In another topic I wrote:In general, I also like to have some rationale for why I believe a system works. I want the source of the profit to be based on something that doesn't change. Systems that rely on human psychology and emotions tend to hold up very well because humans don't change very much, even when they really want to.
Yes, it is an interesting topic.Then a bit later Marc (a.k.a. DutchTrader) wrote:You made a nice point about robustness i.e. the psychological part of all participants of the markets. Can you tell me/us more about your view of this topic. I think it is very interesting!
Consider a long-term trend following system, there are three important psychological considerations that give me reason to believe that long-term trend-following systems are psychologically robust:
- Poor psychological memory - Humans tend to overweight the recent past in their judgements. This means that most people have a hard time buying something that is at it's highs, or selling something at its lows. There are a lot of behavioral finance articles on this sort of thing.
- Need to be right - Humans tend to want to be right more than wrong. They don't like doing things that have a low win/loss ratio. Long-term trend following generally has a win/loss ratio of less than 50%.
- Aversion to Pain - Humans can't stand pain. The long periods of drawdowns of many months or sometimes a year or more, make it very difficult for people to follow systems of this sort.
This is also the reason that I believe certain markets are easier to make money in. If the speculative trading has a significant effect on the price, the markets are choppier, if the trading is mostly non-speculative, the markets tend to have smoother trends.
Compare Gold or Pork Bellies to Eurodollars and the Japanese Yen. In the former case, speculation, especially by neophytes is a large percentage of the reason for price movements. In the later case, you mostly have global economic issues at the governmental level that affect prices, most trading is based on hedging or market making rather than positional.