Perception Versus Reality

I was digging through my archive of data related junk when I came across the regular (yearly) series called Perils of Perception by Ipsos MORI I was going to include one of the slides from the 2016 deck but the resolution was quite low so I decided to reformat it to make it clearer. The slide I picked related to public perceptions of health spending as a function of GDP versus the actual level of expenditure. Making the data a little clearer yielded the following table.

As you can see there is a staggering difference between what people think their governments spends on health versus what they actually spend – everyone thinks that their government spends more on health than it actually does. What is interesting is that this the sample set covers countries of all levels of economic development and political persuasions and everyone gets it wrong. One might forgive the level headed Scandinavians for thinking their government spends more on health care than they actually do because of their extremely generous and well funded health care network. But everyone got it wrong. Perceptions are crap and are completely inadequate for dealing with the world in a sensible way.

The issue here is that humans are perceptual filters not data crunchers our thinking is often more about what we perceive and feel rather than what we observe and analyse. As such our thinking is easily swayed by not only our internal own bias but also by anything that confirms that bias. This is a feature keenly exploited by politicians who are all too aware that the majority of people lack the skills necessary to think critically about issues. This is enhanced by the echo chamber that is social media and the fact that we seem to be living a new form of Dark Age where data is irrelevant.

The implication for traders should be obvious but it often isn’t. Consider the notion of prediction – prediction is a guess and at this time of the year markets are awash with predictions for next year. These predictions are based largely upon perception and narrative – not data. For example all analysts err on the bullish side when predicting the trajectory of market but experience and common sense tells us that markets also go sideways and down not just up. If analysts were basing their predictions on anything approaching data then the prediction would be a range value that was book ended by error bars. Not good for the mass media but accurate.

In trading the only mechanism we have for combating our tendency to perceive and feel rather than to think is to generate a rules based trading system but even here we run into trouble. Over the years I have seen countless trading plans from investors of all levels of experience. The good ones have clearly defined terms and parameters – they are mechanistic in nature. The bad ones operate more on a sensory level will ill defined terms that could not be followed by anyone other than the plans originator and even then they probably couldn’t follow their own plan because it is too loose.

The harsh reality is that if you cannot separate perception from reality as defined by data then yo will find trading very difficult.