NetPicks Author Series

Interview with Denise Shull, Author of Market Mind Games

- Part 2 of 5 In NetPicks¶ Author Series, NetPicks President Mark Soberman sits down with the leading day trading authors as they discuss key concepts that will help individuals elevate their trading. Read this 5-Part series as Mark chats with Richard Weissman, author of Trade Like a Casino, and see what insights are in store. To listen to the entire interview, to listen to past interviews with top trading authors, or to be notified of future webinars, please visit: http://netpicks.com/authorseries. Denise Shull: Well, there are a couple of things. There was actually a study done in 2007 that asked that very question and it did show that the people who were more emotional but also aware of their emotions did better than the people who weren't. The reason for that is, is like whether you like it or not, your unconscious is using effectively your emotional data to skew your perception, and so if you try to be cold and calculating, what you are inadvertently doing is cutting yourself off from the data that your brain is using to literally perceive what it's seeing on the screen. So you're choosing to not pay attention. You think that you're choosing to keep something out that's dangerous. What you're actually doing is choosing to be unaware of something that your brain is going to use whether you like or not. So NetNet, it's sort of better to have all of the information than not. The second reason is there's also a research that shows that the more you use what's called the theory of mind or your ability to predict other people, and we're all born with theory of mind, we all do, you have to have the theory of mind to, you know, drive down the highway, walk down the street, you know, otherwise you'd be running into people all the time, but we all use it all the time, and there's research that shows the more you use it in trading the better you understand market. And, in fact, that specific research compared people whose brains were relying more on their theory of mind networks and networks is no longer the right model for the brain, but we use it because I can't think of a better word, versus people who are using probability and the people who were thinking of the market in terms of other people did better than the people who were using probability. And, in fact, the people who did the best in this particular study, which was published in the Journal of Finance, the people who did the best at predicting markets weren't using probability at all. But if you think about that, that makes actually an enormous sense because, at the end of the day, you're only ever trading other people, you know. And all you're doing when you buy is assuming that people are going to buy at a better -- you know, at a higher price than you, assuming other people are going to sell at a lower price. And that's the fact of markets, no matter what timeframe you're on. No one ever thinks of that question that way. That actually is the theory of mind question. So if again you make that conscious and explicit and you put all your market data, you know, in the context of that question,

you're likely to make a better prediction. Research shows that. If you understand your own emotions, you're also able to answer that question. You're able to see sort of the fear, anxiety, overreaction in the price action, you see other people acting that out, if you understand it in yourself. Mark Soberman: Yeah. It kind of reminds me, you mentioned in the book -- I forget the gentleman's name, but there's a super trader who's been at the top of some list for 10 years in a row, and in some interviews with him, he almost can't even put into words exactly why he trades where he does, it's all instinct and judgment, it's not like a very hyper-specific system to the point he's done so well that you were mentioning that he's, you know, being investigated because, you know, how can you do so well if you can't quantify everything. And I thought that was, you know, kind of an interesting example to somebody who's just -- like you -- I think you mentioned like literally almost reading a tape in a way is able to« Denise Shull: Right. Mark Soberman: «you know, succeed at that level. Denise Shull: When I started, I mean, there were -- I knew a lot of guys like that who could read the tape like a book, really. They'd all been staring at the markets for, you know, 20 or 30 years, but what that is, is the experiential learning in unconscious pattern recognition, you know, what we call intuition which has been validated in many forms including the US military. There's a part in the book that I talked about an article in the New York Times about the Army's use of hunches and actually training, you know, top teams, how to use their hunches, but that's exactly the same as what I said in terms of knowing the difference between intuition and intuitive feeling and impulsive feeling. But you can't do it until you set out to both -- first of all, just to even become aware of what you're feeling, heard in any words, you know, categorized it at any way and make that a part of your process, and not just going to be able to know sort of the difference between unconscious pattern recognition and impulse, you know, tomorrow without having to put some work into it. Mark Soberman: Right. Well, I think that's why like we tell people a lot that we can teach 10 people one of our systems that are actually very specific and fairly exacting and there still is more than likely to be, maybe not 10 different results, but maybe seven different results and I think a lot of it, you know, kind of dates back to this, whether it's somebody with a lot of experience or some minimal experience or somebody, you know, who's not able to either control their emotions or work with their emotions. You can have far different outcomes really with the same initial approach, I guess, to the market. Denise Shull: Right. Mark Soberman: One thing that you mentioned, there's a part you go, the irreducible truth and speculation which I thought was kind of interesting. You said, "You make money by correctly predicting the opponent's future perception, not the facts." I think

