Confirmation Bias

As mentioned in the final sentence, this post from March 2016 begs for a follow-up discussion on confirmation bias.

Just over four years later, here we go!

Confirmation bias is the tendency to interpret new evidence as confirmation of one’s existing beliefs or theories. With regard to finance, this can be a situation where I think I’ve found a viable strategy and [unconsciously] disregard or censor subsequent evidence to the contrary.

In February 2016, I saw a webinar presenting a trading strategy by a guy named Jack. After the presentation, I e-mailed him:

     > I totally agree with your premise that if you can generate
     > enough income to cover the cost of the long then you
     > lose on the trade. Your presentation made it sound
     > like you believe this can always be done. What happens
     > when it can’t? What is your risk management?

He responded with:

     > “What happens when it can’t?”……… haven’t happened
     > to me yet…..I’ll let you know when I don’t….lol
     > “What is your risk management?”…..Fly has limited loss
     > profile……if the market is outside of the fly at expiry
     > the loss is what it cost you to place the fly…since the
     > fly cost you zero the risk is zero…understand?
     >
     > Risk on calendar… at expiry WE DO NOT SELL THE LONG
     > POSITION we just roll the short position till next week.
     > Follow me? If I lose remember it is not money that I’m
     > losing… it is only that I have no profits for that cycle.
     > Said another way, no money is taken out of my account
     > because the market went against me like all other option
     > spread positions…this strategy is truly unique…..;)
     >
     > Hope this helps,
     > keep asking.

I responded:

     > I think your trading plan is very interesting. However, I
     > also think it has a couple fatal flaws. Your presentation
     > made it sound like it can’t lose and that’s why I asked
     > what happens when it does. Your response suggests you
     > still don’t think it can lose because if you lose “it is
     > not money that I’m losing.” Every trade can lose. Also,
     > there are no “unique” ideas and no Holy Grail exists.
     >
     > What you presented was not a trading system but rather
     > a strategy. If you are trading it, though, then I hope
     > you’re trading it more as a system: with defined capital,
     > with max loss limits, and with firm understanding how the
     > trade can lose and how to recognize when it’s heading in
     > that direction. Especially with regard to the latter, if
     > you don’t see these things then I strongly believe you
     > have more work to do.
     >
     > Backtesting is a kinder teacher than Live Trading.
     >
     > I hope I do not seem patronizing or insulting with this
     > e-mail. That is truly not my intent. And if I end up
     > wrong about this then more power to you.

Why do people feel compelled to defend their strategies or advertise them as if they are infallible and can’t lose?

Confirmation bias is a big reason why. This is another reason I believe trading system development is best done with groups.