 | Fools of Randomnessby ZenProfit on May 18th, 2008 at 3:36 pm |
Last week I posted my frustration over Mauldin’s contention that Technical Analysis was not very useful. After 8 years of trying to apply it properly it was a hard pill to swallow. The responses from my fellow Peanut Gallery readers was heartening.
This week I would like to address an equally vexing issue: whether traders are fooling themselves when they believe they can adequately predict the future movement of a proposed transaction — either buy or sell. One of the most erudite books in my trading library is “Fooled By Randomness: The Hidden Role of Chance in the Markets and in Life”. By erudite I mean that I didn’t understand 99% of the references the author made to other author’s works and their philosophies. Hey, I ain’t no genius.
His main argument is that there is no way to know what will happen tomorrow in anything, especially the world of finance. As a result, basing future expectations on past performance is a waste of time. So today’s hotshot Wall Street wizard can just as quickly flame out as anyone else. To use another well-repeated example, if 10,000 people flip a coin once a year for five years, 313 can be expected to flip 5 heads in a row. “Expected” by the Law of Probability. Take those 313, dress them in a suit and you’ve got a hedge fund manager. How many will flip heads the sixth time in row?
Despite the many forests destroyed to fill the shelves at Barnes and Noble with investing self-help books, after the last book has been read, the truth appears to remain: “No one knows anything.”
With no offense to Mr. Fly and the iBC Tabbed bloggers, not to mention the many well-intentioned bloggers I read everyday, aren’t we active traders merely seeking the mutual comfort of shared pain and/or joy when we post our losses and victories, rather than getting any closer becoming Perfect Traders?
If there is one thing the new investo-blogosphere ought to be able to capture, that would be the equivalent of a perfect investing Wikipedia. If this universe of professional and high-end amateur traders can’t achieve Perfect Trading then I submit that all of the discussion about it is for nothing.
When Mr. Fly announces “bought 10,000 (FNSR: 1.53 +15.04%) @ $1.52.” it ought to be clear and obvious to each of us that: 1) Mr. Fly made the right decision and 2) the “why” which led Mr. Fly to make that decision. Like The Borg, it seems to me that if one of us knows what is correct, we all ought to. BUT WE DON’T. At least I certainly don’t. When I read Mr. Fly’s buy announcement I quickly brought up the FNSR chart in an effort to discern Mr. Fly’s brilliance. I could not. I looked at it in 8 different time frames with 6 different indicators.
Now I am not suggesting that I am on the same level of trading as Mr. Fly, nor would I expect Mr. Fly to divulge the edge he saw to risk that $15,300. Neither am I trying to goad or pick on Mr. Fly. The point is, Mr. Fly is either going to make or lose money on that trade.
But after 8 years of study it seems to me that I should see it. Instead all I perceive is a 50/50 chance that the decision was right. No better or worse a chance than flipping a coin, that is, random.
So at the end of the day, after all of the chart “analysis”, after all of the “pattern matching”, after all of the “set-up rules filtering” are any of us really any better off as traders?
Understand that I am not dismissing the necessity of risk management, setting stops and all of the rest. It is just a nagging feeling I have that we fool ourselves into believing we can overcome the ugly randomness of price movement by dressing our actions in the pretty clothes of technical analysis.
Zen,
Assuming Taleb’s argument has merit, which I do, and it would seem that you do also, then sensibly, you would explore his methodology to making money from the market.
Have you done so?
jog on
May 18th, 2008 at 4:22 pmduc
Duc:
I cannot bring myself to explore it because, at the end of the day, the common wisdom (?) is that Technical Analysis works. It’s just that I can’t get in harmony with it.
May 18th, 2008 at 4:59 pmZen, there are likely a lot more reasons why Fly would buy FNSR, besides TA. Also, Fly has not been known to put a great deal of weight in to TA. Perhaps he bought it because he read research that said Fiber Optics were in demand, or because he was looking for a beaten-down networker to buy. Anyway, traders that use TA will typically present their analysis with the purchase. For example, “I bought 500 shares of XYZ because it just made a highest high of the last 20 days.”
As for Taleb and Fooled by Randomness, it is a great book. I included it under my picks in the iBC library. I remember how it changed my thinking after I completed reading it. If you check my old blog, tradewhileworking.blogspot.com, you might even find some posts, if you so desire in searching.
I agree with Taleb about luck and randomness. My system development quest is my effort to defeat luck and randomness, but alas…if one follows Taleb, he understands that even in a well-backtested system, put through the paces of Monte Carlos, there can always be the Black Swan that will take one out of the game. For example, Long Term Capital Management.
Anyway, I believe that if one trades a diversified group of systems, using sound money management techniques, it is statistically possible to beat the markets, consistently, over a lifetime.
In regards to your mention of “perfect trading,” there is no such thing. Or if there is, it doesn’t last forever, as the edge will be exploited to the extent that there is no edge. Thus, diversification of strategies becomes key. (Not to mention the variabilities in definitions of perfect.)
