Pattern Recognition And Confirmation Bias
By Chris Mark on The Capital
Analysts are notoriously mediocre to poor price forecasters. We are taught in general academia to follow a prescription of macroeconomic principles and other themes which lead us to believe that A+B = C in a very static sense. What we all learn very quickly, however, is that other elements outside of this realm come into play, refuting a material portion of that which we are taught.
Some people are vehemently against topics like technical analysis. This has more to do with their general systems of belief as opposed to working knowledge. But then they open a chart, and what is the first thing they do? They start to visualize sequences, patterns, etc. and essentially repeat the very thing they most defiantly offend in the public space.
We are literally hardwired to seek out patterns in charts and other forms of financial data in the same we way get off the couch and go to the fridge. It is nearly impossible for us not to do this when entering the same situation, every day.
All I am saying here is that it is very natural for us to want to find patterns in just about anything, whether it be that price chart or a string of economic or market driven data, and there’s nothing wrong with that. All trading strategies are ultimately built to seek out a series of repeatable events.
But what is disconcerting is the weight on which people place such “surface level” patterns, because, at the end of the day, many traditional price patterns, in and of themselves, don’t lend themselves to favorable outcomes.
What always varies is context. Two people will look at the same chart/data, have completely different biases, and be able to frame an argument based on their own past experiences. Instead of letting the information speak to them, they speak to the information, and reinforce their initial bias by continuously adding layers that support their argument, and dismissing those which don’t (confirmation bias).
Confirmation bias is a systematic pattern of thought that humans develop to form their own construction of social reality using information that they handpick to form their own narratives.
It is described as the tendency to process information by looking for, or interpreting, information that is consistent with one’s existing beliefs. This biased approach to decision making is largely unintentional and often results in ignoring inconsistent information. Existing beliefs can include one’s expectations in a given situation and predictions about a particular outcome. People are especially likely to process information to support their own beliefs when the issue is highly important or self-relevant.
For example, this is known as creating an echo chamber whereby you only surround yourself with people who are of the same opinion and beliefs as you. The reason for this is that humans are hardwired to require constant feedback in the form of positive reinforcement. In investing parlance, confirmation bias is akin to analyzing an investment with blinders on, focusing solely on evidence that confirms their hypothesis.
Patterns exist but to trade them successfully you need to understand what is going on behind them.
Look for areas where traders get caught at disadvantageous prices.
You need a framework for your decision. This is key because the market is always advertising to you. It’s constantly moving, trying to auction for buyers and sellers. Now if you know what you want, you can resist temptation and you can only buy or sell when advertising in an area that you want to do business at. Assess where value is.
Originally published at www.trading-manifesto.com
