tony plummer - sta-uk.org (2).pdf · in case of danger in case of need to anticipate ... us vs them...
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0© Helmsman Economics Ltd, 2014
Neuroscience of trading
Tony Plummer
1© Helmsman Economics Ltd, 2014
Our limitations
On the voyage of science we are perpetually sighting great continents of ignorance that we did not even know were there.Matt Ridley.Science keeps showing us how little we know. The Times. 10th February 2014
2© Helmsman Economics Ltd, 2014
Little known facts
1. Brain and body co-evolved
2. ‘Mind’ involves brain and body
3. Body’s priority is survival
Brain is large because body is complex
Brain is only one part of information-processing system
Can’t distinguish between real & imagined threats
Body is involved in your decision-making
And vice versa
3© Helmsman Economics Ltd, 2014
Another little known fact
NOT the ‘S’-shaped learning curve
1. Learning occurs in three phases
2. Absorption phase uses energy
3. Energy diverted from other activities
New information absorption application
Information moved from long- to short-term memory (Donald Hebb)
External rest / internal work
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Slow start
Rapid progress
Ceiling
‘S’-shaped learning curve
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Learning is a three-stage process (Henry Mills)
Exhaustion
Learning transferred fromshort-term memory
to long-term memory
Mills-Hebb learning curve
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Traders cut profits and run losses
1. Endowment effect
2. Loss aversion
3. Reference point
Owning something increases its value to you
Subjective earlier state used to evaluate gains and losses
Losses have a greater psychological impact than gains
Daniel Kahneman’s Prospect Theory
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What’s going on?
1. Prospect Theory identifies subjective biases
2. Sense of self comes not just from body
3. Need to protect ‘self’ creates anxiety
Contradicts ‘rational’ (left-brain) behaviour
Financial losses affect bottom line and sense of self
Actual and potential losses create anxiety
Includes ‘internal objects’ signifying attachments
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Financial market losses
1. Possibility of increased lossoutweighs
probability of increased loss
2. Have to reduce possibility to zero
No comparable mechanism for profits
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The DJIA, 2007-09
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03-Jan-06 03-Jul-06 03-Jan-07 02-Jul-07 31-Dec-07 30-Jun-08 29-Dec-08 29-Jun-09 28-Dec-09
Volu
me
inde
x
Inde
x lev
el
DJ Industrial Average(Weekly; Heikin-Ashi)
Data source: Bloomberg
Volumes rise as bear evolves
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Fear & anxiety
1. Imagined threats same as actual threats
2. Fear & anxiety have a physical dimension
3. Amygdala(e)
Brain cannot tell the difference
Overrides rational thought
Need to understand role of amygdala
Flight/flight/freeze
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Human brain
1. Brain stem
2. Limbic system
3. Neo-cortex
Reptilian ancestry
Mammalian ancestry
Distinctively human
‘Triune’ brain (Paul Maclean)
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The triune brain: brain stem
Brain stem
Reptilian ancestryInstinctive behaviour
Biological drivesCompulsive behaviour
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The triune brain: limbic system
Limbic cortex
Mammalian ancestryEmotions
Long-term memoryGroup behaviour
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The triune brain: neo-cortexNeo-cortex
HumanConsciousness
Frontal cortex
Pre-frontal cortex
Focused attentionMotivation
Monitoring of goalsRegulate emotionsAbstract thinking
Recreation of pastAnticipation of future
Suppress neo-cortex brain stem & limbic system
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The amygdala
Deals with change
Stores memories of emotional events
Matches patterns
Triggers learnt reactionsAmygdala
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• Electrical ‘spike’
• Activates visual system
• Focuses attention
• Orientation response
Occipital lobe
Pons
Surprise!
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Surprise!
Amygdala alarm
Physical readiness for fight or flight
orfreeze
Conscious awareness
Rational thought is short-circuited
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Reasoning
Format for interpreting
Stimulus
Thalamus
Neo-cortex
AMYGDALA
FEAR RESPONSE
1
2
Thinking slow and acting fast
In case of danger
In case of need to anticipate outcomes
Brain stem Hypothalamus
Amygdala over-rides rational behaviour
MemoriesHippocampus
Orientationresponse
Occipital lobe & Pons
Activated?N Status
quo
Y30
milliseconds
500 milliseconds
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Fear response
Brain stem Hypothalamus
Endocrine system
Autonomic nervous system
Sympathetic nervous system
‘Fight/flight/freeze’
Pupils dilate Respiration increases
Heart rate risesDigestion inhibited
Saliva inhibited
Adrenaline (prepare for action)Testosterone (promotes aggression)
Cortisol (minimises unnecessary energy use)Endorphins (reduces pain)
Oxytocin (promotes attachment)
Hormones
AMYGDALA
Body is involved in decision-making
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Fight-Flight-Freeze
Orientationresponse
MobilisationSympathetic
nervous systemFightReact?
Freeze
Ready?
Flight
Y Y
N
N
(Objectivebuy/sell rules)
(Follow crowd)Rest & digestPara-sympatheticnervous system
PRICE FALL
Biggerlosses?
Y
N Statusquo
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Fight-Flight-Freeze
Orientationresponse
MobilisationSympathetic
nervous systemReact?
Freeze
N
PRICE FALL
Biggerlosses?
Y
Focused attention+
Heightened state of fear=
TRANCE-LIKE STATE
CORTISOL
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The big freeze
1. Resist taking losses
2. Cortisol
3. Trance-like state
Impact of every price change progressively magnified
Open to suggestion
Prepares body for survival
‘Loser’ effect
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‘Loser’ effect
1. Survival mode
2. Prolonged & severe stress
3. Widespread impact
Blood pressure; raised cholesterol; high glucose
Interruptions to: digestion, sleep, immune system, sex
Cortisol dominates a bear (John Coates)
Long-only funds cannot avoid bearGovernments cannot stop it
Increased weight; heart attack; diabetes
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What about a bull trend?