After diversification of strategies, the psychology of the trader can also derail the process. I believe psychology to be almost impossible to quantify, which opens up an even more complicated set of issues to explore.
Duc, remind me of how Taleb trades.
Good post Zen.
May 18th, 2008 at 7:54 pmZen - nice post.
I think you are missing a major point, however, in the discussion of why Fly put this trade on, and even TA as a whole.
The market is the sum of its participants. Markets themselves are unpredictable but human behavior is not.
To clean that thought up, there is an edge in understanding trader psychology. As sophisticated as people like to think they are, the underlying forces of the market are guided by imperfect beings.
People, especially in a mob mentality, often act irrationally. There is an edge to understanding that as well.
For instance, after a big, unexpected move, I think that there is a tendency to fade that move. However, most trend following systems posit that an extreme move will continue.
At least that is my observation of things. So why is Fly putting a fraction of a quarter of a percent /100 of his fund into FNSR? I don’t know.
I just wanted to bring up the point that psychology of others plays into TA heavily.
When you have something as obvious as Dow ~13,100 resistance, it is so well-known that the point is moot. There isn’t an edge in knowing the number as must as reasonably estimating the reaction of others around that mark.
May 18th, 2008 at 9:27 pmDon Juan,
Your quote; “The market is the sum of its participants. Markets themselves are unpredictable but human behavior is not.”
The market is a sum of it’s participants; who/which are?
*Human element
*Quant algorithmic participation [programmed by humans]
*Other? [arbitrage]
So, the claim being made that markets are unpredictable, but human behaviour is predictable, leaves me less than satisfied.
Your statement seems incongruent.
jog on
May 19th, 2008 at 12:23 amduc
Zen,
Common wisdom from who/where?
I would say that the debate surrounding TA is far from settled.
That you yourself, cannot find harmony with it, should suggest that you at least explore some alternatives.
I have actually been looking at the origins of TA via Dow Theory, and certainly what I have found is that TA as practiced by the majority, is an abomination of the original Theory.
jog on
May 19th, 2008 at 12:28 amduc
Wood,
I may well do, but first, I would like to see if this thread develops.
Dessert, only after the main course, you can’t have your pudding, if you don’t eat your meat….
jog on
May 19th, 2008 at 12:30 amduc
My statement is pretty clear ducati…
restated, determining the action of a “market” is impossible. It isn’t a normal distribution. However, the underlying forces of the market are controlled by people whose behavioral patterns may be predictable.
There is not a corollary here.
I disagree that my statement is A=B, B=C therefore A=C as you suggest.
Understanding market participants provides a trading edge (for me) in momentum investing.
May 19th, 2008 at 12:59 amDon Juan,
See changed your proposition already.
Now you state, “the underlying forces of the market are controlled by people whose behavioral patterns may be predictable.”
Emphasis on MAY BE.
That is a significant difference to “Markets themselves are unpredictable but human behavior is not.”
Which takes us back to the original question posited, does it not?
jog on
May 19th, 2008 at 1:08 amduc
Your pedestrian understanding of semantics and the English language is both startling and disconcerting.
“what I have found is that TA as practiced by the majority, is an abomination of the original Theory.”
Even a member of the short-bus such as yourself surely knows that in English (not American) “practice” as a verb is spelled “practise”
Quit splitting hairs.
This isn’t an SEC filing. Precise language, in this instance, is immaterial to the point raised by Zen, or the clarification you asked for.
I subtly changed my language for you ducati. Apparently being totally clear the first time wasn’t clear enough.
I used the tactic some employ with small children, which is removing the black and white aspects of the discussion and replacing them with generalities, to aid in their comprehension.
No thanks necessary for the favor.
May 19th, 2008 at 2:10 amDon Juan,
You have committed a reductio ad absurdum.
The proposition as originally stated, dealt with exactly the same set of participants; viz. “the market” & “human behaviour”
Thus, if you can predict one, you can predict the other.
However, you stated completely the opposite.
With your error highlighted, you modified your proposition, which then became consistent with the original proposition.
This mistake, is central to the argument contained in the original post by Zen.
Human psychology, evolves, over time. This time period however is so vast, in terms of lifespans of humans, as to be almost undetectable, generation to generation.
Thus, as a generalization, we can reasonably claim that human psychology in terms of the stockmarket, and other financial markets, does not change, and can be taken as a constant.
If this is so, then [as postulated by ZEN] technical analysis is a study of human psychology, a map if you will, of the extremes, and reversions, of said psychology.
Of course the problem that is encountered is the requirement to recognise turning points in any timeframe [as markets are fractal] as, the pattern will always be developing and incomplete.
Hence, the false positives/negatives.
Your latest response however is highly illuminating of your own individual psychology.
With regards to your highlighting of PRACTICED.
Did you not understand that in point of fact that I am bilingual?
