Thought of the Week 8th May

Good afternoon all,

There’s been some great discussion on the Forum of late in relation to how Edges work and the role our mindset plays in allowing the Edge to manifest itself into a portfolio.

So, what the discussion has really been about is the interaction between two different types of Edges, a Trading Edge and a Mindset or Mental Edge. :thinking:

The 4 Week Process & Mindset Course is designed to help grow and develop our Mental Edge. It’s something that you can’t outsource…it requires a degree of work and some honest self reflection to reap its benefits and truly transform your investing.

The SPA3 Investor Mechanical trading Edge has been many years and thousands of hours in its research and development. The public portfolios are live examples of its Edge in action. :game_die:

You’ll see various periods of underperformance and outperformance, with the Edge clearly seen over the larger time frame with wins and losses fluctuating in size and number.

Indeed, Mark Douglas reminds us of this in Fundamental Trading Truth No.3, “There is a random distribution between wins and losses for any set of variables that defines an Edge”.

So, “What comes first…The Trading Edge or the Mindset Edge?

Which came first for you?

How has it helped with the other?

Can you have one without the other?

I’m interested in your thoughts. :grinning:

Hi David
I’ve been a SWS client since 2017 I think and in hindsight without The Mindset Edge the benefits that I have derived from the Trading Edge have certainly been limited by my weaknesses in sticking to the trading plan come hell or high water.
Examples include:

not trading for a period after a heavy loss until I thought it was safe to go into the water again
skipping a Buy signal because my personal view of the company didn’t align with the trading plan etc etc.
In doing the 4 week intensive there were several “ah ha” moments the most insightful of which was the realization that casinos win over the long term because they definitely have an edge and they then participate in every opportunity that comes along and don’t pick and choose which ones to be in. I shared on another post that I recently took the Tesla trade which I would have bet I’d have skipped a few months ago due to my personal view about the whole Musk/Tesla/Twitter thing, That sort of thing as well as other circumstances which have tested me previously I am sure will test me again and hopefully I’ll continue to develop the mindset edge.
So in answer to your question doubt I can have one without the other and reach my trading potential!

Barry et al,

These scenarios are discussed in this new eBook that I recently completed. that is now available for downloading:

Hi Gary
Just downloaded it and reading the Introduction was like looking in a mirror cause I saw myself everywhere :joy:

Hi Barry,

Thanks for your comments. :clap:
It can be confronting sometimes when we “look in the mirror” so well done on allowing your rational mind to unpack the reasons (root cause) of those feelings.

Becoming a systemized investor should be a fairly straight forward process…in on a green arrow and out on a red one. Not dissimilar to driving a car and proceeding at a green light and stopping at a red.

Thankfully we understand the consequences of not following the traffic light signals. We understand at a critical level the cause and effect of not doing so…it’s very much ingrained. We get to see examples of poor driving execution everyday and these often provide us with our own “ah ha” moments to learn from.

One of the main objectives of the public portfolios is to demonstrate how an Edge plays out.

The Edge will only ever manifest if the “driver” also has the mental Edge to execute with consistency and discipline in all market conditions. Becoming peaceful occurs when we internalize the 5 fundamental truths and creating positive thoughts and behaviours around them. (25 trades exercise :slightly_smiling_face:)

Haha this is classic after sharing in my post above about taking the Tesla trade and how previously I probably would have skipped it of course entirely on cue this morning there was a sell signal on Tesla :laughing::laughing: which I will duly execute tonight. I confess to a moment of gritted teeth but then clarity of purpose and commitment to just following my plan without emotion
Thanks guys

You’re a good “driver” Barry…Well done. :red_car:

This is a challenging question. Personally I think they go hand in hand. I have been able to trade my edge flawlessly over the past 3 years with one significant trading error exiting WHC which ended up a huge winning trade. This has stunted performance and I vowed never again to do this- pleased to say my commitment to the trading edge is good. I am in drawdown and the recent market pullback has seen my portfolio of 5 stocks on ASX Investor fall approx 12%. This has certainly challenged my mental edge with thoughts about the effectiveness of the edge, will my portfolio funds grow sufficiently to retire in 3-4 years, tapping me into all the times of have been ‘wrong’ financially in the past. I revisited the 4 week intensive and some AHA moments: I was not at peace will ALL outcomes due to adverse market conditions. Very outcome focussed rather than process. I am addressing this at present and then Gary’s C+G comment yesterday referring to if we are questioning performance we are not truly accepting all outcome: was me. Thankyou to the team for the work you are putting in.

Thanks for posting Stephen…you’ve got a great level of self-awareness. It’s not easy looking in the mirror at times, but you’ve taken stock and engaged in the learning process to help transform your habits (beliefs). Great work :+1:

If you don’t have a copy of Atomic Habits, put it on the list as one of the must haves in your trading/investing library.

