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Taming Uncertainty

  #1 (permalink)
 
Salao's Avatar
 Salao 
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I've traded stocks for a little while now, but have only traded futures for a relatively short amount of time. At this stage of my futures trading career I'd say one of the most remarkable characteristics of futures trading is the use of crazy amounts of leverage. This leverage is one of the magical ingredients of futures trading because the potential reward can be great...in a relatively short amount of time. But the potential for loss is great as well. And these losses can rack up quickly...and in a relatively short amount of time. These dynamics require traders to make decisions about an uncertain future with imperfect information with stakes that are uncomfortable for most. In fact we are at constant confrontation with uncertainty and we are penalized harshly for being wrong.

As a beginner trader I couldn't help but notice I am 'wrong' a lot. And this despite what I consider my 'maximum effort.' I am wrong so much at times I am forced to look inward and question a lot of my thinking and decision making while trading. (And then I question whether or not this 'flawed' decision making is permeating the rest of my life and a defining feature of who I am. Haha! ) In my quest for information I took an interest in how people approach uncertainty. I did the standard google searches and read some interesting things and compared them with my own experience to see if it washed. Most of this stuff was not helpful. Recently I found a book called Taming Uncertainty and it seems like it addresses a lot of my questions.


Quoting 
How do humans navigate uncertainty, continuously making near effort-less decisions and predictions even under conditions of imperfect knowledge, high complexity, and extreme time pressure? Taming Uncertainty argues that the human mind has developed tools to grapple with uncertainty. Unlike much previous scholarship in psychology and economics, this approach is rooted in what is known about what real minds can do. Rather than reducing the human response to uncertainty to an act of juggling probabilities, the authors propose that the human cognitive system has specific tools for dealing with different forms of uncertainty. They identify three types of tools: simple heuristics, tools for information search, and tools for harnessing the wisdom of others. This set of strategies for making predictions, inferences, and decisions constitute the mind's adaptive toolbox.

The authors show how these three dimensions of human decision making are integrated and they argue that the toolbox, its cognitive foundation, and the environment are in constant flux and subject to developmental change. They demonstrate that each cognitive tool can be analyzed through the concept of ecological rationality--that is, the fit between specific tools and specific environments. Chapters deal with such specific instances of decision making as food choice architecture, intertemporal choice, financial uncertainty, pedestrian navigation, and adolescent behavior.

Taming Uncertainty
Ralph Hertwig, Timothy Plesac, Thorsten Paschur, and the Center for Adaptive Rationality

I recently started reading this book so I'm only about 100 pages in. I started this thread as a repository for some of the book's more interesting points, to elucidate for myself and share with others. I spent 40 bucks on this book so I'm hoping to get something from it! I also want to expose this material to air to see if traders find it useful or just BS...for the benefit of all hopefully. The book isn't terribly long 300-400 pages but it will be a slow slog through. I work full time and I spend most of my free time on the charts, generally trying to figure out price-action. But I plan to sneak in a few pages at a steady rate hopefully. I am also hoping to start a discussion about the mental challenges that confront traders resulting from uncertainty and the generally murky information available to us. Trade well all!

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  #3 (permalink)
 
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 Salao 
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Very early in the book, Taming Uncertainty, the authors begin to outline the mind's adaptive toolbox for navigating uncertainty. One of these tools is simple heuristics. The book defines a heuristic policy as a wager on the structure of the environment in question...it bets that ignoring some of the available information, potential noise, will enable faster and more accurate decisions.

The authors suggest that the world presents us with a David-and-Goliath imbalance between the individual and the world's complexity and they tell us that simple heuristics can sometimes outperform more complex strategies. Heuristics have been generally held as an accuracy-effort trade off, which can be rational or seriously flawed. They submit that the preference for the use of heuristics may not be a mental bandwidth issue, or stemming from the mind's limitations, but rather because of the effectiveness or the power of heuristics.

They offer that heuristic strategies work best when two conditions are met: "1. The tool-to-environment fit is high, and 2. when information about the decision environment is scarce." Which I feel can be highly applicable toward trading and how we select strategies, no?


Quoting 
The concept of ecological rationality (Todd, Gigerenzer, et al., (2012) highlights the fit between a heuristic--or, as we propose in this book, of any decision-making tool--and an environment. It also raises the following questions:

What structures does the environment offer that a decision-making tool could exploit?

In which environments does a particular decision-making tool succeed?

Which decision-making tools succeed in a particular environment?

How do decision-making tools and environments coevolve?

Taming Uncertainty, Hertwig, Plesak, Pachur, et al., page 9.

I do want to point out again, that I'm a layman regarding this kind of stuff, and I'm simply regurgitating some of the tidbits that I find interesting for learning purposes and for discussion maybe.

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 Blue Eagle 
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I came across this type of info reading Thinking Fast and Slow... tons of info and SOME of it filtered into understanding WHY I do things that don't work but I'm not sure it actually changed anything. Not sure if it was this book or another but one talked about the analogy of learning to drive a car...takes TOTAL focus in the beginning to watch all the cars, lights, signs, pedestrians etc... exhausting mentally. After a while we are ripping along changing radio stations and sipping coffee as we negotiate city traffic.

