We often take learning for granted but the way we learn something is often complex. If we don’t understand how we learn and then go about it the right, way the result can be disappointing.
A lot of the learning that occurs in life comes from experience. Trading and investing is no different. Of course we also need information or knowledge to point us in the right direction. This can sometimes be a problem because a lot of the information commonly offered to those starting out is misleading and sometimes just outright wrong!
One of the purposes of this blog is to provide accurate and reliable information and of course there are also other good sources of information available. You just have to look carefully for them. A good rule of thumb to follow is that if anybody is offering you a way to achieve quick and easy wealth or is trying to sell you some “secret” information, often for an exorbitant price, stay well away from them.
But even assuming we start off with good, correct information, there are still significant hurdles to be overcome as we attempt to develop and improve our skills through practice and experience.
An essential part of the experiential learning process is feedback. Please take a look at the following diagram Fig 1, which illustrates how it works.
First we make a decision to do something and then put that decision into action. This action will eventually produce an outcome. If we get a good outcome it will reinforce the knowledge that our decision was correct and adds to our experience in a positive way so that next time we attempt to make a similar decision, we will recall or perhaps get a feeling about what previously worked along with the inner confidence to simply do the same thing again.
On the other hand if we get a bad outcome we will automatically adjust our decision process so that we are less likely to make the same mistake next time we encounter this type of situation.
Even many animals with far less intelligence than human beings can learn to accomplish a task or range of tasks quite quickly using this approach.
Fig 2 illustrates what happens when we try to develop our skills at predicting market movements. Unless we average our past results across a large number of transactions, the outcomes of the previous completed trade provides us with less than helpful feedback.
Individual good decisions can provide either good or bad outcomes just as bad decisions can also provide good or bad outcomes. Instead of learning from our experiences we simply become confused and frustrated. After a while many simply give up. The same thing happens with animals subjected to a confused learning environment with random or near random feedback.
For those of us that refuse to give up, and persevere, our subconscious mind gradually learns to take over the decision making role and starts offering the best solution it is capable of under these conditions of uncertainty. In doing so, its highest priority is always survival and then, where possible, procreation.
The Executive Function
It may seem that we are doomed to perpetual failure in our trading and investment efforts but this is not necessarily the case. There is a part of our brain known as the pre-frontal cortex that has the potential to intervene and regulate between the conscious and unconscious mind. Psychologically, this function is commonly known as the “Executive”. It is interesting to note that this area of the brain does not normally reach full development in human beings until they are in their mid-twenties.
One of the functions of the pre-frontal cortex is to maintain that valued human characteristic known as consistency, which it does by discouraging you from messing around with the programs in your subconscious mind. New incoming information is compared with known information and if there is any conflict, the new is simply tossed out.
Once the subconscious mind has made a decision in this manner, there is very little that the conscious mind can do about it other than to seek complicity by looking around in memory to find a reason to justify or rationalise the subconscious decision.
Almost any “good story” will do. It is the preponderance of these stories, that accounts for all the trading and investment myths that abound. A very similar thing tends to happen in any other area of human activity wherever randomness or high levels of uncertainty prevail for a given outcome.
The underlying patterns that drive these mostly subconscious decisions are known as cognitive biases and while these subconscious outcomes may not be helpful for the task in hand they do have a primitive sort of rational if you think about money in terms of risk and survival.
These mostly subconscious decisions, based on cognitive biases, account for the negative edge syndrome that I spoke about in the previous article (The Problem). Given enough time and practice, this kind of behavior can develop into a deeply entrenched habit that can be hard to break.
There has been quite a lot of research in recent years into methods of training and developing the executive function. At this stage there appears to be no generally accepted process or method that works reliably although a number of credible research efforts have shown some promise.
This is a subject that I have been personally very interested in now for several years, specifically in relation to short term trading. I plan to continue with my studies and experiments in this area and hopefully one day will be able to report positive results from my efforts in this blog.
In the meantime, simply understanding the problems and how and why they occur seems like a good starting point.