One of the more underestimated tools in a trader’s tool box is the decision-making model he employs. And yet, decision-making is central to our ability to make money. In the next series of blogs, I shall be introducing a decision-making model that I use.
A model is made up of two parts:
- A theory that is subsequently validated (as far as possible) by testing. And,
- Tools to apply the theory.
I’ll start today’s blog by examining what we know about decision-making. Thanks mainly to neurology,we now have some idea about the way the brain operates. It creates pathways of knowledge and forms patterns of thought, generally called schema. When we gather new information, we seek to include the new information within the pattern. But since not all information will fit our existing preconceived ideas, we’ll experience conflict (cognitive dissonance); when we experience a conflict between two ideas, one of three things occur:
- We force-fit the information into the existing pattern. Or
- We adapt the pattern to account for the new information. Or
- We synthesize the new information to create a totally new pattern.
Schema is very useful in that it allows us to make instantaneous decisions - it’s the foundation of intuition. But it has several drawbacks;
- Once we form an opinion, it usually takes a great deal to change our minds. Generally we need much more information to change a notion than it takes to form the original idea.
- Since schema is the filter by which we take in information, it may prevent us from considering our information relevant and important to the decision at hand. For this reason George Soros formed his view that there is a gap between perception and reality.
Using the ideas above as a starting base, I formulated a decision-making model that has given me a measure of success in the markets. But recently, I have had to synthesize my model because of information from two sources:
- The idea that our decision-making is hard-wired. I wrote about this in ‘Day Trade?’ And,
- C. Otto Scharmer’s ‘Theory U’. Schramer seeks to apply his theory for social change. I find it has much relevance to trading.
Tomorrow, we’ll begin a look at ‘Theory U’.
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