Saturday, July 02, 2016

Confusion and Clarity in Trading

There are times in life--and especially in markets--when confusion reigns.  We have all the pieces but can't figure out how they fit into a puzzle.  Confusion often occurs when the parts of our lives don't line up.  When we see the larger picture--when all the pieces come together in a meaningful way--then we experience the opposite of confusion:  clarity.

We don't hear much about the topic, but one of the most important strengths in trading psychology is the ability to accept and tolerate confusion.  The experienced trader recognizes that confusion is information:  it is the way our minds and bodies tell us that harmony is missing--we're not seeing a bigger picture.  In acknowledging and accepting confusion, we can stand back, wait for clarity, and avoid doing damage to our trading accounts.  We can have a great cast of information and tools, but still be in the dark as to the plot.  The experienced trader is accepting of "I don't know".

When a physician is uncertain of a diagnosis--when the symptoms simply don't line up into a clear disease pattern--the last thing the physician (and patient!) wants is to jump prematurely to a conclusion and blindly try out treatments or procedures.  The experienced physician will order more tests, gather more information.  Confusion for the physician is a sign that more data are needed.  With enough of the right information, clarity will come.

The worst thing traders can do when confused is prematurely jump into trades.  Traders do that because they cannot tolerate not knowing: they cannot accept uncertainty.  If we're threatened with "I don't know", we'll trade without true knowledge.  When market behavior is all over the place and things aren't lining up, that's our cue that, like the physician, we need to look in new places, gather more and different information.  Sometimes that means sitting and letting the market gives us that new information.  Confusion can be our cue that it's time to sit and gather information, to be aggressive in generating ideas rather than in risk-taking.

There is another reason we can experience confusion:  When we are dead wrong about markets.  We assume that markets should sell off in the wake of Britain's decision to leave the EU and, lo and behold, we get strong rallies in risk assets.  The experienced trader is fully open to that confusion.  Rather than doubling down on assumptions by indulging in confirmation bias, the experienced trader uses the confusion to stand back and check premises.  Perhaps equities and fixed income are rallying because markets care more about the prospect of global central bank easing than about the news headlines.

Overconfidence bias is deadly because it does not permit confusion and uncertainty.  Confusion is our prod to learn, to expand horizons, to modify assumptions, to gather fresh information.  Imagine how much better our trading results would be if we only traded when we had clarity and doubled down on idea generation when we were confused.

Further Reading:  The Heroic Dimensions of Trading