Studying both experts and novices can improve your trading, here’s how
A large body of research examines skilled performance in various fields by
comparing experts with novices. These fields range from athletics (both
team and individual sports) to chess to various performing arts. Having
now read scores of books and research studies on the topic, I see where much of
this research could be of value to traders seeking to achieve their own levels
of expertise.
A book that I am planning for 2006 will chronicle these investigations–and
their implications for trading–in considerable detail. This article will
focus on one particular finding of interest from studies on expertise in medical
diagnosis: the differences in reasoning styles between accomplished
professionals and neophytes.
Having taught in a medical school for 19 years (and having traded stocks and
equity indexes longer than that), I can vouch for the similarities between
arriving at medical diagnoses and coming up with trade ideas. Both involve
an initial absorption of detail, followed by a comparison of the details with
known patterns, and then a sharpening of one’s ideas prior to taking
action. Traders and physicians alike bring with them mental maps of
familiar patterns based upon didactic learning, research, and personal
experience. In that sense, a trader’s assessment that we are moving higher
is not so different from a psychologist’s diagnosis of an anxiety
disorder. The trader knows what trending markets look like–including
certain configurations of price, volume, and volatility–and the therapist has
an internal representation of anxiety disorders. Pattern search following
careful observation is crucial to their expertise.
It turns out in the medical expertise literature that novices (such as
beginning medical students or laypeople) lack the internal representations of
experienced professionals and thus have a harder time making sense of the data
they collect. Such novices will collect blood test results, physical
findings, and data from the medical history in a far more haphazard fashion than
experts, creating both inaccuracies and inefficiencies. Most crucially,
the novices employ what researchers call “backward reasoning”: they
jump from initially presented information to diagnostic impressions and then
move backward from their impressions to identify data that support their
views. For example, an inexperienced psychology student might observe low
energy in a patient and leap to the impression of depression. From this
impression, the neophyte therapist would ask questions that would be relevant to
mood disorders generally and depression specifically.
Expert doctors, however, do not function this way. They employ
“forward reasoning.” They collect a wide range of data that are
relevant to making differential diagnoses. Instead of jumping to a single
conclusion, they have in mind several possible conclusions and collect the data
needed to distinguish among them. Thus, for instance, the expert therapist
would seek a blood workup and a full history and physical to accompany the usual
psychosocial questions regarding mood. This is because the expert knows
that low energy in a patient can be the result of hormonal imbalances,
nutritional deficiencies, and disease processes–not just depression.
Where the novice works backward from an initial impression, the expert assembles
large amounts of data into clusters and narrows hypotheses until the best one
remains.
It is not unusual for traders to become married to market opinions: They get
an idea in their head where they think the market is going and then they ignore
information that tells them otherwise. I have watched traders selectively
pick information from markets that confirms their biases while ignoring huge
trends that are contradicting their ideas. Only after their markets close
do these traders look back and wonder how they could have missed what was so
obvious.
I contend that the trader who is married to an opinion is behaving like
novices in the medical expertise studies. They form an impressionistic
view of their market and then search for evidence to support their bias.
Expert traders, however, “let the market come to them:” they gather
enough information to sort out random movement from significant tendencies,
eventually arriving at trade ideas that represent their diagnosis of the
market. New traders, I’ve found, are like medical students in that they
haven’t received enough training and seen enough variations of patterns to know
how to assemble data into differential diagnoses. Only with repeated
experience do they learn to identify meaningful clusters of information and use
these to sort plausible ideas from implausible ones.
If this is true, trader education might need to more closely approximate
medical education. Traditional medical education consists of a
pre-clinical phase that teaches basic science fundamentals, so that students
understand principles of anatomy, biochemistry, cell and molecular biology,
pathology, and the like. After this comes a very different clinical phase
where learning is at the bedside, with students encountering a variety of
clinical cases and “reading up” on these. Traders, too, need a
basic education in the fundamentals of auction markets and statistics, so that
they understand the significance of bids, offers, volume, and price levels and
patterns that appear over time. After the basics, however, traders learn
at their equivalent of the bedside: by viewing markets under varying conditions
and looking deeply into these.
Ultimately, what physicians and traders learn is not just a fund of
knowledge, but a method of reasoning. What makes a good trader may come
less from the trade ideas themselves than from the forward reasoning process
used to generate these ideas. Traders who keep journals and work on their
performance may want to think about monitoring more than their moods, trades,
and profits/losses. They also need to think about their thinking.
Brett N. Steenbarger, Ph.D. is Associate Clinical
Professor of Psychiatry and Behavioral Sciences at SUNY Upstate Medical
University in Syracuse, NY and author of The
Psychology of Trading (Wiley, 2003). As Director of Trader Development
for Kingstree Trading, LLC in Chicago, he has mentored numerous professional
traders and coordinated a training program for traders. An active trader of the
stock indexes, Brett utilizes statistically-based pattern recognition for
intraday trading. Brett does not offer commercial services to traders, but
maintains an archive of articles and a trading blog at www.brettsteenbarger.com.