A Quantitative Approach To Intuitive Trading – Part 1/5 [Revised]

After bringing up the inherent problems with the idea of strictly quantitative trading in an earlier post, A Doubtful View of Quantitative Trading, it’s time to try to solve them.

In evolutionary terms, language and reason are very recent additions to the cognitive arsenal.so it’s no surprise the unconscious inference engine evolution created makes its views known in less obvious ways, through emotions, biases, and bodily sensations. People frequently find themselves second guessing the system they’ve decided to follow, rationalizing it with a blizzard of brilliant logic, but ultimately abandoning ship simply because of how they were feeling. When you aren’t comfortable with something at a gut level your mind will eventually find a way for you to escape it.

Given this scenario is almost inevitable it’s important to find a way to tame the wild beast of intuition and turn it into a more positive force. In this five-part series I will describe a basic approach to quantifying intuition, consisting of four main parts:

  1. Ensuring adequate experience and training
  2. Mental housekeeping
  3. Identifying and validating an intuition
  4. Maintaining intuitive calibration and controlling execution

If you’ve been trading for a number of years you can shorten the process significantly, but it’s still important to go through the process in order to reorganize and systematize what you know, both consciously and unconsciously.

Ensuring adequate experience and training

In the broadest sense intuition is no different from conscious decision-making, it’s simply a different path to a solution – one that has been used successfully for far longer than the conscious mind. Research has shown intuition works best in situations of uncertainty and risk, where there are more than two choices and no clear objective answer. Those characteristics describe many things in life and trading is certainly one of them. The other necessary component for good intuitions is an adequate base of relevant experience. Over time experience creates a body of information and connections from which unconscious inferences are made. Thus there is a direct relationship between the quantity and quality of information fed into your unconscious and the quality of the decisions that will result. This means spending a relatively long period of time observing market behavior is an unavoidable prerequisite to valid intuitions. If every possible market event could be experienced over a weekend that would be more than sufficient, but as a practical matter I think roughly 5000 hours of real-time exposure is about the minimum. It’s possible to go live earlier and learn as you go, however most people have strong emotional responses to trading which only muddy the waters when it comes to the later parts of the process.

It’s impossible to know exactly what information your mind uses to develop an intuition so living through 100 years of trading would be the best preparation. Most of us can’t spare that much time so using historical data is the only other option for increasing your exposure to market behavior. Walk forward bar by bar, covering a variety of market conditions, as far back as you can get data. After a period of observation start putting pressure on yourself to find the best trades; track your paper trading results. Everything in the unconscious has an emotional tag and historical data makes it difficult to reproduce the emotional content of live trading so be creative in finding ways to increase your emotional engagement in the process. In this learning process you’re not just learning how to read the market but how to read yourself as well. Your emotional responses are meta-data in the intuitive process. Much like trading an equity curve, at some point you will start to recognize and use your internal sensations and emotional states as trading signals (for example, you may have a specific panicky feeling of missing out right before a top).

No matter what time frame you trade, becoming familiar with the ebb and flow over longer time frames is important to avoid the dangers of picking up nickels in front of a steam roller. The future is unknowable, but market behavior is a reflection of human nature which is relatively constant. Ideally you should be able to bring up a random weekly or monthly chart of your chosen market and tell when it was without looking at the date axis. Memory being what it is, doing a periodic review of historical data is also a good idea.

Though vital, simply feeding as much information into your intuitive database as possible isn’t enough. The reservoir of experience must also be in a form that’s most meaningful and memorable to you, as well as very specific; involving the same sensory input as will be used when making decisions in the future. The unconscious pays attention to far more than the conscious mind is ever made aware (or could understand). In studies, people playing with crooked decks of cards adjust their betting significantly before they become consciously aware that there is something amiss with the odds. So if you spend 5 years following the markets minute by minute in your training phase and unthinkingly have CNBC droning quietly in the background, the intuitive process will suffer without that backdrop, even if you never consciously felt it was worth your attention.

People have different preferences for how information is presented when learning. Some remember what someone said like they have a tape recorder in their heads, others have near photographic memories (mine is mostly pornographic). Which sensory modality you prefer should shape how you present market information to yourself. If you are very musical, presenting charts as musical scores may be more meaningful than a picture on a screen. Hand drawing charts is still popular with a few people because it literally increases their “feel” for price movements.

Selecting the quantitative elements used to filter and present market data is an area ideally suited to rational analysis. The human mind can only process a very limited amount of information simultaneously so if you have more than seven charts and/or indicators on your screen at one time it’s too much. Do back-testing to determine which are most reliable and relevant for how you trade and eliminate the rest, using this remaining subset of market information for all future training and trading. Once you have a stable set of charts, indicators, feeds, etc. that you are comfortable with, keep everything about their presentation the same: Colors, resolution, position on the page; your distance from the screen, even the position in your visual field can modulate the emotional impact and whether it’s perceived as positive or negative. Everything in your local environment should therefore be held as constant as possible. Ideally, the market, as viewed through the filters you’ve selected, and your visceral response to it should be the only variables.

As you gain experience and your unconscious begins to develop hypotheses about market action it’s likely you’ll begin to feel that what you have on your monitor isn’t quite telling you what you need to know (an intuition in its own right). Use that input to change things until you find something that feels right. Not that you “think” is right, but that “feels” right. That distinction is the essence of intuition, so don’t start out by ignoring it. After making any change it’s important to gain more historical and real-time experience before assuming your intuitions will be unaffected by even a minor change to your inputs.

Out of necessity I’ve left out a lot and it probably doesn’t seem like much – all that’s required is time, an open mind, and selecting and controlling some variables. But that’s the easy part of the process. The next installment will cover the mental housekeeping that needs to be done before intuitions can achieve conscious awareness intact and unmolested.

The complete series: Part 1, 2, 3, 4, 5

Further reading:

Western cultures are particularly dismissive of intuition and if I ever get around to writing a book on intuitive trading I’ll spend some time providing a scientific justification for it. When I [unwillingly] started becoming an intuitive trader there was not much science to back it up and I often felt it was barely more reasonable than chanting incantations and reading chicken entrails. Things are better now, and there are a number books to provide a security blanket of science to put your mind at ease.

Implicit Learning and Tacit Knowledge: An Essay on the Cognitive Unconscious (Oxford Psychology Series) A fascinating book. The first book I read that provided a rational basis for intuitive decision-making and still my favorite. Unconscious learning  and knowledge are perhaps the predominant basis for the bulk of our abilities.

An excellent discussion of the integral and indispensable role of emotions in decision-making, and an all around good read is Descartes’ Error: Emotion, Reason, and the Human Brain

A large number of biases in decision-making can throw off intuitive trading. These two books cover the common pitfalls that can result from our genetic heritage. Forewarned is forearmed. Judgment under Uncertainty: Heuristics and Biases
Heuristics and Biases: The Psychology of Intuitive Judgment


4 thoughts on “A Quantitative Approach To Intuitive Trading – Part 1/5 [Revised]

  1. Pingback: A Quantitative Approach To Intuitive Trading – Part 3/5 | Mortality Sucks

  2. Pingback: A Quantitative Approach To Intuitive Trading – Part 4/5 | Mortality Sucks

  3. Pingback: A Quantitative Approach To Intuitive Trading – Part 5/5 | Mortality Sucks

  4. Pingback: Pseudo Random News and Comment | Mortality Sucks

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