Turtle Trading Rules

Chapter 5 Demystifying Turtle Thinking (1)
In the world of trading, human emotions are both the source of opportunity and the greatest challenge.Get it under control and you can succeed.Ignore it and you are at your peril.

To be a successful trader, you must understand human emotions.The market is made up of individuals, each with their own hopes, fears, and weaknesses.As a trader, you look for opportunities in these human emotions.Fortunately, some very smart people (the pioneers of behavioral finance) have gained insight into the influence of human emotions on decision-making behavior.The field of behavioral finance began to gain attention with Robert Shiller's masterpiece Irrational Exuberance (now in its second edition), in which Hersh Schefflin Shefrin's famous book "Beyond Greed and Fear" (Beyond Greed and Fear) has been explained in more detail.Behavioral finance can help traders and investors understand how markets work.

What exactly makes prices go up and down? (Prices can fluctuate enough to turn a self-restraining gentleman into a crying wretch.) Behavioral finance is the study of human cognitive and psychological factors that influence buying and selling decisions, and can explain market phenomena and price movements from these perspectives .Research has shown that humans are prone to systematic errors in uncertain environments.During stress, people make poor judgments about risk and event probability.What could be more stressful than making or losing money?Behavioral finance has shown that when it comes to these kinds of interests, people rarely make completely rational decisions.Successful traders understand this phenomenon and are able to profit from it.They know that other people's mistakes in judgment are their opportunities, and they know that these mistakes will eventually show up in the changes in market prices-the Turtles know this well.

emotional trap
For many years, economics and finance theory have been based on the theory of rational behavior.This theory holds that people act rationally, taking into account all available information in their decision-making process.Traders know this is pure nonsense.Successful traders become winners because they capitalize on the consistently irrational behavior of other traders.Scholars have found overwhelming evidence that most people do not act rationally.More than a dozen categories of irrational behavior and repetitive misjudgments have been documented in the academic literature.In fact, traders simply don't understand why anyone would believe in the theory of rational behavior.

There is a deep-rooted systematic and repetitive irrationality in everyone, and the irrationality of traders will cause market fluctuations.The reason the Turtle Method works, and has always worked, is that it is based on this kind of market volatility that comes from irrationality.

During the trading process, how many times have you felt the following emotions?

Hope: I certainly hope that after I buy it, it will go up immediately.

Fear: I can't afford it again, and this time I have to stay away.

Greedy: I ​​have made a fortune, and I want to double my position.

Despair: This trading system doesn't work and I keep losing money.

Much of the opportunity in the marketplace stems from these ingrained human traits.Using the Turtle Method, we can discover market behavior that heralds these opportunities.As we will see in some of the examples in this chapter, human emotions and irrational thinking can create a recurring market pattern that signals opportunity.

In those relatively simple and primitive environments, some specific world views that humans have formed are of great help to them, but in the trading world, these understandings have become obstacles.There can be distortions in the way humans perceive reality, which scientists call cognitive biases.The following are several cognitive biases that have an impact on trading behavior:
Loss aversion: A strong preference for avoiding losses.In other words, not losing money is far more important than making money.

Sunk costs effect: Paying more attention to money already spent than money that may be spent in the future.

The disposition effect: Realizing profits early but allowing losses to persist.

Outcome bias: Judging a decision as good or bad based on its outcome, regardless of the quality of the decision itself.

Recency bias: More emphasis on recent data or experience than earlier data or experience.

Anchoring: Over-reliance (or anchoring) on ​​readily available information.

Bandwagon effect: Blindly believing one thing because so many others believe it.

The law of small numbers: Drawing unwarranted conclusions from too little information.

People who suffer from loss aversion have an absolute preference for avoiding losses, with profits only secondary.For most people, not making $100 is not the same as losing $100.But from a rational point of view, the two are the same thing: they both represent no profit on the $100.Studies have shown that the psychological impact of a loss can be twice as large as a gain.

