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A Few Notes on Trading from Your Gut

December 11, 2009 • Posted in Animal Spirits, Investing Expertise

In his 2009 book Trading from Your Gut: How to Use Right Brain Instinct & Left Brain Smarts to Become a Master Trader, author Curtis Faith uses stories and examples to “show how to develop your intuition and confidence in the decisions of your gut instinct so that you can use your whole mind while trading.” He preempts left-brained skeptics as follows: “If you are one of those traders who doesn’t believe that gut instinct or intuition has any place in trading, I invite you to keep an open mind. I, too, once felt as you did. After all, I was trained to take a very systematic and logical approach to trading… I believed that it was important to keep your emotions in check.” Some notable points from the book are:

From Chapter 1, “The Power of the Gut”:

Page 9: “…there is a big difference between trading emotionally and trading from your gut. Trading emotionally means reacting to fear and hope, which can destroy your trading decisions. Trading from your gut is…a way of tapping into the extra power of the right hemisphere of the brain, which can be a powerful, effective, and entirely rational addition to any trader’s repertoire.”

Page 17: “…To become a master trader, to be able to intuitively make good decisions, you must first gain enough of the right kinds of experience. …the most effective training is trading itself…the experiences you encounter while trading train your intuition…”

From Chapter 2, “The Purpose of Gut Intuition”:

Page 26: “The left brain is good at extracting abstract models from patterns and examples, and at establishing and choosing categories. The right brain is skilled at determining whether a given example fits the model that defines a category and is good at recognition. The left brain analyzes and the right brain notices.

Page 29: “…Traders who use their right brains will be more creative and will develop more novel ideas because of their willingness to act on feelings without an explicit rational reason.”

From Chapter 3, “Wrong-Brain Thinking”:

Page 36: “…if you want to make money trading, you can’t act similar to most other traders, but you need to know what they are doing…you need to retrain your gut to override cognitive biases [loss aversion/sunk cost fallacy, confirmation bias, outcome bias, recency bias, bandwagon effect]…”

Page 51: “If you want to be a master trader, you need to develop your own reasons for making trades, and you need to avoid doing anything just because others are doing it.”

From Chapter 4, “The Structure of the Markets”:

Pages 56-57: “Having gut intuition in trading is not enough to become a master trader. You also need a mature understanding of the structure of the markets… Repeating market-price behaviors are the source of all trading profits because they present the opportunities to gain…a slight statistical advantage over random behavior. …Master traders understand the importance of this skill and use a combination of right-brain instinct and left-brain smarts to identify and benefit from repetitions in market behavior.”

Page 61: “Understanding that price is a psychological phenomenon is key to understanding the structure of the markets. When you see price movement on the charts, you are looking at movement in the aggregate psychological perspective of the market participants.”

Pages 61,64: “Markets display inertia similar to physical objects. …When it slows, it generally doesn’t stop; it usually reverses. …cycles occur because of pauses and changes in momentum.”

Pages 70,73: “Support and resistance is one of the most important concepts in market structure. Changes in cycle direction because of the crossover between buyer and seller anxiety often take place near support and resistance levels. …a temporary bounce at support and resistance levels is one of the most reliable concepts in trading.”

Page 74:”Markets often act similar to damped harmonic oscillators…a series of progressively smaller waves that oscillate about a center line.”

From Chapter 5, “Training and Trusting Your Gut”:

Pages 90,95: “If you do not have enough raw experience or you have not supplied your right brain with enough trading examples, you will not be able to accurately and swiftly recognize the patterns that a more experienced trader will see with ease. …Master traders train and study to educate their right brains so they…can have superior instinct and intuition.”

From Chapter 6, “Trading Smarts”:

Pages 98-100: “The first step in building a rationale is choosing a type of trading method that works for you. …You need to find a method that harmonizes with your whole mind and your psychological makeup. …swing trading is the most viable option for most traders. You can trade with a smaller account, it won’t consume all your time, and it doesn’t require lightning-quick reaction.”

Page 102: “The way to reliably make money from the markets is to identify repeatable psychological market phenomena in which market prices appear to already reflect an overreaction or underreaction on the part of market participants, and trade against that reaction or anticipate an overreaction or underreaction based on previous market behavior.”

Pages 104-106: “The key to swing trading is identifying changes in the daily price-chart cycles–the transitions between periods when buyer anxiety dominates and periods when seller anxiety dominates. …Master traders learn to develop criteria to determine exactly when the odds tip in the trader’s favor, including these:

  • Market environment–Does the stock market need to be trending up, sideways, or down? Should it be volatile or quiet?
  • Setup–Conditions that indicate a trade is ready to be taken. These are often combinations of several short- and medium-term factors.
  • Triggering event–Specific event that indicates a trade should be taken.
  • Exit event–Specific event that indicates a trade should be exited.”

From Chapter 7, “Simplicity and Speed: Training to Be a Master”:

Pages 124-125: “You need to train the right brain to recognize the patterns you seek to find for your trading, and you need to train the right brain so it can see the big-picture relationships among all the various market data. The best practice for trading is trading itself.”

Pages 130,136: “To train your right brain properly, you need to [analyze] very quickly. Don’t allow time for your left brain to take over. …Keep your analysis visual instead of numerical. …The key to engaging your gut intuition during your practice is to force yourself to keep it simple and quick.”

From Chapter 8, “Techno Traders”:

Pages 143,148: “Master traders use technology…to speed up their learning. …Trading software can help automate the process of training the right brain by quickly presenting you with visual stock and market charts. “

Page 145: “The trading that exists just beyond the reach of technology [like swing trading] offers better opportunity for those who have properly trained their gut intuition…”

From Chapter 9, “A Careful Balancing Act”:

Pages 152-153,155: “Over the years, I have changed my opinion of what accounted for my success… I underestimated the value of my intuition. …Success requires a balance between your smarts and your intuition. …experts [use] their intuition to arrive at an initial plan, and then they [evaluate] that plan for viability using their left brain’s analysis…”

From “Conclusion”:

Pages 160,167: “…there’s no substitute for putting your money on the line and making actual trades. …To develop the art of the trade, you need to practice the act of relinquishing some of your decision making to your gut intuition.”

From “Afterword”:

Page 174: “…if you reduce the pressure on individual decisions by leaving yourself some tactical flexibility and maneuvering room, you will be able to make those decisions more quickly and with a lower level of emotional anguish. …here are some specific actions you can take to reduce the pressure on individual decisions and increase tactical flexibility:

  • Don’t overcommit–so you don’t suffer as much if a decision is wrong
  • Remain flexible–and adapt your tactics as events unfold
  • Experiment–to test several ideas to get more information
  • Have a plan B–to know what to do if an initial decision is wrong”

Some cautions regarding expectations for exploiting “the power of the gut” as described in the book are:

  • The author only loosely ties his beliefs to formal research on psychology, neurobiology and trading, making it difficult to judge the degree to which these beliefs are valid. He does not quantify or otherwise demonstrate the significance of “the slight statistical advantage over random behavior” available through analysis of market structure. It is very difficult to distinguish luck from skill in financial markets.
  • The book is generally vague about the returns reliably achievable by proper integration of right-brain and left-brain thinking at either a trade or a portfolio level. The author does imply strong returns in introducing swing trading on Page 99. (“You can’t earn the 100% average annual returns I earned as a Turtle using the same methods we once used.”)

In summary, active traders may find value in Trading from Your Gut as a means to benchmark their trading thought processes against those of an experienced and introspective peer.

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