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Your Silent Trading PartnerYour Silent Trading Partner IBD & MITIBD & MIT

March 25, 2009March 25, 2009 Mark PassacantandoMark Passacantando

No part of this written or oral presentation should be implied to be a recommendation or construed to be a sale of No part of this written or oral presentation should be implied to be a recommendation or construed to be a sale of a security and there are no explicit representations. This information is purely educational in nature.a security and there are no explicit representations. This information is purely educational in nature.

The Big 3 Questions !!!The Big 3 Questions !!!1) Are there key factors that stack the

deck against us (investor/traders)?

1) Are we aware of them?

2) Is there anything we can do to swing some of that probability back in our favor?

The Big 3The Big 3Yes, 90% of new traders fail in the first year!

Research: due to the fact that we are irrational in execution; miscalculate probability, risk, reward, randomness

Most people are not; maybe some remote awareness; dots are not connected; greed; fear; ignorance; we are too smart

Absolutely! Read on…

VBB – Visceral, Brain, BiasVBB – Visceral, Brain, Bias• Visceral – things hit us without us

knowing about it - influence?• Brain – Chemicals are so powerful;

they rule – influence?• Bias – We come to the table with

“Rules” already built-in – Investors are never neutral! -influence?

Visceral Game RulesVisceral Game RulesQuiet, relax, heighten senses

It straight, hands out, feet flat

Press left hand/foot for STOP; negativePress right for GO; positive

Thevote.abc.comThevote.abc.com

Thevote.abc.com

Pinknews.com/uk Pinknews.com/uk

Vulcansmercy.comVulcansmercy.com

Sanityisland.us.comSanityisland.us.com

NFLlogos.comNFLlogos.com

Sidelinehelmets.comSidelinehelmets.com

What Did You Feel?What Did You Feel?• Any patterns?• Observations?• Impact on state of mind?• Impact on investment decisions?

Control Center – It Is Control Center – It Is Working Right Now!Working Right Now!

More than 100,000 chemical reactions go on in your brain every second! The brain is also a radio transmitter, which sends out measurable electrical wave signals. The brain continues to send out these signals many hours after death!

Among the brain's many jobs is to be your own chemist. The brain produces more than 50 identified active drugs. Some of these are associated with memory, others with intelligence, still others are sedatives.

Source: Altered-States.net

HAPPY BRAIN CHEMICALSHAPPY BRAIN CHEMICALSEndorphin = Brain's painkiller, and it is 3 times more

potent than morphine. Scientific research over the last several decades has led to the revolutionary discovery of opiate-like chemicals in the body that associate with opiate specific receptors in the brain and spinal cord, including Serotonin, a hormone manufactured by your brain.

Serotonin = a neurotransmitter, involved in the transmission of nerve impulses. Besides being involved in the process of addiction, low Serotonin levels are believed to be the reason for many cases of mild to moderate depression which can lead to symptoms like anxiety, apathy, fear, feelings of worthlessness, insomnia and fatigue.

Happy (con’t)Happy (con’t)Dopamine, which makes people more

talkative and excitable. It affects brain processes that control movement, emotional response, and ability to experience pleasure and pain.

Happy (con’t)Happy (con’t)Exercise has been shown to produce

another chemical known as endorphins, which help with depression, anxiety, sleep, and sexual activity. So, besides eating certain foods, relaxation, exercise, and are things that we do that can also affect the level and activity of these chemicals.

Happy to slooooooow downHappy to slooooooow down• Relaxation produces the chemical

norepinephrine; tied to depression in some studies.

StressStress• Cortisol• Stress impairs memory and judgment• Stressors are never static; they mount• Past stress (e.g.PTSD) affect current ability

to handle stress• Stress – neuron firing slows; less flexible

connections not made as readily

Cocaine and InvestmentsCocaine and Investments“ I am About to Make Money!”“ I am About to Make Money!”

• MRI brain scans are remarkably the same!

• Frontal cortex – same neural network controls; pleasure networks – control buying Google at $350/share, orgasm and cocaine

MRI Brain ScansMRI Brain ScansSource: Happy Health Long Life.comSource: Happy Health Long Life.com

Reading vs. Google Search!

Brain & Addiction – Post Stroke, patients found it Brain & Addiction – Post Stroke, patients found it easy to quit smoking; damage to left side of the easy to quit smoking; damage to left side of the

brain (insula)brain (insula)The Dana Foundation, photo: Antonie BecharaThe Dana Foundation, photo: Antonie Bechara

The Brain MattersThe Brain MattersThe FMRI scan on the right detects a brain processing a false The FMRI scan on the right detects a brain processing a false

statement; the less colorful brain on the left corresponds to someone statement; the less colorful brain on the left corresponds to someone in the middle of a truthful statement.in the middle of a truthful statement.

The Neurocritic; blogspot; 9/1/2007; ABCThe Neurocritic; blogspot; 9/1/2007; ABC

Anterior Cortex – Analytical vs. Emotional Response Anterior Cortex – Analytical vs. Emotional Response – Gamble or Don’t Gamble; All Showed an Emotional – Gamble or Don’t Gamble; All Showed an Emotional

Bias; Bias; Emotions Rule!Emotions Rule!