Orientationresponse
MobilisationSympathetic
nervous systemReact?
Buy
Y
N
(Follow crowd)
PRICE RISE
Cash toinvest?
Y
N Statusquo
TESTOSTERONE
What triggers a ‘buy’ reaction?
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Individual exuberance
1. Learnt beliefs about trend
2. Testosterone
3. Dopamine
After 38.2% retracement of previous trend
Pleasure and anticipation of pleasure
‘Winner effect’
Slow-acting; improves performanceFeedback loop with prices
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Winner effect
1. Testosterone for competition
2. Testosterone increases risk appetite
3. Feedback loop with success
Testosterone dominates bull (John Coates)
Stabilises attention
10 times more in men than womenWomen less prone to ‘winner effect’
Increases reaction speed
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Two lines of enquiry
INDIVIDUAL INVESTOR
Can we avoidstress and over-exuberance?
ANTICIPATING THE MARKET
How is individual experience related to collective order?
TECHNICAL ANALYSIS
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Need earlier state to evaluate gains and losses
Neutralising Prospect Theory
1. Endowment effect
2. Loss aversion
3. Reference point
Owning something increases its value to you
Defining the problem reveals the solution
Losses have a greater weighting than gains
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Decisions that are right for you
1. WAIT before you change anything
2. Stress/exuberance is information
3. Don’t ignore intuition
Hope and despair trigger different reactions
Your body knows more than you think you know
The mind depends on the body
Physical reaction is relevant
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1. We don’t know everything
2. Rely on others for missing information
3. Awareness of others’ behaviourRational observation
Basis of ‘herding’ or ‘swarming’
(Certainty is not the same as perfect information!)
Over-rides personal information
Non-rational sensing
Neuro-science of groups
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Very little choice
Herding
1. Psychological
2. Imitation
Non-rational groups
Brain wired for social co-operation/cohesion
Others’ facial expressions, posture, tone of voice, movement, etcMirror neurons
3. Emotional contagionSteroid hormones ensure that we all have the same feelings
Information influenced by feelings
Right brain/feelings
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Five principles
Non-rational groups
Us vs Them
Self-organising
Super-organism
Shared beliefs
Neural network
Inter-group competition
Persist through time
Parts expendable
Act as glue Group mind Pecking order
Competition
Purposeful
Contagious
Accepted uncritically
Individuals as ‘nodes’
Warfare
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Us vs Them
1. Group psychology controls:Nation states
ArmiesReligious sects
Football crowdsGangs
Political parties
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Us vs Them
1. Group psychology controls:
2. Groups will follow a leader
3. Price trends reflect stock market beliefs
Leadership provided by price movements
Reflects group beliefs
Bulls vs bearsStock markets
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Model of mass behaviour
Learning occurs in three-waves
38.2% of bear
38.2% of bull
LEARNING
LEARNING
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Neuro-model of mass mind
Winnereffect
Losereffect
End of main thrust of bear
End of main thrust of bull
End of main thrust of bear
Actual pattern varies depending on bigger cycle
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The threefold sequence of change
Forcible separation from old
CreativeIntroduction of
new
Natural selection
Elliott and Gann treated sequence differently
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‘Elliott’ interpretation
TransitionBase
InnovationTrend
ConsolidationCorrection
1
2
3
4
5
A
B
C
Elliott’s 5-3 pattern is sign of evolution
1
2
3
4
5
Base Trend Correction
a
b
c
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TransitionBase
InnovationTrend
ConsolidationCorrection
Gann’s interpretation
Each cycle has evolution-specific pattern
Base Trend Correction
Energy gap in base cycle
Energy gap in whole process
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Percent of cycle time elapsed
6-m
onth
% ch
ange
6-m
onth
% ch
ange
Percent of cycle time elapsed
Ordered behaviour in the DJIA
Average of three 35-year cycles
Dec 20Dec 57Oct 92
May 32Mar 68Sep 02
Jun 10Nov 46Sep 81
Apr 41Feb 78Oct 12
Oct 07Apr 41Feb 78Oct 12 2015-16 2025-27
Gap?
191619531987
1937-381973-742008-09
32 years
35 years
2021/23
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Gann’s mass pressure pattern
Absolute level
MomentumSHOCK
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2004 2007 2010 2013 2016 2019 2022 2025 2028 2031 2034 2037 2040 2043 2046 2049 2052 2055 2058
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Current cycle (2002 to date)
2-ye
ar %
ch
ange
2-ye
ar %
ch
ange
Percent of cycle time elapsed
Does it work?
54-year Kondratyev
cycle inUS wholesale
prices
18401894194920022057
1813186419171974
2024/27
Rapidly rising money supply
+WAR
WE AREHERE
!17851840189419492002
17921847190119532009
GAP7 years of
‘preparation’47-years
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Implications of neural networks
1. Economy and markets are non-random
2. Driven by collective dynamics
3. Traders need to be independent of crowd
‘Randomness’ is very short-term
Personalised approach
Technical Analysis
Physical effect of steroid hormones
Aware of your limitations
Individual psychology interacts with group neural network
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Practical source reading
1. Thinking Fast and Slow
2. The Hour Between Dog and Wolf
3. Global Mind
Daniel Kahneman
Howard Bloom
Implications for your decision-making process
John Coates
4. The Law of VibrationTony Plummer
45© Helmsman Economics Ltd, 2014
®
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