In my previous article, we reviewed the first seven of 13 “mental blocks” to investing an average CTA or investor may butt up against throughout trading or investing.

To continue from where we ended off in the previous commentary, we will cover the final six biases and blocks that may affect how a CTA tests or back-tests their trading philosophy and system and finish up with the possible tendencies they may have that could affect how they execute and trade their systems.

Blocks that may affect how a CTA tests their system

#8:  “Hindsight” error Bias:  We all know that hindsight is 20/20, and we can mistakenly use data in developing a system that, in present-time trading, will not have taken place yet. Example: If you factor today’s close into your analysis, you will probably exceed any results you may expect in testing your system, primarily if you draw in an exit before the close.

#9:  Optimization Bias:  A CTA is always trying to better and optimize their methodologies and trading systems and can fall into the mind trap that the more they manipulate the data to fit “history,” the more they know about trading well. Instead, I believe a CTA would be much better off understanding how their trading concepts, indicators, or philosophies work and keeping historical back-testing to a minimum.

#10:  Not Protecting Yourself Bias: CTAs sometimes fail to consider that position sizing and exit strategies are the prominent factors separating average performance from stellar performance (a fine line). Therefore, in my opinion, they can put way too much of their risk capital in danger on any given trade. This can be disastrous, especially if a CTA tries to play “catch-up” from prior losses.

Blocks that affect how a CTA executes their trades and systems

#11:  Gambler’s Bias:  To keep it short and sweet, CTA’s and investors alike assume that the probability goes up for a win after a losing streak or up for a loss after a winning streak. It can be compared to standing at a Roulette wheel, watching 6 Reds come up in a row, and then betting on black, given only that data.

#12:  Timid with Profits and a Gunslinger with Losses Bias:  As a natural inclination, people want to take profits quickly and give losers more slack, as this gives the “illusion” of being right (until the margin clerk calls). This cuts profits short and lets losers run, which is the opposite of success in trading.

#13:  My Current Trade has to be a Winner Bias:  This block is probably at the root of all biases mentioned above. Remember that “the need to be right” has zero to do with making money.

Again, as a result, CTAs and investors develop “shortcuts” to thinking and visualizing to help them cope with the bombardment of information their senses are continually taking in.   The results of CTA’s not being aware of and knowing how to handle these natural human mental biases can hinder and, in many cases, thwart their performance in the markets. When you feel the “need to be right” while investing or even in the ordinary course of life, you may fall prey to one or more of the thirteen mentioned “mental shortcuts.”

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