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The Mircowave Oven Theory of Behavior

I started the day with a very simple statement: http://quickstopentertainment.com/forums/showthread.php?p=158177

Don't you wish other people would be that honest with us?  It's very hard for people who give opinions for a living to stand in front of an audience and say: "I don't know."   Somehow they seem to feel that they have to know and, what's worse, once they force themselves to make a decision, they somehow feel obligated to defend it, even if new evidence comes out to the contrary.

This is exactly what's wrong with financial reporters and analysts, especially the clowns on TV (as well as pretty much anyone who makes a living giving you their opinion).   My members are familiar with something I'm going to share with you now.  It is a Nobel Prize-worthy theory that I feel helps make me a better trader and I thought this would be a good time to share it with you:

People love to make random decisions and stick to them like they were directly given it as a commandment!

How does this relate to microwaves? Well, aside from the fact that our brains are constantly being fried by the things every day (ever drive on the highway and see one of those dishes aimed right at you?  Do you know birds die if they fly too close to them?), this is what I observe:

You put something in the microwave, say pizza, and you put in a time, say 3:33 (or maybe you are a whole number person and do 3 or 4 minutes). Now, unless you are a chain store pizza buyer your pizza slice is probably not always the same size or maybe it has different toppings etc., but you probably put in the same number every time.

Theory number 1:  People tend to repeat behavior, especially if it was successful in the past.

So the light goes on and the little thing spins and you are either a watcher or a walker (as you may have guessed - I hit the button and leave the room!), but either way you usually end up standing by the oven with 20 or 30 seconds to go waiting for it to stop.

Here's where the Nobel Prize committee has to recognize me:

Theory number 2:  Everyone likes to think they knew (not know) something.

 

  • Now you are standing there watching the pizza spin and looking at the timer.
  • You may think it is done.
  • You may KNOW it is done (you see cheese boiling)
  • You may be hungry.
  • You may be in a hurry.

But – you WILL wait and you WILL watch the little numbers count down until you hear that beep.  Go on, try it – I dare you to open the door with 3 seconds left!

Theory number 3:  We stick to arbitrary prior decisions despite new information to the contrary.

You pick a random number of seconds to cook food and then, despite observations to the contrary or a change in the situation, you stick to your original decision – In fact you are trapped by it!   It is very, very hard to ignore your own advice, even though you didn't intend it to be advice to your future self at the time – just a number you picked on a whim. Your future self always defers to you because he/she thinks you are the greatest thing since sliced bread.

This is what happens to people just 3 minutes after a decision is made, what about trade decisions that are made days or weeks ago?

Ah hah, so it does go back to trading (I bet you thought I was losing it!)….

Rather than re-research, reread, rethink, reexamine our targets, we tend to treat them as set in stone. Learning not to do this will make you a much better trader (and also help you to finally redecorate the living room or clean out your desk or whatever).

Old decisions were made by the old you. The new you has learned things since then (even if it was just 3 minutes ago). The new you is older and wiser and more experienced and has had the benefit of reviewing your GUESS (because that is all it was) in light of real world circumstances and the new you is ready to make a BETTER decision.

Often the new me can't imagine what the old me was thinking when I made a trade or set a target (or gave that girl my phone number) but since I know AND ACCEPT how often the old me makes mistakes, I have no problem overriding my decisions even if it means a complete reversal!

If you can do that, you can beat the market, because 95% of the people you are trading against cannot let go of those arbitrary targets they set for themselves when circumstances were different.

When Apple, for example is upgraded to $160 but it stutters at $145, SELL!  Open the door and take the pizza, it's done!!!  If it isn't (you take a bite of your pizza and it's still a bit cold) then get back in.  That's right, the old me bought Apple at $120 when an analyst said $160 and the stock went to $142 in 3 weeks and I feel like a genius so I start counting my $40 profit and thinking about what I will do with it.  The next week it "flatlines" between $135-$146 and volume drops but the old me said $160 and it looks like I was right before, as I'm up $25 – so I should have another $15 coming to me….

This is terrible logic!!!  Why are you listening to the old you? (I know, it sounds kind of schitzo) You've had 3 weeks of observations, yet you are willing to ignore that in order to slavishly follow, not even what you thought, but what some analyst thought 3 weeks ago (and he was probably listening to the old him).