University College- London; USA Today 8/07/06University College- London; USA Today 8/07/06

Our Home Grown BiasOur Home Grown Bias• Childhood• Values• Beliefs• Mores• Experiences• Contact with Others

Wisdom Of CrowdsWisdom Of CrowdsJames SurowieckiJames Surowiecki

• New England Patriots vs. New York Giants

• Success rate• IBD at MIT influence - positive

IBD – Strength, but Possible IBD – Strength, but Possible Achilles?Achilles?

• Wisdom of Crowds does not Equal the ‘wisdom’ of one in the crowd

• “Halo Effect” – person has one good quality, other characteristics are judged as better than they really are

• Psychology of group – persons conform to attitudes/beliefs of the group; toward midpoint; regression to the mean

• Tendency for groupthink – our skills are superior; a given approach IBD, Chapman, Elliot, etc.

• Individual can suppress own thoughts to conform to the group

• Choose individuals to speak who’s views conform; others?

Bias #1 – Hate Loss!Bias #1 – Hate Loss!Have $1,000; choose either:A) Sure gain of $500 or,B) 50% chance to gain $1,000 and a 50% to gain nothing.

Audience, you choose…-------------------------------------------------Nobel prize winner Daniel Kahneman 2002;Tversky and Kahneman study

Con’tCon’tHave $2,000; choose either:A) Sure loss of $500 or,B) 50% chance to lose $1,000 and a 50%

chance to lose nothing.

Audience, you choose…

ResultResultTwo problems are identical in terms of

probable net cash!Option A = certain $1,500Option B = 50/50 chance to get either

$1,000 or $2,000

Why?Why?People are risk averse; strong bias to avoid

loss regardless of risk

Argument framed in how much you GAIN vs. how much you LOSE

If sure gain, ”OK, I’ll take risk”Possible loss, “No thanks”; we quickly lose

sight of net outcomes and actual probabilities

Bias #2 – Recent Bias #2 – Recent InformationInformation

We usually place more emphasis on recent events (and therefore overreact to this information)

Examples: Look at in and out trading a lot; recent news, look at co/stock frequently*

Later, look back–it was a blip; Elliot “Snap-back”? Fence? EMA

Thaler, Tversky Kahneman - most feedback traders rec’d lowest returns, lowest money

* Mood changes 1x/day; 6x/day; 390/day; 100,000 year!

Bias #3 - AvailabilityBias #3 - AvailabilityWe tend to overemphasize information

that is in front of us and/or easily attainable! We then make decisions based on it.

U.S. vs. International Investing?

Bias #4 – Over-confidenceBias #4 – Over-confidenceWe tend to be overconfident in:• Our abilities (“I avoided tech crash!”)• Our (believed) understanding of something (co.,

industry, market)• Our ability to “bounce back”• True of mutual fund managers;

DALBAR/Morningstar + media (CNBC)

Usually exists with recent gains.

e.g. Doug’s Lead: Members Predictionse.g. Fred’s “IMHO”

Bias #5 - AnchoringBias #5 - AnchoringWe have a bogie or benchmark or event in

mind; that is what we peg all other observations to;

Tied to our past job? Beliefs?

Last Year’s Returns

Deutche CEO example; Dow 14,000+;clients

Bias #6 – ConfirmationBias #6 – ConfirmationSource: fun.front.lv/i/illussionSource: fun.front.lv/i/illussion

We are always scanning the environment for information that supports or confirms our own beliefs.

When we see it, does that make it true?

WFMI, SBUX, TIF, APOL, FNM, RGR, SWHC

Bias #7 – Outcome Bias #7 – Outcome Judge things based on our hoped for

outcome or desired result as opposed to current conditions or “what you see!”

Head/Tails Coin Toss (H-T-T-H-T-H or H-H-H-T-T-T)…which is more likely?

“It will come around! It must! I did the research! I will wait until it does.”

Regret Aversion Regret Aversion

• Admit I am wrong! Never!• Mistake. Hold. Not a mistake.• Winner! Congrats! Hold, hold, hold(regret selling, watch it go higher)

Motto: use pre-determined rules, use discipline; let go of ego, emotion

Help The BrainHelp The Brain• Exercise – help executive functions• Diet – stay sharp; “prevent defense”• Stimulants – increase short term

memory/reaction time• Music – activate reward centers;

reduce activity in amygdala• Meditation – cells fire in synchrony

Self-Test ChecklistSelf-Test ChecklistBias???Bias???

Yes No Maybe

1 Loss Aversion

2 Recent Information

3 Availability

4 Over-Confidence

5 Anchoring

6 Confirmation

7 Outcome

TipsTips• Heighten awareness of these facts; YOU!• Understand your biases• Don’t over-trade• Self-analysis tools• Hire a coach• Emotional discipline – have it?• Stress – must be controlled• Consistency – strive for it; measure• Risk Management – always• Humility – Great traders have it; I have no control

over the markets

Mark’s Tips to MarkMark’s Tips to Mark• Understand each Yes/Maybe Bias• Manage emotion• Use tech tools(stops, programs, etc.)• Invest v. swing trade v. day trade

Final Tip!Final Tip!*&%#((*_&*&(%$*&%#((*_&*&(%$

“Don’t look at beautiful women anchors in business channels when you are making investment decisions.”

means…

Never make financial decisions when you are sexually stimulated!!

Source: “High Risk Investments and Sex”; Stock Market Guide; April 6, 2008

Northwestern University; Stanford University joint study