THE PSYCHOLOGY OF SUCCESSFUL TRADING

THE PSYCHOLOGY OF SUCCESSFUL TRADING Behavioural Strategies for Profitability

This book is the first to demonstrate the practical implications of an important, yet under-considered area of psychology in helping traders and investors under- stand the biases and attribution errors that drive unpredictable behaviour on the trading floor. Readers will improve their chances of trading successfully by learning where cognitive biases lead to errors in stock analysis and how these biases can be used to predict behaviour in market participants.

Focussing on the three major types of bias – Belief-Formation, Quasi-Economic, and Social – the book provides a rigorous discussion of the literature before explaining how each of these biases plays out in financial markets. The author brings together the fields of philosophical psychology and behavioural finance to introduce ‘Theory of Mind,’ providing readers with tools to predict biases in others as well as using these predictions to form optimal trading strategies for themselves. Readers will also learn to understand their own behaviours, counteracting biases such as overconfidence and conformity – and the ‘curse’ of their own knowledge –to strengthen trade performance. Pairing his skill and experience with an extensive research bibliography, Short positions the foundational sources of cognitive biases alongside concrete examples, experimental designs, and traders’ anecdotes, helping readers to apply theoretical guidelines to real-life scenarios.

Shrewd professionals and MBA students will benefit from The Psychology of Successful Trading’s intuitive structure and practical focus.

THE PSYCHOLOGY OF SUCCESSFUL TRADING

BRIEF CONTENTS

Acknowledgements viii

1. 1  Introduction 1
2. 2  Beating the Market 11
3. 3  Theory of Mind 24
4. 4  Belief-Formation Biases I 37
5. 5  Belief-Formation Biases II 74
6. 6  Quasi-Economic Biases 107
7. 7  Social Biases I 122
8. 8  Social Biases II 149

Bibliography 176 Index 186

6. 6  Quasi-Economic Biases 1076.1 Certainty Effect 107 6.2 Reflection Effect 111 6.3 Isolation Effect 114 6.4 Endowment Effect 116 6.5 Conclusions 118
7. 7  Social Biases I 122
   1. 7.1  The ‘Curse Of Knowledge’ 122
      7.1.1 The Advantages Of Disadvantages 125
   2. 7.2  Dunning-Kruger Effect And Expertise 130
   3. 7.3  False Consensus Effect 140
   4. 7.4  Conformity Bias 142
8. 8  Social Biases II 149

1. 8.1  Fundamental Attribution Error 149
2. 8.2  Halo Effect 156
3. 8.3  Self-Presentation Bias And Over-Confidence 1598.3.1 Over-Confidence, Or Why Females Are Better Traders 166

Bibliography Index

176 186

ACKNOWLEDGEMENTS

Thanks to Stefan Joubert, who lent me the book that gave me the idea for this one. And who is also a terrific piano teacher. I am also grateful to Prof. Grahame Blair, who was crucial in getting me out of one incident which I describe in the book. As ever, thanks for interesting and stimulating times are due to the Gordon Square Dining Club (Mog Hampson, Jerome Pedro, Tom Williams, Karine Sawan, Alex Sayegh, Laura Silva and Lea-Cecile Salje) and the UCL Professors Dining Club (Treasurer Lancaster, Prof. M.A.) of which I am an elected member. I am grateful to Dr James Monk for a useful trading anecdote I have used. Kev Riggs is real and first prodded me to move into philosophy.