The map is not the territory - Part 2 of 2

Last week in part 1 of this post, I linked a video by Julia Galef, where she use the metaphor of a Soldier and Scout to refer to two different mindsets. 

In the trading/scalping world. These two metaphors could be used to highlight two key skills needed to scalp. Let's see what they are.

Scalper as a Scout - If you remember in the video, Ms. Galef says, "The scout's jobs is not to attack or defend, his/her job is to identify the terrain, look for any obstacles, and above all understand whats out there as accurately as possible" 

In the scalping world it means, knowing the "Range" probabilities of the instrument that you are trading. You need to know how far can it go in either direction. The following are some of the questions that you would need answers for.

1. What is the median/mean range of the instrument that you are trading?
2. What is the standard deviation? or IQR interquartile range?
3. What is the probability of a mean reversion of the instrument on an intraday basis?
4. Are there any time based probabilities? For example is there a a time slot where the probability of a mean reversion is higher?
5. If range expansion happens, at what time slots is there a higher probability of an expansion? or does it expand in a linear way? 
6. Are there any day based probabilities? For example are Mondays on an average low range day or expiry days are high range?

As as scalper you need to know all these and more, that's the terrain on which you would be fighting the battle. How can you even afford not to know it? Remember how the Allies (with all their artillery and trained soldiers) lost the Battle of Gallipoli against the Ottaman empire. One of the main reasons for that was inaccurate maps and lack of understanding of the terrain. 

Back to markets, so without understanding the range probabilities of the instrument, your trading tools (read charts, indicators etc.) are all of no use. You cannot be shooting bullets if you are down in the ditch. 

Scalper as a Soldier - While you definitely need to know the terrain well, you also need to know how to fight the battle. Which in the language of trading would mean, entries, exits, scaling-in and scaling-out, understanding indicators and other tools for precise entries and exits.

You also need, psychological traits of courage, patience, and most importantly resilience.  

Lastly, it's important to recognize that as Soldiers sometimes we loose sense of the territory, after all maps are not territories. They are abstraction of the territory. Maps are in our minds.

In the words of the Polish American philosopher Alfred Korzybski these are metaphors of belief and reality - "Reality exists outside our mind but we can construct models of this 'territory' based on what we glimpse through our senses." - Perhaps that's the reason we use the term "Mental Maps" and not "Mental Territories".

The only way out of this Map vs. Territory paradox, is to reconcile both, as often as possible.  

The map is not the territory - Part 1 of 2

A few days back, I was having a coaching conversation with developing trader and as usual I started with the concepts related to Range (High-Low Range of NIFTY). Being a young, eager student, he said - "No No, I know what a range is, and all that, all that I need to know is when to Enter and when to Exit, that's more important for me" 

And, unfortunately he is not the only one I came across who was more interested in Entries and Exits than in understanding the boundaries of the playground i.e before playing the game.

I follow Julia Galef through her Rationally Speaking podcast, and she has done a very relevant Ted Talk about decision making. She uses the metaphor of the Soldier vs. Scout to illustrate two different ways of Information gathering and there by using that information for decision making. 

While I do recommend that you watch the video for yourself, here is a summary of what she is saying.

There are two ways of looking at the world around us and gathering information. In our context let's say you are looking at the index/markets.

Soldier Mindset - This is a metaphor for people who engage in what is called Motivated Reasoning, meaning - Unconscious emotional drives impacting our decisions instead of reason and facts. People who use this approach consider some ideas as allies and want to hold on to those ideas and other ideas as enemies,and would we want to shoot them down.

Let's say, you follow someone on Twitter and that person says, I think this is the bottom for the day, now you really admire this person (for several reasons), now there are two things possible - He/she is right or He/she is wrong. No issues at all if he/she is right as you know and believe that they are pretty good at predicting the markets. However the problem is, when they are wrong - you would find it very difficult to convince yourself that they may not be that great at predicting. Instead, you may want to give them some benefit, and continue to hold them in high esteem, because that belief in this person is of greater value to you than being curious to check or re-examine your beliefs.

You can also be applying the "Soldier Mindset" to your own self. Let's say you believe in some "Gann numbers" thing. If it works even a little bit, your belief in that system only grows stronger. Now lets say it doesn't work. What you would do is, instead of questioning the rationale behind the system, you may just brush that instance aside or even put your own reading in question - Telling yourself - "Oh may be I don't know Gann system so well. I need to work more on it."

I am sure you get the drift now. It's essentially about holding (unconscious) biases while gathering information and making decisions. 

The other side is what she calls the

Scout Mindset - Here the person in question is driven not to make one idea win or other loose, but to see what is there. This person is looking for facts and evidence. He/she is curious and takes pleasure in learning new information, even if it contradicts his/her own belief. In fact, some people with the "Scout Mindset" may seek others who are willing to contradict their ideas. They constantly keep testing their own beliefs. More importantly they are grounded in the sense, their self worth is not tied to them being right or wrong, but instead to finding what is right or wrong.

She also points to the fact that people with "Scout Mindset" make better quality decisions and this mindset does not correlate with IQ. So you could be very intelligent but bad at decision making.  

So whats in it for us Scalpers and Traders?

As traders we make multiple decisions and use varied frameworks to understand market structure. Obviously our success depends on making more of right decisions and less of wrong decisions. And if you are developing trader its important that you start with creating and following frameworks which are more evidence based rather than "belief" based. In other words you need to be more of a "Scout" rather than a "Soldier".

So what is it that you could do to develop a "Scout Mindset" as a trader?

1. Ask for evidence - Whenever you come across a system or an indicator, always seek evidence in terms of back tests, better still learn to do these yourself. Perhaps learn to code in Python or R.
2. Develop co-relational curiosity - Looks for co-relations between different signals/events. If X happens does Y also happen.
3. Calculate Probabilities - i.e - Yes if X happens Y also happens, but how often does Y happen? - This would tell you if there is an edge in the co-relational relationship that you found. 
4. Question Ideas, People and Systems - That's the only way to progress. If you find someone becoming uncomfortable with your questions and becoming defensive, that's a sure sign of a scam. 

Unfortunately this is an industry full of snake oil sellers who feed on thousands if not millions of bright eyed suckers who come in everyday, only to loose their hard earned money and more importantly their self-worth.  Being a "Scout" is one good way to avoid this eventuality. 

I am sure by now you may thinking - All this is fine, but what was that Range, Map and Territory thing? - Well that's for Part 2 of 2