ”Rat Casino” model.

The rats who participated in the study gambled for sugary treats and learned to avoid the risky options, however when flashing lights and music was added to the mix they started taking much riskier bets.

Catherine Winstanley, associate professor in the Department of Psychology and Djavad Mowafaghian from the Centre for Brain Health said, ”Unexpectedly the effects were enormous. Anyone who’s ever designed a casino game or played a gambling game will tell you that of course sound and light cues keep you more engaged.

This appears to have exactly the opposite effect of letting the first trade go by. The environment we work in has to play a big role in our ability to remain in the zone for want of a better description. Recently I heard Chris Pulver describe how he wears sunglasses during trading to protect his eyes from the glare of the screen. What if those same sunglasses were having a secondary effect by helping keep his focus at the correct levels for the selectivity he requires during trading.

Time for Bed

We all know we make worse decisions when we’re tired than after a good nights sleep. A study published in the Journal of Neuroscience looked into the effects of sleep deprivation on decision -making skills, finding that a tired brain tends to make overly optimistic gambles. The study found that tired people tended to try to maximise their winnings rather than defending against potential losses. As we all know in trading protecting our capital is one of the golden rules so getting into a regular habit of getting a good nights sleep has to be a must. Personally I find that having a few drinks the night before affects my sleep so that I feel groggy the next day, even if it’s only two or three glasses of beer.

The Professional Short Term Day Trader

Lastly after all those investigations above into the why rather than the how, I want you to go and listen to one of the best trading podcasts I’ve ever heard here, around 30 mins long scroll down and listen to episode episode 115 with special guest host Matt LaCoco. Take special note of the 5 things that Matt says he keeps in the fore-front of his mind while trading. Listen to how he assesses himself as part of the trading system. Think about what he says he might do after a couple of losses. And by the way the first time I heard about someone who lets the first trade go was, yes Matt LaCoco. Note how he likes to enter trades so he knows he is wrong very quickly and how this helps his focus to be more selective and it doesn’t allow for jumping in on impulse. This is pure gold for short-term day traders and a must listen too, many, many times.Finally listen to his final words, which are ” It’s more important to think about why you’re trading than how you’re trading.”

















6 responses

  1. Glad to see you are doing well fxoutlier, trading with real money and making money. Keep it up, we are cheering on you in the background.

  2. Thanks for the support jon. Sorry I’m not writing much these days but I wanted to concentrate on my trading. Hope your own trading is going well and I give my background cheering with it to go:-)

  3. Hi Simon.
    This is Martin.

    We met recently and compared a few notes after noticing the coincidence of each other’s preoccupation with Forex. As I said at the time, it’s a first for me; never have I sat down with a pint to see the occupant at the closest table doing precisely the same thing! You may recall watching me make two small profits, each over a matter of seconds, within minutes of each other…

    So far, I’ve enjoyed reading your blog very much. As you may imagine, I have not got right through in one bite; but I always like to take my time over a good meal.

    You are clearly very thorough. But better still, you present all manner of well-researched ideas in an enjoyable and interesting manner.

    You may also like to hear that I have continued to do well, with profits totalling almost 6 for the week at close of play yesterday – almost exactly 5 since we met – which includes 10 open trades whetting my appetite for Monday morning! (I’ll explain the meaning of those numbers in person!).

    I will continue to dip into this excellent blog over the next few days and weeks, but it might be interesting to come into Derby to compare notes again, sooner rather than later!

    1. Good to hear from you Martin. I too enjoyed our conversation. Rarely do I meet anyone with the slightest interest in trading, especially day trading. I definitely would like to learn some more about your trading style. At present I tend to stick to a few pubs, The Little Chester as you know, the Golden Eagle where the beer isn’t the greatest selection but I’m guaranteed a seat, the Smithfield, the Alex and the Peacock also café nero in derby for a coffee where I like to first stare at my charts before moving on for a couple of ales or back home if the tradings not gone well. Got to limit myself to 2 or possibly 3 pints as I like to be up early to set my charts up for the Frankfurt open. Got myself a new tablet too a nice 10.1 inch Samsung with some internet as sometimes the wifi connections are poor. Sticking with the GIF format for my screenshots for now at least. Glad to know your trading is going well although mine has taken a little nosedive whilst I’ve been distracted with computer issues. Will get back to you, as off to work for a night shift now, the last off 4, so a few days off to trade coming up. Keep up the good trading.

  4. P.S. I am familiar with every pub I’ve so far seen, here. If you email me, we can arrange to meet again. Evenings this week look good apart from Tuesday.

    I look forward to hearing from you soon.
    All the very best…

  5. Thanks for your reply.

    03:34 and the GBP continues to be kind to me. Bailed out against USD as was too heavily committed but did so with significant profit. Opened GBP/JPY at 01:43 and 260 better off for it in less than two hours…

    Kept written record of thinking and took screenshots…
    Enjoy your nightshift. Mine has kept me fuelled with a little too much adrenalin!

    All the best.

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