Trading and the Placebo Effect

[Helenqu]

Hi all,

Had a sudden rush of lateral thinking last night, bringing together a few disparate thoughts to produce a theory.

In medicine the placebo effect is a measurable, observable, or felt improvement in health not attributable to treatment. Studies place 50-70% of treament effectiveness on the placebo effect. Strangely little red pills produce the greatest placebo effects of all.

Recalling that, set me to thinking about whether such an effect exists in trading. I think it probably does. How often do you come up with a new strategy/plan that "seems" to work well for a while and then stops being effective? Could this be one of the reasons why so many of us flit like butterflies from strategy to strategy rather than settling and really working hard to perfect just one?

Discuss

 

[Trader333]

Placebo Control

Hi Helen,

I would guess one way of checking this would be to use a random entry into a market and comparing the results against the strategy in use. It is also possible to backtest strategies automatically if you have enough data available. This is useful as it allows you to determine maximum drawdowns, percentage of profitable trades, average win value versus average lose values etc. I have done this using Tradeststion which is pretty good for that sort of thing. I am sure there are other ways or software that can do this and I have always found it a useful tool.

Cheers


Paul

 

[ChartMan]

Aha! Very interesting... I have often thought about the effectiveness of trading just support and resistance trend lines on the price action..... In hindsight, it's very effective, like alot of other strategies....

 

[farzin]

Well It is true (at least on my case) changing strategies time to time. But don't you think it is normal in every market? If there is only one strategy which works, so would be any market at all? I think one of the most important reasons is change in fundamentals. I also believe the art of trading is to recognize new patterns and exercise your knowledge of technical or fundamental to these new pattern and stop it before it is known to everyone.

 

[Austin_Clone]

Hi Helen,

I think the effect is valid. When we have something new, we tend to follow the directions more closely, whether it be the new juicer or the new trading system.

After it becomes familiar to us, we tend to get relaxed and "bend" the rules a bit. So, in a matter of weeks we're not only putting "forbidden fruit" into the juicer, but we're taking trades which are against the system.

Then, we're at odds as to why that wonderful juicer doesn't work after ingesting a few dozen coconuts or our trading system no longer produces the same results as before.

Of course, the solution is: A bigger, more powerful juicer, and a bigger, more powerful trading system!

Unless we are cognisant of the sabotage we're committing, the cycle will continue ad infinitum.

 

[warm_machine]

Quite often the strategy itself may be at fault - it may have worked the first few times by pure chance and the variables that you believed were affecting the price action are not in the end reseponsible. This is of course were back-testing holds the key and ought to be a must for those taking the directional/momentum trading path.

 

[Helenqu]

Actually guys I wasn't really talking about backtesting etc. It was more about ones feeling about a strategy you might have developed, maybe even though extensive backtesting.

The strategy is like the placebo pill, it appears to work and you feel good but then as the faith/euphoria/heightened awareness reduces, small niggles and doubts appear. You then begin to look for the next pill/strategic fix

My own belief is that most strategies will work if you consistently follow them and use effective money management.

Simple strategies are easier to follow consitently (ie Trend Support, Resistance) so appear to be the most effective. But I do think that a large percentage of traders/would be traders never settle down long enough with any system to find that consistency. If that happens, trading becomes a roller coaster of alternating hope and despondency instead of a steady climb up a learning curve.

 

[neil]

Familiarity breeds?

I think Austin has hit the nail on the head. For placebo read familiarity. You then second guess your system or tinker without realising you are doing it. Result, chaos.

Thats why "trading in the zone" recommends trying to trade a system mechanically and coldly 20 times in a row. To show you how difficult it is to trade without emotion. It's emotion that destroys the placebo.

I think....

 

[ivorm]

Hi Helen,

>>My own belief is that most strategies will work if you consistently follow them and use effective money management. <<

I think you're absolutely right. I've been guilty in the past of switching from one strategy to another . Recently, however, I made a decision to stick to one tried-and-trusted system.. The result has been better and more consistent trading, combined with a more peaceful state of mind because I'm not constantly asking myself if there's a better method arouund. (I'm not being complacent about my system, and I'll still look at other startegies, it's just that I don't feel the need to be constantly searching for the 'holy grail').

I think part of the 'chopping-and-changing' problem is that trading attracts people who (1) like tinkering around with systems, and (2) like playing with computers. For that sort of person, (and I am most definitely one), it's kindof hard to resist the temptation to constantly try out new 'toys' ( read 'strategies').

 

[cassiopeia]

Hi Helen

Interesting theory.

There may be a difference though, since medical placebo's are there to establish (along with the treatment results) how much can and cannot be attributed to the direct effect of the treatment. Placebos are not strictly a measure of how much you imagine you feel better since the power of the mind can really make you better, also placebo's will pick up genuine long term remission effects. Say if you applied a placebo to homeopathy for example I think in many cases you would find people have genuinely recovered from the illness even though the treatment had no direct effect.

In the case of trading or investment strategies I think people 'con' themselves into a false strategy due to limited back-testing or data-mining, both which can be demonstrated to be statistically invalid. As a result they may temporarily have some success due to chance but it will eventually fail since the strategy really doesn't work. In contrast with medicine the beneficial power of you believing your strategy works really doesn't help at all, neither is it likely to start working for any other reason.

I suppose where the similarity arises with medical illnesses is where you get short term remission effects which is common with chronic conditions. This falsely gets attributed to the effect of the treatment, but just like unsound trading strategies this happens purely due to chance and in the long run it really doesn't work.

(PS Thought I could do with some new scenery, hope you don't mind me following you around!)

