Monday, July 14, 2014

Data Rich, Information Poor: Improving Your Cognitive Environment

Discussions about psychology among traders tend to focus on the emotional challenges of making sound decisions in the face of risk and uncertainty.  Less appreciated are the cognitive challenges of trading.  Thanks in large part to the online medium, today's trader is not at all like the tape reader of yesteryear, hunched over a ticker tape spitting out transactions.  Today we have multiple screens that display multiple charts, multiple indicators gracing each chart, and an endless barrage of news reports, tweets, and chats.  Early traders lacked timely data and therefore operated with very incomplete information.  Today's traders are overwhelmed by data, with few ways of distinguishing which of the data constitute relevant information.

To use Kahneman's terms, we spend so much time thinking fast--keeping up with the data barrage--that we rarely think slowly, deeply, uniquely, creatively.  This leaves us data rich, but information poor.

It's not surprising that a knowledgeable observer of the financial media such as Tadas Viskanta of Abnormal Returns counsels in his book that market participants should go on "a media diet."  In a world swimming in data, the challenge is focusing on the right information, filtering out the rest.  I strongly suspect that Abnormal Returns is popular precisely because Tadas serves as an effective filter for readers.  Just as we rely on curators to decide what to include in museums and what to exclude, we rely on the curation of expert websites to help us channel our limited resources of time and attention.

In some cases, the filtering expertise of websites draws upon the wisdom of crowds:  Trip Advisor for restaurant and hotel suggestions; Rotten Tomatoes for movie reviews; and Beer Advocate for ratings of craft brews.  While the crowd may deliver wisdom about such matters as best IPAs and imperial stouts, it's less clear that it possesses a distinctive edge in areas of specialized expertise, such as medical diagnoses or portfolio construction.  For those needs, filtering expertise relies upon the wisdom of individual expert curators.

(A site like Stock Twits is unique in that it captures both the expertise/folly of crowds via social sentiment analyses and the insights of experts who develop reputations within the community.  In a future post, I will explore the curation of tweets--a particular challenge given the sheer volume of content generated daily.)

The value of information filters is that they minimize distractions and interruptions from sources with low signal-to-noise ratios.  Research suggests that such distractions and interruptions actually make us dumber:  we're less able to perform basic tasks with divided attention.  Just as having a cluttered physical environment can interfere with concentration and information processing, the ability to avoid distraction can help us process information more intelligently

Might it be the case that traders make poor and impulsive decisions, not because of intrinsic emotional conflicts or lack of discipline, but because their unfiltered cognitive environments leave them less able to identify and act upon valid information?  This is a neglected area of inquiry and one I will be tackling in a future post.

Further Reading:  Finding Your Optimal Environment