Michael Covel: News & Info.

An article forwarded to me from BW titled Hedge Fund Toddlers (PDF).

A good read about Richard Donchian from 1978 (PDF) - wholly relevant to today’s traders.

I get criticized by some people. They don’t like my message perhaps. Or maybe they detect an attitude that doesn’t work for them. It all comes with the territory. Along those lines I saw Mark Cuban offer a good bit on criticism today at his blog:

“The easiest thing in the world to avoid is criticism. All you have to do is nothing. Do nothing of your own free will. Do only what is asked of you and nothing more, and chances are you will never be criticized. For those of us who set goals and want to have an impact in the business world in particular, criticism is part of the job description. You have to be able to be able to take it and sometimes you can’t be afraid to dish it out. Although criticism is typically perceived as a negative, it can be one of the most positive and motivating forces any of us can experience. The key to turning criticism into a positive is understanding the nature of the criticism. In a nutshell it comes down to content. Is the criticism based on content or not. I’ve received a ton of criticism in the media over the last few weeks. People criticized where, when and how I did things. Not a single person criticized or challenged why. I get criticized a lot. So what. If someone says something of value. I will learn from it. If they criticize to fill up a column or to hear them[selves] talk, I can get a good laugh out of it. What it all comes down to is content and effort. If someone puts in the effort and challenges the content and makes me rethink my position, I come out ahead. So criticize away.”

This ‘attitude’ is useful for anyone and everyone no matter what they do or pursue.

From Morningstar comes this ditty:

“There are several tools that Morningstar uses to interpret the fundamentals of a firm in order to bridge the gap between art and science, hopefully paving the way to a nice profit in the process. Two of our favorite bridges that help us arrive at prediction of a company’s intrinsic value and a “consider-buy” price are moat and risk. Briefly, an economic moat is a firm’s ability to utilize its sustainable competitive advantages to outperform rivals and earn returns greater than its cost of capital. The risk of a company, on the other hand, is the strength of the underlying business and the predictability and certainty of its future cash flows. Risk is determined by analyzing factors such as cyclicality, leverage, legal issues, and other outside events. In turn, risk ratings affect the size of the margin of safety that we build into our investment recommendations. But not everyone’s opinion, interpretation, or prediction of these metrics is the same. This is where we believe value can be found: by correctly selecting firms with economic moats that are trading at attractive discounts to our fair value estimate, given the margin of safety implied by our risk rating.”

How is the average trader (or frankly the professional) supposed to do all of this and do it right? Why do many of the great traders never think like this?

Janice Dorn, M.D., Ph.D (bcoached@cox.net) sent me her most recent article:

“The way we perceive our actions or the consequences of our actions is, often, entwined closely with the way we identify who we are. We traders often define ourselves in terms of our trading…our actions and inactions, our triumphs, our gains and our losses. As a result, it is easy to merge so strongly with a decision that has resulted in unexpected negative consequences that we actually become that decision. The disappointment and shame we feel when we make what we perceive is an error, grows until it becomes a dominant part of our identity. We rationalize our “poor” decisions by labeling ourselves incompetent decision makers, or, in the trading vernacular “idiots.” Imagine walking around all day telling everyone that you are an idiot? Why are you doing that? What gain are you getting from that, and what message are you giving to those around you? Your true identity cannot be defined by your choices. Your essence—what makes you a unique human being– exists independently of your decision-making process. This is one reason why we are able to love someone (and, ideally, ourselves) without condition. We love who they are as a person, and understand that people do not always make choices that are in their best interest or the best interest of others. Nonetheless, we continue to love them. Trading is not about being right or wrong. It is about making money. It’s about making more than you lose. All trades contribute to your development and are an integral part of your evolution to trading mastery; yet they are still separate from you as a person. A trade that does not result in its intended outcome (making money) is in no way a reflection of who you are as person. (The same is true for winning trades, and I will have more to say about that at another time). Nonetheless, a trade gone bad (losing money or not cutting your losses short) can have dire effects on your ability to trust yourself. Your self-esteem suffers and this spills over into every aspect of your life. You can avoid becoming your trades by affirming that a “bad trade” was just an experience, that you did not let your losses run, and that the markets will always give you another chance. Every trade is an opportunity to learn, grow and make you a better trader. If you are not learning, you are not growing and your trading ability will stagnate. You will not progress through the four critical phases necessary to achieve trading competence. You are not your trade, but you are RESPONSIBLE for your trade. If it doesn’t work, get out, regroup yourself and wait for the next signal. It is fine to analyze after the fact what you did and why you did it. In fact, it is essential to trading success to look at every trade you do, why you did what you did and how you felt at the time you did it. However, be quick about it. Avoid lingering in the past and beating yourself up over the bad trade. Try to analyze, backtest and reflect on the consequences of your decision from a rational rather than an emotional standpoint. Allow your primitive, limbic, rat brain to send emotional signals quickly into the new, rational brain for processing and integration. Accept your rat brain and feel the feelings, but get out of that part of the brain and into the higher learning centers. Strive to understand why you made the choice you did, forgive yourself, and then move forward. In other words, get over yourself as quickly as possible. A perceived mistake becomes a valuable learning experience and is, in essence, a gift from which to learn and grow. You are not a bad person and you are not your trading decisions; you are simply human. Keep going, keep trying, learn from your great trades and your not-so-great ones, and never ever give up!

Feel free to drop Janice a line at her email above. I understand her web site will be up soon.

A good presentation found recently (PDF) covering ‘Successful Communication using Behavioural Finance’. A quote from the powerpoint:

Traditional Finance is more concerned with checking that the price of two 8oz bottles of ketchup is close to the price of one 16oz bottle of ketchup, than in understanding the price of the 16oz bottle.
-Larry Summers

James Montier in a paper a few years back offered two systems of reasoning:

System One/X-system/Reflexive/Intuitive
Holistic
- Affective (what feels good)
- Associative - judgements based on similarity and temporal contiguity
- Rapid parallel processing
- Concrete images
- Slower to change
- Crudely differentiated - broad generalisation
- Crudely integrated - context specific processing
- Experienced passively and preconsciously
- Automatic and effortless
- Self-evidently valid: “Experiencing is believing” or perhaps wishing is believing

System Two/C-system/Reflective
- Analytic
- Logical
- Deductive
- Slow, serial processing
- Abstract images
- Changes with speed of thought
- More highly differentiated
- More high integrated- cross context processing
- Experienced actively and consciously
- Controlled and effortful Require justification via logic and evidence

He explains:

System X is essentially the emotional part of the brain. It is automatic and effortless in the way that it processes information. That is to say, the X-system pre-screens information before we are consciously aware that it even made an impact on our minds. Hence, X-system is effectively the default option. X-system deals with information in an associative way. Its judgements tend to be based on similarity (of appearance) and closeness in time. Because of the way X-system deals with information it can handle vast amounts of data simultaneously. To computer nerds it is a rapid parallel processing unit. In order for the X-system to believe something is valid it may simply need to wish that it were so.

System C is the ‘Vulcani’ part of the brain. To use it requires deliberate effort. It is logical and deductive in the way in which it handles information. Because it is logical, it can only follow one step at a time, and hence in computing terms it is a slow serial processing unit. In order to convince the C-system that something is true, logical argument and empirical evidence will be required. The table below provides a summary of the main differences between the two systems.