*****David Blair, The Crosshairs Trader, is a blogger/trader/educator who does a wonderful job of sharing research on elite performance and how it relates to trading. Below is his latest post for the SMB trading community.***** — Editor’s Note
“My Aunt lived to be 100 smoking 2 packs of cigarettes a day since she was 18; therefore, smoking is not bad for you.” “I have a friend who does not believe in wearing seat belts. He has been in two accidents and walked away with but a few scratches and bruises; therefore, his belief has been validated not once but twice.” These statements sound really stupid do they not? We use statements such as these to prove something or to reinforce a belief we may also hold, but they actually prove nothing at all. What these statements do prove is that we often succumb to what is commonly referred to as the availability bias or heuristic. Traders are also guilty. We make statements such as “you cannot go wrong trading the trend” or “when my MACD indicator does this the stock does that” or “every third Friday is positive for the S&P when the second Friday is negative”. Or, as past investors or traders are apt to say “since I lost most of my money in the last crash I do not invest/trade in the market anymore. I cannot trust it.” We can even place a negative spin on a technical pattern by saying “since the last three breakout trades failed, breakouts do not work.” We can go on and on.
The availability bias says we paint a picture of the world based on information that is readily and easily available to us as if what is easy to recall is what is most likely the cause. And for traders, we reason that what has happened most recently is most likely to happen again, particularly when we want to believe it can affect the outcome of the next trade. In reality, things do not happen more frequently just because we conceive of them more easily. They can happen for any number of reasons that are not so easily conceived or believed. We want to believe that it is OK to smoke 2 packs of cigarettes a day and live to be 100 just like we want to believe that a MACD crossover causes a stock to rise or fall. Basically, we underestimate the risks associated with our limited thinking. Smokers do die of cancer, motorists do die without seatbelts. Trends do end, stocks rise and fall for other reasons besides a MACD crossover, not all Fridays end up after a previous down, and not all breakouts fail. But it is easy to believe these are so, especially when they are making headlines and awaken our emotions for potential gain.
Check out the following links if you are interested in saving yourself from riskless (= wreckless) thinking associated with what is readily and dramatically available versus what is silent and lurking under the surface.
The Classic Study on the Availability Heuristic (Tversky and Kahneman)
The Availability Heuristic (Wikipedia)
What is the Availability Heuristic? (Psych Answers)
“Following catastrophes, people are likely to overestimate how often similar events have happened in the past; people are also apt to overweight the likelihood of the recurrence of similar catastrophes in the future.” (Mind & Market)
“Every time you hear of a lottery winner, a 100-year old smoker, or a kidnapped child, you are adding to your brain’s store of available outcomes, whether or not those outcomes are truly likely. And since those outcomes appeal to our emotions, they will stick in our minds.” (MoneyNing)
“As human beings, when making decisions we often take into consideration our past experience, even when it is hardly relevant for our present and future.” (Higher School of Economics)
“While it can be useful at times, the availability heuristic can lead to problems and errors.” (About)
Availability is easy but is it right?
THE CROSSHAIRS TRADER
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