That same change happens with trading... our brains slowly get used to all the info and can lump it into important or not easier which allows focus where needed. Continues to this day for me...

Enjoy the book and the pondering... some will be useful...

Craig

Until you make the Unconscious conscious, it will direct your life and you will call it Fate...
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  #5 (permalink)
 
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 Salao 
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Blue Eagle View Post
I came across this type of info reading Thinking Fast and Slow... tons of info and SOME of it filtered into understanding WHY I do things that don't work but I'm not sure it actually changed anything. Not sure if it was this book or another but one talked about the analogy of learning to drive a car...takes TOTAL focus in the beginning to watch all the cars, lights, signs, pedestrians etc... exhausting mentally. After a while we are ripping along changing radio stations and sipping coffee as we negotiate city traffic.

That same change happens with trading... our brains slowly get used to all the info and can lump it into important or not easier which allows focus where needed. Continues to this day for me...

Enjoy the book and the pondering... some will be useful...

Craig

Hey @Blue Eagle! I enjoy reading your journal, it has become one of my daily reads!

I have a copy of fast and slow on my bookshelf so maybe I’ll get to it next. I think the analogy of driving a car is a perfect example of developing heuristic policies for learning to navigate roads from within a speeding vehicle...I’m a bit of a lead foot. Haha!

For trading, I guess I’m in the phase of culling out bad heuristics that lead to inevitable crash and burn. Which, to boil it down to the root of the matter, means that I’m trying to distinguish between noise and signal. But conversely, Lately I’ve been more of the mind to assume that there is no noise and that all the information means something. This is so that I don’t inadvertently dismiss a piece of information that may be in fact critical. This I imagine is a long process. The end goal is to develop some kind of heuristics, and then I maybe can make a distinction between noise and signal. So that maybe one day I’ll be able to navigate a city street, sipping coffee, listening to an ebook, and screaming at my broker on blue tooth. Haha!

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  #6 (permalink)
 Trailer Guy 
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1. There is something about positive affirmations that is very comforting when we are facing what we know is an uphill struggle. Unfortunately they don't explain what is going on.

You really really need to read "The Undoing Project". "The Undoing Project explores the close partnership of Israeli psychologists Daniel Kahneman and Amos Tversky, whose work on heuristics in judgment and decision-making demonstrated common errors of the human psyche, and how that partnership eventually broke apart."

Or just find a current text book in Behavioral Economics. Michael Lewis is an easier read. My bottom line those two gentlemen turned the world upside down for a lot of academics and proved that we are not logical thinkers. Period. Mr. Spock was only half human and he struggled to be logical. We have literally no chance. So embrace your natural disability and start structuring an environment where your non-Boolean brain can succeed.

2. In a positive way you need to keep up with what is offered on this site if futures look a bit chaotic to you.
But let me quote Tom Dante (who would be banned for language in a heart beat) and his very famous bit of what to do.


Between the videos and all the posts you can work through the ever obscene Trader Tom Dante's decision matrix.

On the dollar issue there is an easy answer. Futures Trader 71 (yes I am one of the faithful 500 or so that listen to him every single morning before the open) lobbied hard and the exchange now offers micro contracts. Morad says watch the minis but trade the micros so you don't blow up your account. Yes the commissions are a bit higher but cry me a river the trades are one tenth so no way the brokers can do it for the same rate.

3. What makes me feel less lost at the end of the day? A big helping of order flow starting with the free morning report from Morad (FT71). Using the tools from Ninja (multi day profile, current depth of market and trade detector because there is no volume on a tick chart)). So I have an idea of where they may be going and stopping before the day begins. After dinner I watch Mack's free video (PriceActiontradingSystems) mostly for comparison to see where we saw things differently. Particularly how he drew his trend lines. So I don't feel as lost as I used to. Not ready to do play by play commentary but at least I can follow the game pretty closely now. And I am a slow learner, just ask my wife

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  #7 (permalink)
 
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 Salao 
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Trailer Guy View Post
Or just find a current text book in Behavioral Economics. Michael Lewis is an easier read. My bottom line those two gentlemen turned the world upside down for a lot of academics and proved that we are not logical thinkers. Period. Mr. Spock was only half human and he struggled to be logical. We have literally no chance. So embrace your natural disability and start structuring an environment where your non-Boolean brain can succeed.

Hey @Trailer Guy! I think what the authors of Taming Uncertainty would say is that perfect logical thinking is difficult for people to do when information about the decision environment is scarce or not easy to identify. But the researchers claim they have an argument that heuristic policies can perform and outperform strategies that "make the greatest possible use of information and computation." Which sounds like good news for us discretionary traders. I haven't read far enough in the book yet, so I don't know how they came to that conclusion. When I do read that portion, I'll definitely post what I learn.

I'm going to have to add 'The Undoing Project" to my list...but it's going to be a while if I ever get to it. .

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GJStrader
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Another good book related to all this... "Thinking in Bets" by Annie Duke. Discusses making decisions in the face of uncertainty

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