You are you from the future. Full of knowledge that the old you wishes he had at the time.

HOMEWORK: Watch Back to the Future, part 2, where old Biff steals the 1950-2000 sports almanac and gives it to the young 1955 version of himself.  He tells himself all he has to do is pick the winners and he'll never lose.  Obviously, right?  Then why do you keep sticking to decisions you made in the past when you ARE you from the future?  You know more than you did then, listen to yourself – that should be obvious too!   

Also, watch Deal or No Deal (NBC) with the Microwave Theory in your hand and think about how you make decisions.

Let me know if this is helpful of if I am losing it – I always like to know how the old me is/was doing!

"People like us, who believe in physics, know that the distinction between past, present, and future is only a stubbornly persistent illusion."Einstein


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  1. Hi Phil and all, re CCJ

    this is part a good but very detailed story today from:

    http://www.globeinvestor.com/servlet/story/RTGAM.20070727.wrcover28/GIStory/

    if you have an interest in CCJ you may enjoy reading it all….it’s just too long to post all of here.

    Lying low at ‘Sleepy Hollow’

    ANDY HOFFMAN

    Saturday, July 28, 2007

    McARTHUR RIVER, SASK. — — Underground at the world’s richest uranium mine, it all seems so easy.


  2. It was pleasant to revisit the Microwave Oven Theory of Behavior. Looking back, I just realized how influential you have been on my thinking. It is hard to ‘shed things written in stone’ despite knowing very well that time has managed to change everything ‘written in stone’. Thanks to you, Phil, I do think differently. During the last dip in Feb, I cashed out my positions, if I did not read you, I would not have done that, and it did save me from potential losses. Someone remarked on Friday, that their portfolio was neutral during this dip, so is mine. The new ‘me’ recognized the value of hedging, something, I learnt from you. Thanks again.


  3. Hey Phil or anyone – I left a long message on the friday thread that ill synosize here as a simple question -

    I built my portfolio as a long-term portfolio – but assessing the vega risk has me wanting to either hedge out vega or liquidate the uglier of the positions and vega-hedge the rest – or at least mitigate the vega risk which amounts to about 1% of my portfolio value per percent of underlying IV drop.

    So I have 3 choices as I see it –

    1. Liquidate and come back another day (I have about 8 positions total – a time-delayed roll perhaps ?)
    2. Vega-hedge the biggest vega offenders using more options on the underlying
    3. Vega-hedge by buying VIX puts (what about VIX volatility crush ?? my head spins to think of that)

    I know you said cash is king, but ive tried to keep my portfolio calibrated so I had just enough delta hedge to keep it even /on options expiration/. Right now its down about 3-4% all-told, and is positionned so a 2-3% market rebound would put it in the sweet spot. I figured there would ‘always be an option’.

    I dont mind being vega’d-up while the market goes down, but once it turns Im gonna wanna shed vega with a quickness. I currently have no uncovered options, but my portfolio still has way too much vega for my taste.

    Ideas ?

    As always, thanks for all the insight. I truly do appreciate it.


  4. I don’t post very much as it’s been a long learning curve for me to finally have a consistent string of good trades. What you said in this post resonated deeply with what I have learned through all my trading mistakes (and successes). The 20% rule was kind of what brought everything together. Learning to be happy with small, reasonable targets has actually helped me to reach larger gains because I was able to be alert and objective at every moment along the way to see when something was truly “cooked” instead of having some randomly rising target that was pretty much powered by greed. It’s funny how easy it is to freeze when say your gain is not quite at your target (45% not 50% or 90% not 100%), even though everything is screaming at you that the run is well done already. It was very nice though to have the concept laid out to basically be objective and reevaluate your position each moment and day in light of the price action that has already taken place. “I don’t know what will happen today” is my mantra now. More than anything, the trading advice you have given in these type of posts has been what I have felt is of the most value to me. I don’t think that everyone can copy your style and trade execution exactly and trying to do so without the proper resources (financial, mental, and experience wise) can be detrimental to your account. So at least for me, it is the insight into your trading psyche and your often brutally honest but insightful view of the many facets of the investment universe that has made every penny I have spent for this membership all worthwhile. And I just wanted to say thanks.