Approaching trading with an empty mind

Cognitive psychologists emphasize that we see what we want to see: we are all
prisoners of the mental maps we create. Once a trader forms an opinion, he or
she is more likely to overweight information consistent with this view than
information that is contradictory. In one behavioral finance experiment,
subjects have the opportunity to offer an item for sale. In one condition, the
subjects have won that item in a contest. In the other condition, the subjects
price the item for sale, but it hasn’t been given to them. As you might guess,
the subjects who owned the item demanded much more money for the item than those
who had no ownership. It was the same item: only the fact of ownership made it
valuable. So it is with our market opinions: once we own it, we overvalue it.

Other studies suggest that we see only what we expect to see, and thus become
blind to new realities — much like the Florida sellers.

Laurence Gonzales, in his fascinating book “Deep Survival: Who Lives, Who Dies,
and Why”, describes a research study from Harvard psychologists. They showed
people a film of basketball players passing the ball to each other. During the
film, a man in a gorilla costume walks into the middle of the action and stays
visible on the screen for about five seconds. One group of subjects was asked to
count the number of passes among the players; the other group was simply asked
to watch the film. Incredibly, 56% of the subjects who counted the passes didn’t
ever see the gorilla. Of course, everyone asked to simply watch the film noticed
the gorilla man on the basketball court.

The point is that the brain is a kind of search engine: a Googler of reality. If
we program our search to look for passes among basketball players, that’s the
output we receive from the brain. What is extraneous to our search (gorillas) is
eliminated. When we conduct a broad search, we receive a wider range of outputs.
Focused searches work well if we’re looking for a specific item, such as lost
car keys. They don’t work so well when we need to process all of the information
needed to survive in an environment of risk and uncertainty.

It is very easy to approach the markets in focused search mode. We develop a
hypothesis about the market (bullish or bearish) and we prime ourselves to look
for certain chart patterns or indicator readings. In our haste to find what
we’re looking for, we can miss the gorillas in the market. Afterwards, we might
look back on market action and think, “How in the *^#@ could I have missed
that??!!”

Gonzales writes, “The practice of Zen teaches that it is impossible to add
anything more to a cup that is already full. If you pour in more tea, it simply
spills over and is wasted. The same is true of the mind. A closed attitude, an
attitude that says, ‘I already know’, may cause you to miss important
information. Zen teaches openness. Survival instructors refer to that quality of
openness as ‘humility’. In my experience, elite performers, such as high-angle
rescue professionals, who risk their lives to save others, have an exceptional
balance of boldness and humility…” (p. 91).

Gonzales has provided a concise formula for trading success: boldness and
humility. The exemplary trader has the boldness to act with conviction, and the
humility to realize that what is apparent may not be all that is there.

Notice how so many of the excellent market bloggers —
Charles Kirk and
Trader Mike come readily to mind–track
a variety of sectors and indices, examining the market from multiple angles.
They’re not just looking for the passes on the basketball court; they want to
make sure they’re not missing any market gorillas.

As I recently emphasized on my research blog, TraderFeed, the dominant themes of
the equity markets have changed. Everywhere we look, there is evidence of
risk-aversion. Look at which sector funds are growing assets and which are
losing them. Look at which sectors have outperformed the market, and which have
not. Value is trumping growth, and large caps are outperforming the small and
Midcaps. This is no longer 2003 and 2004.

We can fail to update our mental models, like those Florida homeowners, and miss
the gorilla in the market, or we can have the humility to accept and work within
changing realities. When it comes to the markets, an empty mind goes a long way
toward ensuring a full pocketbook.