Thursday, May 14, 2009

How You Process Information Influences Your Trading Results

Trade Your Way To Financial Freedom
By Van K. Tharp - International Institute of Trading Mastery


Van Tharp 2009 Trading Workshops

As a trader part of your challenge is that you must make decisions based on a large amount of information. Thousands of volumes have been written on how to analyze the vast amount of investment information available. Few investment authorities will admit that most of this information is of low quality and has little predictive value. Since investment information is of such low quality, mental strategies (how you make decisions) become especially important in determining the profits or losses that you will experience.

To give you just a little insight as to what I mean about how we deal with this information in our decision making process, let me share this information from the Second Edition of the Peak Performance Home Study Course (which we will be releasing soon).

Information as a Concept

As a child when we first learn a language, we ask mom, “What is that?” Mom might say, “It’s an apple.” And then the rest of your life you relate to each apple, not through a direct sensory experience about the apple, but by the word "apple." If mom said, “That’s called an apple,” you might be a little more inclined to have a sensory experience of an apple. But typically Mom says, “That is an apple.” And you accept her word for it. And even when you eat an apple you don’t really experience the apple. Instead, you just swallow something and say to yourself, “That was an apple.” And that’s quite different from being in the present moment with an apple.

The market is even more indirect and full of concepts that you don’t really know or understand. You never really have a direct experience with a stock. Instead, you see quotes on a computer, bar charts, and a place on your computer screen where you can fill out some information and open a position. You can never directly have an experience of that stock.

So all day long we are basically dealing with concepts flowing through our heads, not having a direct experience with anything. And the market is probably as indirect as anything.

Your head is probably filled with chatter. And most of it means very little. For example, let me stop for a minute and give you a running commentary of what’s flowing through my head:

“Oh, now you’ve done it, what are you going to say? And I probably had something important right there, but now thinking about it, I don’t know what it is. He’s in my head. Boy, I’m feeling sleepy. OK, a minute is probably up.”

Notice that what I said is mostly junk, but it’s actually what I said to myself when I recorded my thoughts for about a minute. Psychologists estimate that about 80 - 95% of the information we pay attention to in our heads is total junk. It doesn’t mean anything and it is repetitive. But for most people it is still the reality to which we give our attention.

So let’s see. What do we know now? Our thoughts are mostly junk concepts that we mistake for reality. And our only exposure to the markets is through vague concepts that just add more junk into what’s going on in your head. And it’s what’s going on in your head that you really trade (i.e., your beliefs)—not the markets!

This means that traders do not have direct sensory feedback about their trading performance. Typically, investment information is delayed and transformed through many levels of coding. For example, when a trader opens a position in the market, he does not get immediate sensory feedback about the investment. Most investments are traded symbolically. Typically, you might get a computer confirmation from your broker. You enter the order in your computer, it’s executed, and you get a summary statement of what happened.

Tom Basso (of New Market Wizard's fame) did a study in which he estimated that it took 2.5 minutes total elapsed time for him from the time he saw a signal on his quote machine in St. Louis to the time an order was actually executed in Chicago or New York. A lot can happen in 2.5 minutes. That was about 15 years ago, so you may be able to do it faster with today’s computers and the Internet. But the amount of information you have to deal with has probably doubled in the last 15 years as well.

When making an investment decision, the trader may get a verbal suggestion from someone, read a newspaper article or a newsletter, call into a hotline service, or study arbitrary visual representations of the investment’s history (called a daily bar chart, a financial report, etc.). Some investors receive price quotations at their computer via phone lines and then transform the information via computer software into arbitrary transformations known as bar charts, moving averages, oscillators, Market Profile®, etc. Thus, most of these sources of information are coded and recoded many times and are, at best, far removed from the original source.

Even people who work on the floor of an exchange get second-hand information, since the only information available is symbolic (e.g., verbal, written, or hand signals). Investments seldom change hands on the floor of the exchange. They are simply coded in log books or computers as having changed ownership. Direct sensory feedback, the highest quality sensory information, seldom exists for traders.

I only know of one example of traders receiving direct sensory feedback. Some floor traders on various exchanges use noise level as a system for trading. That is, they use the amount of noise on the floor as a signal for action. When the noise level on the floor is high, they become suspicious of what everyone else on the floor is doing and if the noise level later becomes quiet, they go against the crowd. But floor trading is quickly disappearing in favor of electronic market making.

There are many other aspects that go into how we deal with trading data. There is an aspect of responsibility that is important. I also teach internal representation and how that affects the way you view market information. It is also important to understand how you produce your internal models and the structure of internal information. However, this is extensive information, which is covered in an entire chapter of the Peak Performance Home Study Course.

How we process information can have a huge influence on our trading results because we use that information to make trading decisions. When you are studying the market and making your plans for trading ask yourself, “What does this data really represent? What does it really mean to me and how does it help me meet my trading objectives?” Just a little shift in your thinking can sometimes go a long way toward understanding yourself and your objectives better. And in my opinion any advancement in the understanding of one’s self is an advancement in your trading.

About Van Tharp: Trading coach, and author, Dr. Van K. Tharp is widely recognized for his best-selling books and his outstanding Peak Performance Home Study program - a highly regarded classic that is suitable for all levels of traders and investors.

Click here to learn more about Van Tharp at International Institute of Trading Mastery.