Dynamic Hedge: What Science Can't Explain About Testosterone, Cortisol, and Compounding Trading Losses
Monday, September 20, 2010 at 11:15AMWritten by Michael Bigger. Follow me on Twitter.
The folks at Dynamic Hedge have a fabulous blog post titled What Science Can’t Explain About Testosterone, Cortisol, and Compounding Trading Losses. The post discusses the role of testosterone and cortisol in trading. The big lessons for traders are “learn to harness these chemicals” and don’t overleverage.
Here is how we go about this in our investment and trading activities:
- Trading: Our trading is done primarily by an algorithm and is thus not subject to these influences. Decisions are made based on strict rules that are not influenced by fear or overconfidence.
- Investment: We have increased our timeframe to three to five years. Increasing your time frame removes the emotional component created by short-term fluctuations. We invest less but much better. We try to take advantage of these influences.
The following excerpts from our e-book, In Praise of Speculation! demonstrate how the above trading methodology limit the negative effects of hormones:
On May 6, 2010 at about 2:45 pm, the stock market experienced a stunning 9 percent drop followed by a partial recovery. The frantic action was over by 3 pm…
Our algorithm made 70 basis points on that day. This was a pretty good result considering the SPYs were down about 3.50 percent. More importantly, we had the opportunity to see how the algorithm behaves during a sharp drop. This was a dream come true as the algorithm stayed positive throughout the episode.
The algorithm did very well because during the fall, it unwound the stocks in the portfolio that did not move very much, according to our metrics, and it bought stocks that were decimated. When the gap between each group of stocks narrowed after 3 pm we generated profits. We doubt we could have taken advantage of this discrepancy without the help of computers.
In the above example, the algorithm made decisions that we might not have had the fortitude to make on our own. Or as the author of the Dynamic Hedge blog would see it, excessive cortisol levels would have prevented us from having a very profitable day. Did that ever happen to you?
Reader Comments (8)
Great article! I agree that it's very important to develop a trading strategy that is mindful of human weakness and blindspots.
Well said Michael. In the heat of battle I can't trade effectively using my discretionary system. It reminds me of the quote - "Often wrong but never in doubt can be a virtue, because we automatically cut our loses and let our profits run" - Robert W. Colby. The most profitable trades from my mechanical trading models usually end up being the ones where I'm placing the trade and thinking "I can't believe I am taking this position, it goes against all my analysis."
Cheers
Derry
Great article. I have been looking around and really am impressed by the great content material here. I work the nightshift at my job and it is boring. I have been coming here for the past couple nights and reading. I just needed to let you know that I’ve been enjoying what I have seen and I look forward to reading more.. Thank you!
Derry,
Thanks. I know exactly what you mean. Consistency pays off.
I think this is such a wonderful eye opener! Very well! Just followed you on twitter -bchok
Thank you -bchok.
well this is really a great article....very interesting and informative i've been reading blogs about testosterone lately and im glad i came across this one....will look forward to read more of your blogs.,,=)
good article indeed! there are lots of article about testosterone but this one is really interesting and also an eye opener.