10 Aug 2015

DOES INTUITION PLAYS PART IN TRADING?

So to talk about whether intuition can help you with trading, you first need to ask a question, what the intuition is.
With the recent advance in neurosciences and the bloom of behavioral economics, we can define it a lot better than, lets say, 10 years ago.

In short - the first thing we have to acknowledge, is the fact that most of our decisions are made based on, how a chemical, called dopamine, acts in our brain. Dopamine is directly responsible for pattern recognition and learning processes - from recognizing whether there's a lion hiding in a bush, to becoming a chess grandmaster.
When our brain recognizes a pattern, it rewards us with a surge of dopamine, which similarly to endorphin, makes us feel pleasure. The interesting thing is that the recognition itself is rewarded a lot more than the actual reward. To put it in an example - a research with monkeys shows that when a monkey has learned that he'll get a banana right after there has been a sound stimulus - when he hears a sound, the surge of dopamine is about 4 times higher than when he actually gets the reward - banana.
Or - when you recognize a pattern in trading, the surge of dopamine is a lot higher than when the pattern actually plays out and you earn money.

Now the important part - to teach us to avoid bad patterns - aka losing (whether it's a banana, trade or a card game) our brain dramatically drops the dopamine levels when we experience pattern which is playing out differently than before. This drop is said be about twice as strong as the surge when you recognize a valid pattern, therefore, our conscious mind is able to feel it a lot better than when a pattern is valid.

This evolutionary advantage happens to keep us alive. When you suddenly hear a loud, unexpected bang, all your senses come alive, you are alert and ready to act. The problem is - these reactions happen in unconscious part of our minds.

Consider this experiment by neuroscientist Bechara - he designed a game - a player was given 4 decks of cards - two black and two red - and 2000$ worth of playing money. The cards, however, weren't distributed by random. Two of the decks were full with ''high risk'' cards. They had higher payouts (100$) but they also included larger punishments (1250$). The other two decks were conservative - they had smaller payouts (50$), but they rarely penalized the player. If the gambler only draw cards from these decks he would come out way ahead.

At first the card selection process was completely random, as players had no reason to favor any specific deck. On average, it took about 50 cards before they began to draw solely from the profitable decks. It took about 80 cards, before any of the subjects could explain WHY they favored the profitable decks.
Logic is slow!

Anyhow, lets return to chess. A chess grandmaster can look at a board only for couple of seconds and he already knows what to do. It is said that the most important part of learning how to play chess is to analyze your mistakes. In other words - you need to consciously recognize errors in the patterns you made, so that the next time you are in a situation like that your dopamine neurons would let you make a better choice.

Niels Bohr has said - ''An Expert is someone who has made all the possible mistakes that can be made in a very narrow field.''

And to return to the original question - can we rely on intuition when trading? The answer is - Yes... If you are an expert in the field. Scientists say - it takes about 10 000 to 30 000 hours of practice to become an expert in most of areas. Considering the countless variables and the completely uncertain nature of forex, I would think, to become an expert is more towards the 30 000 hours.

So if you have been trading only for a year or two - the answer is - probably NO. You shouldn't be relying on the ''gut feeling'' as it is more likely to be something you ate for lunch than a reliable and genuine expertise that will help you in trading...



Sources:  
How we decide by Jonah Lehrer.
Thinking, Fast and Slow by Daniel Kahneman

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