And remember that retirement is just a date in time and investing shouldn’t stop simply because you’ve reached that date. :calendar:

Life expectancy rates are increasing as a result of improvements and advances in
medicine, and there is a strong chance that for couples reaching 65 years of age that one
of them will live until well into their 90’s. :chart_with_upwards_trend:

So, the skills that you’re developing today (by engaging with the learning) will most definitely serve you well into the future. :man_student:

For me understanding the Trading Edge came first as it naturally built on my prior training and experience in probabilistic methodologies used for decision making in the petroleum exploration business (a previous career). SWS’s evidence-based research is demonstrated proof of the edge that locked this in place for me.
The Mindset Edge came later - it still is, and probably always will be, a work in progress. I suspect that is the nature of (re)training the mind. Reading ‘Trading in the Zone’ and completing the recent training intensive course has made collective sense of many topics that Gary has presented in the past.

Locking in the trading edge gave me the incentive to pursue the mindset edge.

I don’t believe you can have one without the other and be a successful investor in the long term. Many people who engage with the share market have neither!

Great point Bruce :clap:

If you’re not trading/investing with an edge then you’re purely speculating and more than likely chopping from one strategy to the next, trapped in an endless cycle of frustration.

Having a Edge is crucial, both in the system that you’re using AND in the mindset required to allow it to play out.

You simply can’t have one without the other.

Habits + Deliberate Practice = Mastery :trophy:

Or in another way, Mindset + Process = Mastery.

Which comes first….the system edge or the mental edge - It all came a bit at the same time for me, I looked at the public portfolio, compared it to mine and said hey - I am wrong, then did the intensive course and it all sort of clicked. The back testing via the simulator cemented and confirmed it in my mind. I find the back testing gives me peace of mind in so many areas. Not that you can control the future in the market, but history does have a habit of repeating itself. Human nature does not change, the old fear and greed characteristics are inbuilt as is the instinct to just grab a handful and run.

Accepting the 5 Fundamental truths was another aha moment - “anything can happen” is so true as is “You don’t need to know what is going to happen to make money”, as is “There is a random distribution between wins and losses for any set of variables that define and edge”, as is “An edge is nothing more than an indication of a higher probability of one thing happening over another” as is “Every moment in the market is unique”.

The thing is now to keep accepting and applying the principles, becoming a consistently peaceful investor. Easy when the market is going my way. Keeping track/control of what goes on in my head. Being aware in part, of how my mind works is a powerful tool.

Thanks for prompting me to write this down, its all part of the process of cementing it in my head.

Thank you David and Gary for providing the resources for me to get over the hump!

Hi All,

Below is an article which helps explain why you set off on the journey to becoming a better investor and the theory behind Mark Douglas’s work. Kahneman and Tversky’s original work was in the 1970s.

Why we invest the way we do

By Robin Bowerman, Vanguard newsletter, 15 May 2024

Investing Strategy

A lasting legacy from one of the pioneers of behavioural economics.

We live, for better or worse, in the age of influencers.

So, it is timely as investors to take the time to reflect on the positive influence on our understanding of investor behaviours of the late U.S. academic psychologist, Daniel Kahneman.

Kahneman died, aged 90, in March after a lifetime of work devoted to understanding the way we make decisions, the biases involved, and effectively establishing a new field of academic study now known as behavioural economics.

What the work Kahneman and his long-time research partner Amos Tversky did was challenge one of the foundations of economics – that human beings will fundamentally make rational decisions.

The ground-breaking feature of their work was to be able show systematically that people would make what economists regarded as irrational decisions based on the way information was presented to them.

The paper that saw Kahneman awarded the Nobel Prize in Economics in 2002 (Tversky had died some years earlier) was titled Prospect Theory and it delved into why we value gains and losses disproportionately. It really set the scene for the new discipline of behavioural economics, and in practical terms the development of “nudges” where decisions are framed to make positive use of our emotional biases.

Two different systems

His best-selling book Thinking, Fast and Slow took a deeper dive into the two different systems we use in making decisions. System one being fast, efficient, probably over-confident and error prone. System two being slower, research heavy, and full of doubt.

In a practical sense the two systems work together – system one identifies the dessert as a delicious treat, while system two flags calories and longer-term health benefits of going with fruit.

For investors there are some basic lessons out of Kahneman/Tversky’s work.

Essentially we are not that well wired to make rational decisions, particularly around financial risks. Their work quantified that it hurts roughly twice as much when we, for example, lose $100 compared to the pleasure we get when we make $100. And why, when given a choice of taking $100 for certain versus a 50/50 chance of winning $200, most people will take the $100.

The research highlighted inherent biases that we are prone to, and in particular how important the framing of a question or proposition is in the decision-making process.

Practical learnings

The lasting impact of the Kahneman/Tversky work was how two academics trained as psychologists fundamentally influenced the study of economics and resulted in the fusing of both disciplines into behavioural economics, which has resulted in some practical, useable learnings for investors of all persuasions.

A favourite podcast – Hidden Brain – recently broadcast extracts from interviews done with Kahneman some years ago. There were some classic comments – and humour – but this quote perhaps captures the essence of what we can all learn from Kahneman’s work: “The stories about the past are so good that they create an illusion that life is understandable, and that’s an illusion. And they create the illusion that you can predict the future, and that’s an illusion.”

A powerful reminder from one of the world’s original thinkers about the challenges facing all investors when it comes to forecasting future returns.