that also potentially goes against the grain and probably throws people because everybody gets hung up on, you know, valuations or if you're watching like crude oil this morning when it's rallying up, you kept going higher and higher. I mean, surely you can't go any higher, everyone is trying to quantify all the time and you're talking about it's kind of almost the opposite about it, it's the money it's made on, how everybody else is perceiving what you're seeing. Is that« Denise Shull: Right. Right. I mean, because that's really -- yeah, I mean, it doesn't matter why it's going up or why it's going down. The point is, if someone else is going to want to pay more for it for some reason, like they're short and they thought that surely it will reverse and it doesn't, and they stay a short longer and they stay a short longer and they stay a short longer until they can't take anymore and they get out, you know, same thing on the downside. When you start to realize that whether it's valuation or an oscillator, that those two numbers are meant to give you a clue about what other people are likely to be perceiving and feeling and, therefore, likely to be doing. You put it in a context of what the market is fundamentally, you put it in the context of the way your brain is actually much better able to understand markets and you're much more able to do this than it might sound like because theory of mind, which is all that is, is a natural skill we all have. I had a guy -- I don't know if I mentioned this in the book or not -- but the guy that I've coached at a hedge fund who had over a billion dollars under his discretionary management and he traded futures, stocks, primarily futures, you know, across the board, but literally billion dollars and he said that one question helped him more than anything. Now, I will also say this, people always ask me what's the difference between the average trader and some of these, you know, major traders that I've had the opportunity to interact with and it usually is this, that they were taught -- even if they can't articulate, they were taught that this is just a competitive game, that they're playing against other traders, and they naturally think of it that way. Now, the guy that I just mentioned said, for him to make it an explicit question and he was always asking himself, helped him even more, but he still knew on some level that he was just dollars trading the other guys that, you know, were trading in his league. And I think anybody can do it in terms of, you say, "Okay, well I can't ever know what that guy is thinking," but I don't think you have to. I think you can think of it in terms of you're not experienced and the other traders you know and think about it sort of in your league and it will still work. Mark Soberman: Yeah. I think people -- and I imagine even the people listening to us now there's got to be a few people kind of with their arms folded and sort of saying, "Well, yeah, maybe that's how it used to be, but now there's all these program trades, these algorithms. I mean, I'm fighting against the machine," but you make a clear point that it's a human factor and humans that actually went, you know, have developed all those systems and that's really -- actually factors in. I think you even talked a little bit about, you know, the IBM's Watson and how it played on Jeopardy. I mean, that was sort

of a point that I think you were making, that it's, you know, there are systems and algorithms and everything. It's still human input that's happening in the markets. Denise Shull: Well, somehow a few years ago, I got myself on the quantitative systematic trader's speaking circuit, if you will, so I've had the opportunity to speak at maybe, I don't know, at least 10 quantitative trader events and, you know, I've found out basically that they do what they call recalibrate a lot. Well, let's even go back a step. First of all, whenever they develop a model, it has the X factor in it. The X factor is often implied volatility which they have to make a judgment call about. There could be a second X factor, but usually, you know, the factor that they have to make a judgment call that makes it work is what volatility are they going to choose. So from the get go, the model and then the algorithm that, you know, emerges from it has a judgment call. So the person who owns that model and the algorithm is always thinking, "When it starts not working or not working as well, hmm, should I, you know, switch up my --" let's just say it's implied volatility, and some of them will admit maybe, you know, after a cocktail that they've been known to recalibrate on a daily basis. I'm not saying all of them do that, but there are humans behind those things and, you know, some of them do it more frequently than a daily basis. So what you've got is a human with a robotic arm who can change their system frequently and then obviously they can execute many more trades in a much shorter period of time than a human being. But they may be changing up their parameters a lot more often than one would think. Mark Soberman: Right. I mean, I think it's -- we encountered this because same thing in our systems. Well, sometimes what we do is we'll update settings, you know, because we try to explain to people that, you know, markets change, they are dynamic and we definitely confront a lot of people who think that's a weakness of the system because the second you give in or show any flexibility it means that it must be broken, but in reality, like you said, you have to kind of do some of that, you know, tuning up or recalibrating. And, yeah, that is our human element that's factoring into it, but we're doing it for a reason based on the overall perception of, you know, maybe how the market or, you know, the system is trading at that time. Denise Shull: Well, I mean, you're absolutely -- markets have personality changes, you know, hour to hour, day to day, month to month and certainly year to year. You know -I mean, you know that and I don't need to tell you that. But they certainly -- you take it the other way around, they have personality changes or, as CNBC will call it, regime changes, you know, in the long term, in a year to year picture, but they certainly also have it intraday. And that's one of the problems I have and, you know, I'm going to go out on a little bit of a limb here to hopefully explain myself, if I'm stepping on any toes, it's one of the problems I have with the strategy of, you know, make X dollars per day and quit. Now, it's okay if you're doing that as a training exercise. But given the way market personalities change in the short term, you know, within a week or within a day, it doesn't actually make any sense because basically you want to be active when things are

happening and you want to stay away when nothing is happening. And if you set yourself up to say, "Okay, I'm going to try to make X dollars today," it's okay if you're realizing you're just doing it to practice a certain skill. But ultimately, you want to get to the point where you're really active when things are, you know, when your personality is active in the market and really not active when it's not, you know, and match up your activity to the current personality of the markets. To listen to the entire interview, to listen to past interviews with top trading authors, or to be notified of future webinars, please visit: http://netpicks.com/authorseries.

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