Wednesday, July 23, 2008

Dilemmas of Integrity

Consider the following scenarios:

1) You're a scientist renowned for your research based on an elegant theory that has been named for you. Your research has attracted steady grant funding and a host of prestigious publications. Suddenly the results from your most recent experiments disconfirm your theory and suggest that a rival theory--one advanced by a competing researcher--accounts for the data much better. What do you do?

2) You're a squadron leader in the field and, under the pressure of battle, two of your men fire on civilians and kill them. If reported, this will likely destroy their career and yours. It would also greatly set back relationships with the host government. One soldier suggests planting weapons on the dead civilians to make the squad's actions look like self defense. The others quickly agree. What do you do?

3) You're a trader who has been cultivating skills at reading and trading short-term market patterns. You love trading and envision making your living from it. Suddenly your research uncovers a much larger edge to a set of market patterns that set up over months or even years. The returns are much better than for short-term trading--and they are achieved with far less risk, making only a couple of decisions per year. You only have enough capital to allocate to one set of strategies, and the correlation of returns between the two approaches make it unlikely you'd benefit from pursuing both anyway. What do you do?

It's not always easy to "do the right thing". We live, Ayn Rand, by the evidence of our senses, but sometimes that evidence leads to an unpleasant verdict.

Still, I suspect there's a special place in Valhalla for those who shut the door on one set of dreams to open the door to many others.


speedtheplow said...

There is nothing either good or bad but thinking makes it so. (Hamlet)

Bill aka NO DooDahs! said...

There's a really big, actually HUGE, difference between those three scenarios.


A solitary activity, like trading, is easier to amend and admit "mistakes" concerning. There's no public loss of face and fame, and no close, battle-hardened friends to argue with, if you change your trading strategies.

Firebird said...

Dr. Steenbarger,

As much as I love your blog, I don't quite see the parallel between 1 & 2 on the one hand and 3 on the other.

Also, even though I understand that lengthening the holding periods would benefit many ultra-short term traders by reducing slippage, commissions and undue losses caused by excessively tight stops (possibly motivated by fear of losing scared money rather than being based on sound principles), I fail to see how holding periods of months or even years may produce superior returns with reduced risks (assuming, of course, that we're referring to individual traders, not hedge funds). Would you please elaborate or clarify?

Thank you, best trading,


Brian said...

Maybe it is because I am a value investor, but I find it surprising that number 3 is even a dilemma.

markus said...

Sorry, Brett, what has the third story to do with integrity? I don't get it. If the trader says:" O.k., I like to pursue my short term trading even if I will have a worse risk adjusted return compared to the long term game, because I love it this way". It would not be very rational but also not without integrity.


Brett Steenbarger, Ph.D. said...

Thanks for the many thought-provoking comments on my post. A few reactions:

1) There's a good case to be made for ethics being more than subjective preference. See the writings of Brand Blanshard.

2) Trading is *not* a solitary activity for many, many traders. There is peer pressure galore at trading firms, and there can be quite a bit of pressure one feels regarding obligations to spouse and family. Doing a 180 degree turn in one's trading can affect many people, especially if you're leaving moderately successful approaches for less known, more promising ones.

3) My most recent research suggests far more promise to a longer-term trading methodology based upon intermarket and sector patterns than to my shorter-term trading methods. So this issue has personal relevance; hence my post.

4) The longer-term trading methods might be considered active investing (somewhere the two converge) and, yes, the key is to find market pricing relative to norms ("value").

5) I believe that being rational *is* an expression of integrity, as it is living by fidelity to one's own perception and judgment. To knowingly trade an inferior strategy when investors depend on you (hedge fund) or when your family depends on you lacks rationality, but also lacks integrity.

FWIW, very near my equity curve highs, which I have hit for four consecutive years now, I have shut my trading down and have begun refining a new approach. To not pursue what looks worthwhile--even though it means putting aside work I love--would feel like self-betrayal. Hence the post on integrity.


Brandon Wilhite said...

Let's not forget Hamlet is a tragedy, and he was a very depressed, emotionally unstable man when he makes that statement. ;)

The main difference I saw between #1, #2, and #3 is the psychological aspect of it...what if the trader is not well suited to trading this different timeframe and strategy? So maybe this would be a case where it would not be irrational to continue trading the shorter timeframe.

Maybe we could call this a decision based on the non-rational. The decision itself would be rational even though part of the data on which the decision is based would be non-rational. If that were the case, then I think the trader would still have his integrity intact.


Club STC said...

Interesting thread Brett. Thanks.

My take: it seems to me there are two variations of integrity. In (1) and (2), we owe a duty to society not to consciously harm other humans, physically or their reputation (abstain from fraud, force or coercion).

In (3) the duty is to ourselves and the outcome we seek based on what is achieves our aim in the long run.

If our aim is to create wealth in the most effective way possible,if there is no conflict in other areas of our life, and if the longer-term strategy suits our personality, then integrity dictates we adopt the longer-term.

radicimo said...

I believe a desire for "action" and the extreme discipline needed to wait for 1-2 "fat pitches" a year are much more difficult internal obstacles than most here are willing to admit.

Someone who "loves trading" is going to find it nigh impossible to watch and do nothing, day in and day out.

The discipline required to follow the markets, and allow a multi-month/multi-year pattern to play out is inherently different than the discipline required to be successful at short-term trading.

Sometimes you have to realize that your strengths lend themselves to one form of trading, at the expense of perhaps better returns and far less churn.

I have been struggling with a variant on this theme for years. I happen to believe my strengths are in longer term swings, and my results prove it. However, the discipline to let these trades play out often eludes me, and a need to be "doing something" is incredibly hard to shake.

markus said...

Brett, if being rational is an expression for integrity the soldiers in your second example should make the action look like self defense. It is rational but I doubt it is in accordance with integrity.


dfx said...

I've specifically trained myself to do short term trading (scalping, reading the day's mood OR/tick etc.) in order to address my long term trading problems. And it has worked very well.

You learn much faster how to make decisions, to read things clearly, to react rationally, to not take it personally when facts change, to not chase, to understand crowd thinking, fear/greed, who the different time-scale players in the game are. to not make mistakes. What to do when you do make a mistake. Then these lessons are applied at other time scales.

abel said...

I look forward to whatever direction you take, and the valuable insights you offer along the way.

plainfont said...

Dr., with regards to "Trading is *not* a solitary activity...", I would agree that taking mark-to-market pain can be quite frustrating especially as peers pile on the short-term winners. However, from what I've seen, the short-term profit bias usually leads to failure, whereas trading for making long-term profits leads to a long career. I think a firm will understand a few months of losses if the bets payout consistently. Hell, the most profitable trades have been big, almost value-investing like bets a la Paulson, etc.