Praise for Trading from Your Gut

Balance in Trading
An example of a healthy partnership between intellect and intu-
ition in strategy development illustrates one way in which you can
achieve this balance. Suppose that your right brain notices that a
certain price pattern often precedes large up moves in many of the
stocks you have been following. For the purposes of this example,
suppose you noticed that an inside day followed by an outside day
tends to precede a large move in the direction of the close of the
outside day. Your intuition tells you to investigate a strategy in which
you would buy if you had an inside day followed by an outside day
that closed higher, and you would sell if you had an inside day fol-
lowed by an outside day that closed lower.
Your intuition has flagged an idea as a potential trading strategy.
Your left brain, being the natural skeptic, runs through its list of
potential problems:
• Visual perception bias—Your intellect is aware of the visual
perception’s tendency to notice significant points on the chart
and ignore points that are less visually significant. For
traders, this often means that your eye is drawn to the prices
that surround big moves and the patterns that precede them,
but you might not even notice when the same pattern shows
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up inside a price consolidation. This will sometimes cause you
to believe that the pattern is more significant than it really is.
To determine whether the pattern really represents a trading
opportunity, your intellect knows that you must take a
methodical approach to investigate that pattern. This might
initially involve carefully analyzing some charts in which you
use your left brain’s attention to carefully search for the pat-
tern in all the data. Then if the pattern still appears promis-
ing, you might use a backtesting application to run a historical
analysis of the pattern. A properly programmed computer
will not be susceptible to the same visual perception bias to
which your right brain is vulnerable.
• Not enough data—Your intellect is aware that although
your intuition might have found a pattern, the pattern might
appear only in the relatively limited amount of data repre-
sented by the charts you have been looking at. Your left brain
is aware of the need for a statistically significant sample size
and of the way in which our intuition can be fooled because a
pattern emerges a few times in a relatively short period of
time.
To validate the idea over more data, your intellect will move
you to analyze more charts. You might try looking backward
several more years to see if this pattern holds up. If the pat-
tern still seems promising, you will likely want to run com-
puter backtesting to analyze the pattern over a lot more data.
In this example, notice how the ideas that your intuition noted
were used as the basis for more rigorous testing. This is as it should
be. If you can satisfy your intellect that a strategy you have devel-
oped using your intuition is, in fact, valid and profitable, you will be
able to trade it with full confidence. Your whole mind will be able to
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get behind the strategy, so your confidence trading it will be higher.
This makes it much easier to display the emotional and psychologi-
cal strength that distinguishes a master trader from the pack.