 

[Helenqu]

Hi Cass,

Delighted to see you over here Draw up a chair (or should that be settle down in your dog basket?) and make yourself at home.

 

[Les Carlin]

In medicine the placebo effect is a measurable, observable, or felt improvement in health not attributable to treatment. Studies place 50-70% of treament effectiveness on the placebo effect. Strangely little red pills produce the greatest placebo effects of all.

Recalling that, set me to thinking about whether such an effect exists in trading.

I've tried to follow this thread, but i'm having trouble with your premise. The placebo effect occurs because the person BELIEVES the placebo pill is the real thing. Quite how and why such a belief is converted into physical changes in the body is currently a topic being researched and thought about. But what's the connection to trading here?

You may have a belief about which strategy works, but only once you research it you will decide whether to use it to construct your trade plans. The placebo effect works without the patient having to verify whether the pill they're taking is the real thing or not. The mechanisms that mediate this process must be the mind-body interface and thus outside conscious control.

Not so with trading. Use a trading plan outside of your conscious control and you will soon be reflecting on the state of your capital account! For that reason we [should!] have researched the strategy behind the trade plan, thus placing it within our control

IOW, i don't think there is a parallel here between placebo and trading - one occurs without awareness, the other hopefully with.

Now mebbe i'm missing something here and if so, please enlighten.

Les

 

[Helenqu]

Hi Les

You found me.

"i don't think there is a parallel here between placebo and trading - one occurs without awareness, the other hopefully with"

Ideally yes. Perhaps I was thinking more of people starting out. Who buy strategies off the shelf, or out of books. They start with a belief that the thing works, cos someone has told them it does (as one would with a placebo treatment) but find out that it isn't effective over a period of time, as people on placebo treatments do.


It was an idle thought that provoked a response.


BTW did you get my mail re July?

 

[Les Carlin]

BTW did you get my mail re July?

Hi Helen,

Yes i did. That's ok and thanks for the 75 minute slot. Been out of circulation for a bit - due to family computer problems. Just built a new system for my daughter of which i'm dead proud. Gives me an outlet for my gadjet mania and keeps the testosterone vaguely under control.

 

[Les Carlin]

They start with a belief that the thing works, cos someone has told them it does (as one would with a placebo treatment) but find out that it isn't effective over a period of time, as people on placebo treatments do.

Um that's my point really. Placebo efffects DO work over time and frequently just as well as the the real thing. The mystery is why. But not so with trading. One quickly has to adjust one's belief. I think the real difference is probably that an individual's belief can have a dramatic effect on one's personal physiology, but not on an entire market.

 

[Helenqu]

That's great to hear, I'm building a lot of the day round the psychology theme

But I STILL need another 30 min "hard" TA/Trading slot............volunteers????

 

[Les Carlin]

That's great to hear, I'm building a lot of the day round the psychology theme

Ok, but perhaps we could converse about this at some time in some detail so i can tailor my slot accordingly.

And i have a suggestion: perhaps some of the pros can give a short 15 minute slot telling us how they have dealt with the discipline/psychology issues. This would further my thinking a lot. My own view is to constantly seek solutions at the psych level, rather than get too involved in analysing problems.

 

[cassiopeia]

Les

Although I agree with you I can still see some sort of analogy here.

Consider an experiment to determine if charting works.

In one case you provide real charts to subjects and ask them to record when they would trade with the object of maximising profits or points (you are reasonably convinced they haven't seen the charts before)

You then provide the same subjects, unknown to them, with the equivalent of a placebo, a randomly generated chart (which in some cases look amazingly like the real thing) and ask them to do similarily.

If there are statistically higher returns from the trades using the real charts then this would provide an objective proof charting works. You would also gain insight into the degree of self deception of chartists.

A better method would be to force the subjects only to see the historic part of the chart before trading, but even this doesn't account for the stress of trading for real (unless you made them gamble).

Of course a potentially better method still is to examine their real trading records but the above methods would yield far more data and there would always be some doubt over the validity of real trading data.

 

[Les Carlin]

You then provide the same subjects, unknown to them, with the equivalent of a placebo, a randomly generated chart (which in some cases look amazingly like the real thing) and ask them to do similarily.

This is where it comes unstuck. The chart, however generated, is not the placebo. In my view the placebo is either a pill or a methodology which is used to achieve some successful outcome. The chart is the equivalent to the human body, ie it would be the object one looked at to determine the outcome. Thus the equivalent of a placebo pill in trading terms must therefore be not a chart (which simply shows market action) but a placebo METHOD used to trade that market.

One can believe that the placebo method works or not, to predict what the chart will show, and one can believe likewise whether a pill will work or not to effect a cure in the body. So that makes the placebo a trading strategy/plan in which you may believe.

 

[Austin_Clone]

Hi Les,

Although this isn't following the thread of "the placebo effect" you may want to investigate the following phenomenon for your presentation on Traders Day.

There's been several experiments regarding market entry based on coin flips. Traders are given entries supposedly generated by a "scientific" system. In actuality, it's merely coin flips. Heads, go long, tails, go short but the signals are shown to the traders as if generated by a highly sophisticated program.

Traders who were consistently good traders before engaging in this experiment made money. People who were mediocre, money losing traders before the experiment lost money.

So, it wasn't the method, ie, the entry signals that predicted success, but something within the traders themselves which was causing the divergent results, both during the experiment and "real" trading.

So what psychological traits do the successful traders have that the unsuccessful traders don't or vice versa?

A good question for a brilliant psychologist like you to tackle!