Wednesday, April 01, 2020

Trading Process: Information Flow Versus Idea Flow

We often hear about the importance of following a trading process.  This is helpful, but not quite accurate.  Good trading is like good manufacturing; it consists of many processes.  The superior trader is a manager:  one who weaves distinct processes into a seamless whole.  Much of the work of improving our trading comes from examining our intellectual assembly lines and figuring out where we might be experiencing glitches.

One topic I've recently discussed with portfolio management teams is the distinction between information flow and idea flow.  Information flow is the real time processing of new inputs, whether those be breaking news, data releases, or conversations with knowledgeable peers.  Information flow also embraces real time data as to how various markets are moving and what buyers and sellers appear to be doing in those markets.  An important component of team success is high quality information flow from all members.  Having more eyes and ears on more things allows traders to expand their bandwidth and respond more quickly to shifting market conditions.  When teams fall down, it is often because of inadequate information flow or unfiltered flow.  Not all data qualify as information.

Separate from information flow is idea flow.  Trading ideas, as I've noted elsewhere, are the result of a reflective, creative process.  We assemble pieces of information into a larger picture that provides us with a broader perspective on risk/reward.  For example, I may notice that traders are lifting offers among consumer staples stocks but not consumer discretionary ones.  That information could lead me to examine the relative yields of those two groups and the earnings guidance that companies in the two groups are providing.  Out of these investigations, I could develop a thesis that investors are seeking safety, stability, and yield in an uncertain world of zero interest rates.  That could inform my stock picking and, indeed, could have implications for trades in other asset classes.

Observe how different these processes are.  Information flow benefits from broad, fast processing.  Idea flow benefits from deeper, slower reflection.  Good trading requires fast thinking, to use Kahneman's framework, and it requires deeper processing.  The information flow helps us manage positions in real time.  The idea flow provides the source of these ideas.  An important element of teamwork--whether it's individual traders connecting with peers online (I've been sitting in during the online team chats/meetings at SMB, for example) or actual portfolio management teams--is separately evaluating the quality of information flow and idea flow and making sure that we are never relying on stale thinking.

Further Reading: