“I got them all wrong” exclaimed one private equity portfolio manager. “Ha! Right!” said another Chief Investment Officer when I suggested that the pattern recognition skills embedded in succeeding with the Bloomberg Tradebook Trader Brain Exercise (TBX > GO) resembled private equity decisions.
With almost ten thousand players, this exercise/game illustrates an underlying hunger for new ways to improve our market decisions.
On the other hand, the essence of the game – predicting the movement of animated shapes – doesn’t necessarily seem relevant to predicting where a trade is headed. So what gives?
As Michael Mauboussin of Credit Suisse recently said “Investing is an inherently social exercise.” What he means is that whenever anyone enters the market, they are implicitly betting that some other market player is going to want to buy/sell the same asset at a worse price in the future. If you pay $115 for Apple you are saying you believe that someone else will pay $118, $120, $125… In fact, if you could know who will pay what for anything – tomorrow, next week, next month – you’d literally be able to make any amount of money you want.
This social prediction is the essential question of trading or investing in equities and futures markets. Yet hardly anyone speaks directly to methodically and explicitly asking it!
Ironically, humans are actually inherently good at predicting other humans’ feelings, beliefs and future behavior. Neuroscientists and psychologists call it theory of mind – meaning you literally have an expectation about someone else’s mental state. It’s the mental skill germane to successful poker playing – being good at interpreting bluffs and other mind games being played around the table. Another term for it is cognitive empathy.
John Netto, author of The Global Macro Edge, has garnered returns over 100% in part due to robust understanding of cognitive empathy. He systematically outlines who the players are that he is trading against and then goes on to predict their viewpoint and positioning at key inflection points in the market. Bloomberg Tradebook’s Trader Brain Exercise can be a tool to help others gain John’s skill.
One client, a former CME floor trader who is now becoming successful on the screen, initially said he couldn’t think of those on the other side of his trades – there were too many of them! In coaching he noticed however that his gut feel about when to exit was almost always correct. He could feel shifts in momentum but had been ignoring them in order to stay “disciplined.”
After the umpteenth missed opportunity, he started experimenting. He conceded that he had a very distinct feeling of pattern recognition. Then he realized that he did indeed have a story about the other players in the market. He realized that he was cognizant of who was stuck where or when buyers or sellers were reversing.
Likewise, when he first played with TBX, he didn’t exactly knock it out of the proverbial ball park. Sticking with it, he eventually realized that he was again feeling a story – his theory of mind worked. He just hadn’t been able to hear it. Furthermore, once he began connecting with his instincts in the game, he also realized that his market stories were getting more robust.
In September, John Coates and researchers at Cambridge declared that gut feel in trading is real. They came to this conclusion via studying 18 hedge fund traders. A correlation emerged between those who were better at accurately counting their heart beats and trading results. Those who could better track their own heart rate had higher P&L statements and longer track records.
This sensing your body is called interoception – i.e. internal perception. Feelings of non-conscious pattern recognition also occur in the body more so than the head. Hence the logic flows that if you can feel your heartbeat without aids – a rather difficult task – then you must also be adept at recognizing the other bodily sensations like “instinct”. Research repeatedly demonstrates that what we think of as the brain actually extends to the body’s ability to organize and summarize large amounts of non-conscious knowledge.
The trader brain exercise offers two opportunities – finding your gut-feel and warming it up before a trading day. Answering the questions directly taps into the theory of mind brain networks. You literally get to play with the process that delivers gut feel while only risking being wrong on an unpublished and uncompensated game score.
What people don’t realize when they first try it is that their bodies will indeed deliver a story to their conscious – if they listen.
I virtually guarantee that the problem with our aforementioned Private Equity PM and CIO was overthinking. They tried to reason it out. Instead they should have been introspective around the answer their internal perception mechanisms delivered. The body offers insight.
Business school didn’t teach them how their brains and bodies combine to create insight. Surely these astute investors talk about instincts, intuition and the feelings they get during the due diligence process. What if they could practice?