Friday, May 1, 2015

Information Processing and Trading

Here is an interesting observation drawn from the past six months of working
with a large group of full-time traders: The most successful of the group never change
the displays on their screens. Each morning the same information appears in the same
place. The less successful traders, on the other hand, tend to experiment. They will look
at different indicators each week, different ways of displaying the data, etc.
Now it may just be that successful traders are sticking to what has been working
and less successful ones are casting about for solutions. I think, however, that it goes
beyond that. New traders who become successful start out more consistent with their
screen displays than struggling new traders.
From an information processing and learning vantage point, this makes sense.
How do traders develop a feel for the market? During the research for my book, I came
across a large—and underappreciated—body of research documenting the phenomenon
of “implicit learning”. Subjects in studies, exposed to complex patterns in number
sequences, eventually learn to predict the next number in the sequences at levels far
greater than chance. This typically occurs only after thousands of trials and immediate
feedback regarding success/failure. Interestingly, even after they have developed this
predictive ability, they cannot explain how they are able to anticipate the next in the
sequence. They have learned the pattern, but cannot explain it: their learning is implicit.
My sense is that successful traders develop a feel for the market the same way
that the subjects of these studies develop a feel for the patterns that they are exposed to.
This would explain several things:
1) The best traders can make money, but can’t necessarily explain how they do it.
2) The best traders generally start out by losing money, but develop their skills over
an extended period of experience.
3) When markets change—in trend or volatility—the best traders generally need to
go through another learning curve.
4) The best traders lose their edge when they are taken away from the settings in
which their learning has occurred, as in the case of successful pit traders who
cannot succeed in electronic trading, or successful S&P traders falling down when
trading currencies or bonds.
5) The best traders get more exposure to the markets than their less successful peers
by spending more time following markets—even after hours by reviewing tapes
and charts.
This sheds a different light on the observation regarding the data displays of
successful and unsuccessful traders. When traders change their displays, they basically
restart their implicit learning process. If thousands of repetitive trials are necessary to
internalize complex patterns, changing displays prevents such internalization. Adding
charts to a display or toggling among multiple displays does not necessarily inform the
trader. Immersion in smaller amounts of relevant information may be far more
contributory to success.
A second implication of the above line of reasoning is that traders may fail, not
because they are unable to learn market patterns, but because the patterns are not being
captured in a user-friendly manner.
Let’s take an example from schooling: A student in an elementary mathematics
class might not pick up the idea of division by reading about it. When the process is
explained out loud, however, or when it is demonstrated on the blackboard, the student
immediately catches on. The problem is not that the student is stupid; rather it’s that the
student assimilates auditory and visual modes of presentation more easily than the written
word. Time and again during my student counseling days at a medical school, I
witnessed academically struggling students suddenly come to life when they joined study
groups. The act of talking the material aloud and processing the information
(inter)actively transformed mere learning by rote reading and highlighting of notes.
When you look at the information that is processed by the trader, you see that at
least 90% of it is visual—most often pictoral, in the form of charts. The idea of using
other senses to process market information—olfactory, kinesthetic, gustatory, even
auditory—is quite foreign. It is not at all clear, however, that all people (or all traders)
are visual learners. Might it be that traders fail, not because they’re unable to learn
market patterns, but because the traditional ways of presenting these patterns are not userfriendly?
Suppose data were presented in an auditory format, with trading volume
represented by auditory volume and price represented by pitch? Or if traders read their
information from a numerical table rather than a chart? Or if traders processed
information in groups rather than individually?
It is common to hear traders assert that it takes months or years to “learn the
market”? Might that be more a reflection of the poverty of our displays than any
existential reality? Putting different information onto our screens might be akin to
shuffling deck chairs on the Titanic. If success has been elusive, perhaps it is time to
“see” in a different way.

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