Tuesday, April 08, 2014

Selective Attention and Trading Blindness

Selective attention can be a blessing and a curse in performance activities.

Before you go any further with this post, please take this short selective attention test from the research of Chabris and Simons.  You'll see students in white and dark shirts passing balls.  Your goal is to count the number of passes tossed by the people in white shirts.  That requires a good degree of concentration, as you have to filter out the activities of the black-shirted participants.  Give it a try and see how many you count.

The advantage of focused attention is that allows us to process information within our focus quite efficiently and effectively.  Chabris and Simons note that chess experts recall board positions better than non-experts, but only when the board depicts realistic game situations.  If the boards are laid out randomly, the experts show little if any advantage in memory.  Their focus and memory are quite selective, based on the positions they've studied and played.  

With selective attention, however, we can become so focused on what we expect to see that we fail to notice the unexpected.  That is the big takeaway from the test in the video linked above.  If we expect that markets will move a certain way based on our research or experience, we're apt to miss the information in front of our faces that tells us that the market is doing something unexpected.  This is called inattentional blindness:  the inability to see things that we don't expect to see.

Have you ever traded during a day, lost money, reviewed your trades, and then asked yourself how you could have possibly made those decisions?  The chances are good that you're noticing something in your review that you were not prepared to see during the trade.

Inattentional blindness is a natural outcome of confirmation bias.  We look for information to support our expectations and disregard what does not fit into our ideas about the world.  As traders, we can be very calm and focused--and completely biased and blind.  One cure for inattentional blindness is to actively mentally rehearse a variety of scenarios and outcomes, so that you're truly open-minded when events do unfold.  

We often hear that risk-taking should be predicated on one's conviction in their market views.  It is when our conviction is highest, however, that we are most at risk for blindness.  It is the explicit and active consideration of multiple views--not just confidence in a single perspective--that enables us to best see what is there in markets, and not what we expect to be there.

Further Reading:  Countering Information Processing Biases