The recent global pandemic resulted in significant economic uncertainties and market volatility, which curiously created another curveball: More Americans began investing.
A Charles Schwab study discovered that 15% of U.S. stock market investors began in 2020. And they’re not chasing the next hot stock; they’re investing and planning for their futures.
Toby Carrodus, a global investor and quantitative analyst, trades futures on equity indices, bonds, commodities, and currencies. He is writing a book for intermediate traders about his robust trading strategies.
“I have been investing and trading both for institutions and myself for most of my career, making millions of dollars,” Carrodus writes in his book’s introduction. “This has been an extremely challenging process, and I have made many mistakes. If I had this book when I started my career, it would have saved me years of work and money.”
Making mistakes in trading or investing of any kind is a natural part of the journey. Carrodus addresses common blunders and how investors can avoid them in his book.
Toby Carrodus Recommends Investors Establish Well-Defined Plans with Strict Boundaries
Newbie investors who think they have a well-defined trading plan often discover, compared to experienced investors, they have a loosely constructed plan. Accomplished traders go into investing with a precise plan. From the outset, they know entry and exit points, how much capital to invest, and the maximum loss they will take.
Toby Carrodus takes this approach one step further by systematizing his entire investment approach using a rule-based strategy. He prefers this approach because it is evidence-based and data-driven, while the more subjective strategy, discretionary trading, is built on “gut feel,” which is heavily influenced by emotions, which for most humans vary day to day, introducing an additional element of unpredictability.
“By having a set of rules in place, you can focus on the essentials and make decisions based on data and evidence, rather than being swayed by emotions or outside factors,” Carrodus explains. “A systematic approach to trading can help cut through the noise and distractions that come with being constantly bombarded with financial news and reports.”
Toby Carrodus and Other Experts Say that Rules Generate Better Outcomes
Toby Carrodus was born in Cairns, Australia, and achieved a Bachelor of Economics and a B.A. in political science from the Australian National University. He earned a Master of Science in Economics from Humboldt-Universität zu Berlin. One of his favorite courses unraveled the philosophy of Nobel-Prize-winning Friedrich von Hayek, a brilliant philosopher who espoused the spontaneous evolution of modern order via free-markets as opposed to government directives, and focused on the interplay between psychology and market systems.
Carrodus touts Hayek’s influential book “The Sensory Order: An Inquiry into the Foundations of Theoretical Psychology,” published in 1952, as a contribution to theoretical psychologists and economists. Hayek’s book, still in print, describes the human mind as “a vast network of interconnected neurons that acts as an instrument of classification.” Perception, he wrote, is always an interpretation of reality, and there are limits to human reasoning.
With its fixed mental capacity, the human brain can’t always access all the facts and variables to make correct decisions, Hayek wrote. To cope, humans rely on implicit and explicit rules to determine appropriate behavioral responses to situations. Hayek found that abiding by rules can result in better outcomes as opposed to discretionarily attempting to maximize outcomes on a case-by-case basis. Untold numbers of humans from generations ago performed the trial and error that birthed society’s most fruitful rules. These generations gleaned more information than one person could, giving them weight.
Carrodus says that understanding the limitations of the human mind can stave off the overconfidence that can generate unwise investments. “By relying on rules and systems, we can overcome our cognitive limitations and improve our outcomes,” he says.
Studies Have Shown Toby Carrodus and Other Economic Experts that Smaller Sets of Variables Yield Superior Results
Other psychologists and economists have written works containing ideas similar to Friedrich von Hayek’s. One book that Toby Carrodus references is the famous work of Israeli-American psychologist Daniel Kahneman, “Thinking, Fast and Slow.” The book delved into the psychology of judgment, decision-making, and behavioral economics.
Kahneman won the 2002 Nobel Memorial Prize in Economic Sciences based on his empirical findings that challenge the assumptions in modern economic theory about human rationality. As Carrodus writes in his book, Kahneman’s research reveals that human decision-making is inconsistent depending on the environment. Studies have documented such phenomenon in many fields of expertise, including investing.
Research by Terrence Odean reveals that investors overestimate the forecasting power of their knowledge, become overconfident, and perform poorly. It turns out that more information and learning do not necessarily improve forecasting accuracy but can often have the opposite effect, leading to overconfidence and poor decision-making.
Odeon’s findings dovetail with more than 200 studies Kahneman examined that compared the results of clinical (i.e., human “expert”) and statistical (i.e., systematic rule-based) predictions. They ranged in predictions from bank lending to the appropriateness of foster parents to cancer patient longevity. 40% of these studies showed tied results regarding the accuracy of predictions between experts and formulas, with the remaining 60% showing formulas being superior to the experts. Kahneman writes, “No exception has been convincingly documented.”
The message from the experts is clear: Investors who work via rules and systems will reap more benefits in the investment world than if they were to free-wheel it.
“Rules simplify the number of factors that need to be considered in a given situation,” Carrodus says. “This allows us to free up mental capacity to address more challenging questions.”
Sources:
https://www.bloomberg.com/press-releases/2021-04-08/the-rise-of-the-investor-generation-15-of-u-s-stock-market-investors-got-their-start-in-2020-schwab-study-shows
Thinking, Fast and Slow. Daniel Kahneman
https://www.amazon.com/Sensory-Order-Foundations-Theoretical-Psychology-ebook/dp/B009GJQIS4 – Book
https://www.beastglobal.com/post/five-notable-nobel-prizes-in-the-study-of-behavioural-economics – Nobel Prize
https://citeseerx.ist.psu.edu/document?repid=rep1&type=pdf&doi=0f9cf9f9a2ae0efaa8d67bd91b – Terrence Odean’s research in the stock market