Tuesday, December 17, 2013

Costs are not losses | The Reserve Bank of Australia (RBA) marks our cards

Costs are not losses

For this writer, two most interesting authors at present are Daniel Kahneman (Thinking, Fast and Slow) and Nassim Nicholas Taleb (Fooled by Randomness, The Black Swan), both of whom deal with psychology, and the psychology of trading in particular.

These two writers agree on many things, and reference each other’s work quite a bit. One striking finding, which they have convinced is valid due to the scientific rigour of their methodology, is that losses are far more significant in the human psyche than are wins. An individual, and traders are no exception, will think much less of a win of a given amount than he or she will of a loss of exactly the same sum. The statistic that convinces is the one that has found that professional golfers will take far more care over a putt to save par than they will on a shot that will win them a birdie. One of the authors mentioned has calculated that this phenomenon has resulted in foregone revenues for Tiger Woods amounting to some millions of dollars over the course of his career.

Drawdowns, or trades that do not work out and which result in a lowering of the trader’s account equity, are part and parcel of the activity in which we, as traders, indulge. The market participant who claims that 100% of trades result in additional profit is either using a strategy that is so conservative that it returns less than the US Treasury bond rate, or they are being economical with the truth.

Yet the fact remains that when drawdowns do occur, no one can be expected to like them.

One way to deal with them is to regard them as the cost of doing business. A cost in any commercial activity, unless it gets out of hand, is not regarded as a loss. If ordinary dealing results in a surplus of profit over loss, then the trade that does not work out can be seen in this light.

This is particularly the case if the trader has defined and tested a methodical strategy, found it to be effective and is confident that he or she is able to faithfully execute it on a day to day basis. Algorithmic routines, such as the OmiCronFX Silver Trigger and Mandelbrot, assist greatly in this regard.

The Reserve Bank of Australia (RBA) marks our cards

The minutes of the Aussie RBA for December were released yesterday. They reiterate what was already in the public domain about the need for a transition from a mining based economy to one that is dependent on domestic consumption, and the importance of a lower Aussie dollar so that this can be facilitated.

As is known, the governors are concerned about a residential housing bubble, particularly in cities such as Sydney. Although they are not in favour of lowering the cash rate, for this reason, they left open the possibility that such might have to happen in the future. This can be seen as part of the policy of “jawboning” or attempting to talk down the Aussie as opposed to taking concrete action that would ensure devaluation.

For us, the most significant part of the minutes was a discussion that took place on the subject of US tapering which, as pointed out here previously, is a big part of governor Stevens’s thinking for bringing about a lowering of the Australian unit. The RBA feels that "The consensus view within financial markets remained for a ‘tapering’ of the Fed's asset purchases to commence in March".

Interesting. Interesting indeed.

1 comment:

  1. Hey Seamus,

    Thanks a lot for this write up! Ended up downloading all the books & watching this clip after a long googling spree!

    Thinking, Fast and Slow looks like a true masterpiece! I'm going to read it now!
    Found something like this after a longtime. Last time it was Brett Steenbarger & Mark Douglas.

    Keep up the good work!