Monday, October 24, 2011

Second Level Thinking



I was reading the above book yesterday, and there are some concepts to market psychology and how price action plays out similar to how sessions of poker plays out.. firstly an excerpt from the book 'The most important thing' by Howard Marks

Thinking should be intuitive and Adaptive rather than mechanical and fixed
  • What is the range of likely future outcomes
  • Which outcome do I think will occur?
  • What's the probability that I'm right
  • What does the Consensus think?
  • How does my expectation differ from the consensus?
  • How does the current price for the asset compare with the current view of the future, and with my view?
  • Is the consensus psychology that's incorporated in the price too bullish or bearish?
  • What will happen to the asset's price if the consensus turns out to be right, and what if I'm right?
This is a great template for how we should actually frame our thought process before we act upon our own spreadsheet calculations, technical support and resistence lines, basically in every judgement we make whether fundamental or technical incorporates a human element...
I think the greatest macro traders and risk managers tend to be able to understand their own psyche along with the conditions of the market and how their portfolio is positioned against the current market sentiments.

In poker, 80-90% of hands are played out in a standard fashion - u fold 80% of your hands preflop - and play 20% of your top 10 hands raising the flop and based on how flops play. However once every hour or so, there are changing dynamics that require you to be both intuitive and adaptable - there are times when you're tested for all your chips preflop holding QQ - and your not sure whether your opponent has KK or AK - this is what Mike McD would call a 'feel' situation and essentially an internal psychology against all the hands that you've played against your opponent until that moment. However the situation may not only be dependent on your hand vs his hand - the next level of thinking is based on whether or not the game has been going for a long time, how many players have been playing aggressively, whether or not your opponent is deciding to change his temperament etc.. all these intangible factors have almost less than 5% of the significance in the actual value of the hand and even so leads to a variable outcome when the chips go in the middle. The required level of thinking for such a seemingly trivially small % of impact in the actual hand is needed in the game no-limit- where 1 hand can determine a large portion of your stack for the session.

Similarly I feel that in recent weeks, the volatility and the sell-off has presented a remarkably harder trading environment, but also a very feel based environment where the next breakout of the trading range was seemingly imminent at every turn, only to stay range bound for a long time. Each EU announcement seemed to be a headfake, and even today it seems to be the same - each support level getting crushed on the emerging markets while the sp500 seemingly held up fairly well on Bernanke rhetoric.

Despite the erratic earnings report so far, the economic data coming out of US have been surprisingly not so bad, and this is leading to a situation where the market is so heavily priced for a really bad outcome in the EU - which seemingly is not a high probability anymore.

Given this, my trading has remained steadfastly feelish on the bullish, buying mainly the AUD/USD on the bottom of the short term ranges and the euro as of today, getting ready for the likelihood of a very good finish for risk-assets by year's end.