In terms of trading behavior, loss aversion affects one's ability to use mechanical trading systems because people who use such systems feel losses more strongly than potential profits.A person can lose money by following the laws of the system as much as by missing an opportunity or ignoring the laws of the system, but the former is far more painful than the latter.In this way, losing $1 is just as painful as missing out on a $2 winning opportunity.

In business circles, sunk costs are costs that have already been incurred and cannot be recovered.For example, an R&D investment for researching a new technology is a sunk cost.Under the sunk cost effect, a person is used to considering the money already spent when making a decision, that is, those sunk costs.

for example.Suppose ACME Corporation invests $1 million in developing a particular technology for producing laptop displays, but after that money has been spent, the company discovers that another technology is significantly better and more likely to be brought to market in time. to its desired outcome.From a purely rational point of view, ACME should weigh the future cost of adopting this new technology against the future cost of continuing to use the current technology, and then make a decision based on future revenue and expenditure, regardless of the research and development that has already been spent invest.

However, the sunk cost effect can cause policymakers to consider the money already spent, and they may think that switching to another technology is tantamount to wasting $1 million.They may stick with their original decision, even if it means future production costs are two or three times greater.The sunk cost effect leads to poor decision-making, and this phenomenon is often more pronounced in group decision-making.

How does this phenomenon affect trading behavior?Let's consider a typical novice.Let's say he just made a trade in hopes of making $2000.When the deal was just completed, he set an exit standard for himself: as long as the price dropped to the point where he lost $1000, he would immediately exit.After a few days, he lost $500 on his position.A few more days later, the loss rose to over $1000: more than 10% of his trading account.The value of the account has dropped from $10000 to less than $9000.This is exactly the exit point he originally set.

Should I exit with a loss of 10% as originally decided, or should I continue to hold the position?Let's see how cognitive biases affect this decision.It is extremely painful for a trader with loss aversion to cut meat and exit, because it will make the loss a certain reality.He believes that as long as he insists on not quitting, he will have the opportunity to wait for the market to rebound and finally recover his lost.The sunk cost effect can spoil the decision-making process: A trader with loss aversion is not thinking about what the market will do next, but how to avoid losing that $1000.So, the novice decides to hold on to the position not because he believes the market will rebound, but because he doesn't want to take a loss and waste that $1000.So what happens if the price continues to fall and the loss rises to $2000?

Rational thinking demanded that he quit.Whatever his initial assumptions about the market, the market has clearly proven him wrong, as the price has dropped far below his original exit point.Unfortunately, the two above-mentioned cognitive biases became more serious at this time.He wanted to avoid the loss, but the loss was bigger and more unbearable.For many people, this mentality will continue until they lose all their money, or finally flee in a panic, and lose 30% to 50% of the account-that is, 3~5 10%.

I worked in Silicon Valley during the golden age of the dot-com boom and knew many engineers and marketing executives at high-tech companies.Several of them are worth over a million dollars because they own stock options in listed companies.During the period from late 1999 to early 2000, they watched with complacency as stock prices skyrocketed day after day.When stock prices started to drop in 2000, I asked many friends when they planned to sell their stocks.Their answers were almost the same: "When the price returns to X dollars, I will sell." And this X is much higher than the market price at that time.As a result, almost everyone watched their stock fall all the way down to 1/10 or even 1/100 of its original value, and they never sold.The lower the price, the more reason they have to wait. "I've already lost $200 million, so what's the point of losing a few hundred dollars?" This is their common mentality.

The disposition effect is the tendency for investors to sell stocks that are rising in price but keep stocks that are falling in value.Some argue that this effect is related to the sunk cost effect, since both phenomena demonstrate one thing: investors are reluctant to admit that past decisions were not successful.Similarly, the tendency to cash in profits early stems from people's tendency not to let go of a winning opportunity.For traders with this tendency, it is difficult to make up for big losses, because trades that can make big money are closed early, and the potential is lost forever.

(End of this chapter)