In my previous article we went over the first seven of 13 “mental blocks” to investing an average CTA or investor may butt up against throughout the course of trading or investing. In this article we will cover the remaining six, and for a re-cap of the previous article and prior seven “blocks” please go to this link: Click Here
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 possibly 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 as of yet. Example: If you factor today’s close into your analysis, then you will probably exceed any results you may expect in testing your system, especially 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, my belief is that a CTA would be much better off understanding how their trading concepts, indicators, or philosophies work and keep historical back-testing to a minimum.
#10: Not Protecting Yourself Bias: CTA’s sometimes fail to take into consideration that position sizing and exit strategies are the prominent factor which separates average performance from stellar performance (it’s 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 is trying 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 have a tendency to 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 and watching 6 Red’s 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). What this really does, in fact is cutting profits short, and letting losers run, which is the exact opposite action of success in trading.
#13: My Current Trade has to be a Winner Bias: This block is probably at the root of all above mentioned biases. Always keep in mind that “the need to be right” has zero to do with making money.
Again, as a result CTA’s and investors develop “shortcuts” to thinking and visualizing in order to help them cope with the bombardment of information their senses are continually taking in. The results for 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 find yourself feeling the “need to be right”, while investing or even in the normal course of life it may be possible you are falling prey to one or more of the thirteen mentioned “mental shortcuts”.
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