There was a recent University of Cambridge study that was mentioned in the Wall Street Journal and the Financial Times, among other media outlets, regarding the actual success of using “Gut feelings” for trading success over using machines. Of course, an article like this also flew around LinkedIn, at least among the types of people I am primarily linked to. At first I chuckled and then began to ponder…
If you’ve read my About page (if you haven’t now is a good time) you know that I ‘grew up’ in futures trading pits. This was a true bastion of gut trading. While I did also learn technical analysis (charts – oops, I mean “Data Visualization”), much of what all of us did was act on our body’s reaction to what was happening around us. A lot of times “I know it’s going up” was the reason to load up on a position. What’s humorous is that somebody else’s gut was telling them it was going down at the same time. If all those guts where right at the same time we’d never have had a functioning market.
“Our results suggest that signals from the body, the gut feelings of financial lore, contribute to success in the markets,” is how it was phrased in the study. While the articles I read didn’t seem to mention a direct comparison to machines and algorithmic trading, most of those same articles did mention this implication, that ‘gut feelings’ can outperform those computer models. Having used both approaches in my career, I’m not sure which way to lean on this, but really can’t stop chuckling at the study itself.
One of my favorite college Political Science professors also did work for one of the major polling firms at the time. He taught us how easily any survey can be “rigged” to reflect the pollster’s intended results, and they usually are. This political season has certainly given us the opportunity to hear this refrain. No matter which side you’re on, the reality of this shouldn’t be denied. Not that we should stop surveys and polls, we just need to understand the inherent ‘flaws’ in the results.
And so it is with trading and investing. The Cambridge University article was published on September 19, 2016 and more widely publicized in the 2-3 days following. And yet, at the same time, a column was written on Yahoo Finance titled, “The Old Wall Street Trader Is Dead, Algo’s Now Rule The Day.” Here we’re told that “Big Data” is now what drives trading. The ability to analyze unimaginable amounts of information in equally unimaginably short periods of time has to over-rule gut, intuition, intelligence, etc. So how do we reconcile these two equally valid yet diametrically opposed viewpoints?
As a fan of ‘whatever works,’ I wonder if we really have to. As to the gut feelings, I’ve always actually compared this to the work I’ve done on automated trading models. In trading and investing, Discipline is generally accepted as a necessary trait, perhaps the most important. And the reason for automating trading, be it mean reversion, the generally accepted ‘aglo’ style, or automated trend following, where I spent most of my own programming and testing, or both, is to enforce the discipline of repeatable action. This was my best method of taking my emotion or gut OUT of my trading. Huh? One thing I learned about my own gut was that the feeling there was more often indigestion than a correct hunch. I don’t, however, completely discount the gut feelings of the “broad” study sample of 18. Really? All those articles for a sample of 18? Given the sheer number of ‘gut’ traders out there, I’d call that a rather limited group from which to draw such an impactful conclusion…maybe we’ll cover that part of statistics another time.
I chalk up the successful gut trading to the unconscious recognition of previously successfully acted on conditions. In other words the situation, or setup, has some resemblance to a previously successful trade or investment. And it is that recognition that fuels the body reaction. For myself, I needed to put it all in code. But these guys (it was 18 males in the study) were able to judge the difference between being right and feeling ill. And isn’t that what the use of charts is all about? It’s a way to see the effects of people’s decisions based on what they felt in their guts and brains. And then I took those charts and programmed the repeatable pictures I was looking for. So here we have, what in essence is the combining of the case of relying on your gut, and the use of programming machines to all accomplish the same goal, profit.
No matter what side of this your opinion falls on, I prefer to just lean on the idea of “Whatever Works.” I always return to my charts because I find it the easiest way to interpret what You are doing and then acting in response to that. The beauty of this industry and the reason it thrives is due to all those differing ways of processing the available information. Research, programming or indigestion, they all work and they all fail. Pick the solution that fits your strengths, and keep the Discipline. The rest is noise.