Thus my spelling and useage, is in point of fact entirely correct.
jog on
May 19th, 2008 at 12:33 pmduc
Duc:
Do you fucking know how to speak modern day English, or are you stuck in some sort of time warp—where middle English is spoken?
May 19th, 2008 at 1:56 pmel-midge,
You should be on your knees kissing the ground. I am attempting to elevate your vocabulary from sub-human levels.
Did Don Juan request help from his hero?
Possibly he should continue writing sexual fantasy posts.
jog on
May 19th, 2008 at 2:05 pmduc
You must be joking.
Your usage of the English language is appalling. If I were grading your posts, you would have received C+ at best.
It is not important to diversify verbiage, for the sake of diversifying. What’s paramount is the fluidity of your thoughts.
You Sir are quite rigid and lack the sense of humour [sic] to communicate with men.
May 19th, 2008 at 2:11 pmBe nice to Ducati, he prob just lost a shitload on his POT trade
May 19th, 2008 at 2:13 pmFuck you Cubs.
I didn’t lose a red cent. I am a long term bear on POT.
May 19th, 2008 at 2:15 pmHuh, I’m talking about The Ducati. Check his blog, big time bullish on POT and The Market over this weekend.
May 19th, 2008 at 2:17 pmDuring his brief hiatus from this site, Ducati was obviously working hard to get into the most ‘assholish’ shape of his life. Losing his lunch money on POT doesn’t help, I’m sure.
But, I must thank him for teaching all of us the art of ‘insulting people on the internets with flowery prose’.
May 19th, 2008 at 2:21 pmel-midge,
Well, we can certainly agree on the importance of thought and thinking.
This really underlines my criticism of your loss of exactly this faculty and process.
No longer do you exhibit any thought process. You have abdicated reason and analysis to join the abject herd floundering in a world of confusion.
jog on
May 19th, 2008 at 2:27 pmduc
Cubs,
Indeed, POT is certainly not playing the game today.
Naughty POT.
jog on
May 19th, 2008 at 2:29 pmduc
DPeezy,
You seem to be crying out for some attention.
I have taken pains to simply ignore you and your minor trespasses to date.
However, I shall acknowledge your sleight. There, there, feel better now?
jog on
May 19th, 2008 at 2:35 pmduc
Duc:
I don’t believe I was talking to you (thus not referring to you in the 2nd person), but thanks for reading my comment. Hope it wasn’t too ‘painful’ for ya, because it has made my day.
No, scratch that. It has made my week, knowing that the great Ducati deemed my comment response-worthy, despite it not being addressed to him! So this is what it must feel like when ‘Dear Abby’ responds to your letters! What a glorious and beautiful day!!
Let the sunshine in!
May 19th, 2008 at 2:57 pmDP,
I understand, happens all the time. Always pleased when one of the little people feels appreciated and fulfilled.
See, I’m humane like that. I’m so underappreciated for my charity and benevolence.
jog on
May 19th, 2008 at 3:12 pmduc
duc-
you fell out of character with the inclusion of the sentence “See, I’m humane like that.”
that grammar and sentence structure sounds like my 13 year old niece.
May 19th, 2008 at 3:58 pmnull,
Agreed, that could have been worded better. But, there you go, being charitable to the little people…just how much shame and humiliation can one bear. [the little people]
jog on
May 19th, 2008 at 4:25 pmduc
See, Ducati is like totally humane like that, bro.
That would be my…fifteen year old from encinitas.
May 19th, 2008 at 4:32 pmMy fucking maid communicates with people better than Ducati—and she’s from Prague.
May 19th, 2008 at 4:38 pmDon Juan,
What…no pornographic tittillatory anecdotes for your readership regarding your….”That would be my…fifteen year old from encinitas”
They will be inconsolable.
jog on
May 19th, 2008 at 4:41 pmduc
el-midge,
Wow.
I must rate that A++
Truly, madly, incomparable.
Such wit, humour, insight, all contained within a concise and precise sentence structure.
I am suitably chastised, and in awe!
jog on
May 19th, 2008 at 4:44 pmduc
Yes, tenk you veddy mooch for men-shun, Boss.
Now, what aboud dat race, like yoo promise?
May 19th, 2008 at 4:48 pmNo need to put “precise” in the same sentence as “concise.”
It’s redundant.
May 19th, 2008 at 4:49 pmBy the way, women from Prague are hot, as a rule.
Did you run this hire by Immigration*?
________________
*(Mrs. Fly)
-
May 19th, 2008 at 4:50 pmChap’s
As always…..it’s been emotional.
Off for my brekkie.
jog on
May 19th, 2008 at 4:50 pmduc
No need to put “precise” in the same sentence as “concise.”
You are obviously unfamiliar with New Zealand White Rap styles.
May 19th, 2008 at 4:51 pmel-midge,
Just caught me.
Nonsense. In future, please check prior to wasting my time.
jog on
May 19th, 2008 at 4:52 pmduc
haha you’re a sick fuck galad
May 19th, 2008 at 5:11 pm