One of the things that is interesting about trading psychology is the notion that it is idiosyncratic, that is the psychological processes that afflict traders are only found within the realm of trading. This is a somewhat narrow dogmatic view and in many ways is simply an attempt to distinguish the filed of trading psychology from the broader church of human behaviour. It is the idea that my field is special therefore you cannot understand it. Unfortunately, I do not think this view is true – there are no unique trading problems there are merely human problems expressed through the lens of trading. And these mistakes occupy every field of human endeavour.
As usual, history shows this to be true. Consider the Imperial Japanese Navy (IJN) during WW2, after the success of Pearl Harbor the IJN went on a rampage through the Pacific pushing all before it for six months before the US Navy regained its balance and literally belting the living daylights out of them. Many attribute the success of the US navy to their overwhelming material advantage but this advantage was not realised until later in the war.
At the battle of Midway where the tide of the war in the Pacific turned decisively, the Japanese went into the fight with a slight material advantage over the US and this advantage would have been even greater if the US had not USS Yorktown not been repaired so quickly. Yorktown had been badly damaged at the Battle of the Coral Sea and was in drydock in Hawaii where it was thought she would take two weeks to repair. Repair crews had her underway in 48 hours.
But is here that we see the first similarity between traders and the IJN. In preparing for the battle the IJN extensively rehearsed their strategy for the coming battle and in the tradition of the Japanese military at the time it was overly complicated at rigid to a fault. Junior officers were castigated for deviating from the rules of war game and moving the US carriers out of position and then trying to work out how to respond to this new information. As it turned out the junior officers had surmised exactly where the US carriers were and where their devastating strike would come from. Had dogma about precision and rigidity not overtaken the Japanese they may have had a chance of stopping the strike that turned the battle in a matter of moments.
It is here that we find the first similarity with traders and to highlight this similarity I want to return to the history of trading and the hedge fund Long Term Capital Management (LTCM) TCM was founded by ex-Salomon Brothers trader John Meriwether and Nobel Prize winning economists Myron Scholes and Robert Merton. LTCM collapsed four years after being founded. LTCM engaged in a variety of quantitative trading styles which were initially successful much like the IJN. However, the Russian financial crisis in 1998 brought about by the Russian government defaulting on its local currency bonds was simply not supposed to happen. LTCM was wedded to an idea and a strategy that had done something they had not thought possible and they were wedded to the strategy. This was made worse by an arbitrage play in Royal Dutch Shell and Shell. They were short Royal Dutch and Long Shell believing that according to their models that their value must converge. It didn’t play by their rules and the collapse of LTCM was assured.
Traders display an inflexibility in their capacity to understand the range of possible outcomes of a trade. Traders when they put on a trade only think about the upside. In no way do they consider other alternatives or engage in what could be called variant perception. Very rarely is the question asked – what if I am wrong. This is a question that the IJN failed to ask themselves before Midway – they simply assumed that the Americans had read their script and would follow it verbatim.
I mentioned earlier the notion of American material might being in the ascendency and later in the war, this proved to be true. After the Battle of Santa Cruz in 1942 the US navy only had two functional aircraft carries. At the end of the war, they had 28 fleet carriers and 71 smaller escort carriers. Contrast this with IJN which by the end of the war had completely ceased to exist This gives some idea of the extraordinary capacity of US shipyards. I mentioned that carrier Yorktown was rushed back from drydock to participate in the Battle of Midway. The US had an extraordinary capacity to not only produce and repair ships but also to keep them afloat after they had sustained damage that you would think would send a ship to the bottom of the ocean.
Consider the case of the USS Laffey. The Laffey was a destroyer that was on picket duty off the coast of Okinawa – its job was to give early warning of impending kamikaze attacks. As such these small ships were often the first ones struck by kamikazes. The Laffey was hit by four bombs and eight kamikazes yet somehow the damage control teams managed to keep the ship in the fight. Allied ships regularly managed to absorb tremendous damage but keep going. The skill of damage control teams was a sharp juxtaposition between the Allied navies and the IJN. In Allied navies every member of the crew was skilled in damage control whereas in the IJN damage control was regarded as a second rate consideration as it was not offensive in nature, the very defensive nature of damage control was anathema to Japanese military psyche and was considered beneath them. Damage control team were led by what were considered to be the most incompetent of officers who had not been assigned to more important offensive operations. For example, the Japanese aircraft carrier Taiho sunk after a single torpedo hit due to terrible damage control. Contrast this with HMS Illustrious that was hit in the flight deck by a kamikaze but which resumed flight operations in under an hour.
Good traders understand the purely defensive nature of trading poor traders boast about their achievements and how they are going to show the markets. This is an attitude I used to encounter all the time in my last career in finance and strangely enough, seems to replicate itself on social media many decades later. Thereby showing that people never change. If you are knocked out of the fight by the very first blow then your career will be very short.
The IJN simply failed to learn a single lesson from each of its defeats and merely repeated the same mistakes repeatedly. Whereas the US navy showed extraordinary flexibility in the things it did – if something didn’t work it was changed. However, this inflexibility was not only the preserve of the IJN their cousins on the Japanese army displayed the same dogmatic and inflexible approach. As the US island hopped across the Pacific, they fought a series of battles dislodging entrenched Japanese forces from various islands. The Japanese strategy for defending these islands was to simply keep fighting until everyone was dead – that was it. As a result, commanders of other islands were unable to learn from the experiences of other commanders because they were all dead. The flow of information simply stopped and there was no capacity to adapt or improvise new tactics and whilst it was costly for the US Marines who took each island in no way were, they slowed in their advance.
The point here is obvious, or at least it should be. If you do not learn from your past mistakes then your career may be spectacular, but it will be a short one. Which means that traders need to go through a review process that looks at what went well and what went badly but more important to this they need to engage in a process of journaling to understand why they did the things they did.
So, where does golf fit into this potted exploration of the Pacific war?
Many analogies are made to explain trading and unfortunately, most of them are wrong. But in terms of games golf comes the closest because golf is a game won by the person who makes the fewest mistakes. It is also a competition against yourself, everyone plays the same course, but some people manage the course and themselves much better than others. We all trade the same market but some trade that market much better than others, they also manage themselves much better than others. However, traders display the same level of foolish adherence to new toys that traders have. If you want to make a fortune in golf – don’t play the game tell others you have a new tool for playing the game. The golfing world is resplendent with clubs that are supposed to hit further and straighter, range finders to tell you how far you need to hit the ball and even magic golf balls that are supposedly possessed of some amazing property. All of which play into the golfers need for something special and new and all of which detract from the notion that it is a see the ball hit the ball game.
For example, whilst writing this I have just Googled best moving average and have received 1,310,000,000 returns. Yet in my experience, the best moving average is the one you use but people will forever argue over whether 30 EMA is superior to a 35 EMA and what is perhaps not surprising is that the people who argue for 30 will never be convinced by the people who argue for 35 because they have a religious belief rather than a belief founded in evidence and an understanding that the tool doesn’t actually matter.
I must admit I am always surprised that people are surprised when they encounter some sort of glitch in behaviour caused by human psychology. I am even more surprised that people in behavioural finance think they have uncovered something new when all they are seeing is old mistakes dressed up in a new setting. As they say –
“The thing that hath been, it is that which shall be; and that which is done is that which shall be done: and there is no new thing under the sun.”
