Saturday, December 08, 2007

Market Myopia

Does watching the market tick-by-tick improve your trading returns? Clearly, if you're scalping the market (trying to buy bids and sell offers), you have to be glued to the screen. If, however, you're trading over time frames lasting an hour or more, does it add value to be glued to the screen? Does watching each tick lead to better trading decisions or returns, or does it lead to a kind of myopia in which we become reactive and no longer follow our original trading ideas?

My sense is that watching markets tick-by-tick often stems from an illusion of control: that, by monitoring events tightly, we can somehow better control them. Research suggests, however, that getting more feedback about investments leads to risk aversion and reduced returns. This myopia stems from the fact that we tend to perceive meaningful patterns in events even when those aren't present. When we watch markets tick-by-tick, we begin to see patterns that we believe are indicative of shifting supply and demand. This perception leads us to exit positions before they've reached their target or delay entering positions that otherwise offer favorable reward:risk.

I also get the sense that some traders equate working hard with being glued to screens. In reality, the hard work of trading lies in what comes prior to putting the trade on: the research and analysis that pull together observations across markets and time frames to generate valid ideas. To the extent that tracking markets tick-by-tick is an expression of anxiety over one's position, it is not only not productive (in the research/analysis sense), but is actively destructive (keeping oneself in a mindset that is harmful to sound decision-making).

A very useful exercise is to define your trading rules so that you can clearly identify a stop and a target for each of your trades. Then you can see how your discretionary management of the position adds value to simply following those rules. By cutting winners short and delaying entries into good ideas, the trader glued to the screen reduces the risk:reward potential of each trade. Perhaps that is why frustrated traders who are "working hard" find that their trades are hardly working.


* Inside the Trader's Brain

* Four Insightful Studies