INTUITION
Intuition is an important part of the trading process for many traders and styles of trading. It is certainly more important to some types of traders than to others, but even highly quantitative work benefits from intuitive leaps at some points in the process. Though there is a lot of misinformation and misconception about intuition, the best working definition might be that it is a way of knowing that falls outside rational thought.
Someone who arrives at an answer through reason can usually explain every step—how an answer led to another question, which led to another answer, in an unbroken logical chain. When someone arrives at an answer intuitively, the individual will often say that he or she “just knows” or “feels that it is right,” and cannot explain much, if any, of the thought process behind the answer. Intuition works in leaps and bounds.
This is not a sign of sloppy reasoning; it is a completely different mode of thought, another way of knowing entirely. Many developing traders overestimate the importance of intuition, believing that it will cure all of their trading ills. They may think that great traders have a sixth sense that other people do not, that they just trade based on this gut feeling.
Some people believe that great traders are born with market sense—either you have it or you don’t. Other traders, particularly systematic traders, may believe that intuition does not really exist or that it is unreliable and mostly useful only in hindsight. As usual, all of these viewpoints contain an element of truth, but they are also wrong because they miss some essential points.
Developing Intuition
There is no magic in intuition. Rather, it is a normal problem solving skill that functions on a level outside of consciousness. As such, it cannot be forced, but it can be cultivated—there are things you can do to foster the growth and development of intuition. Everyone has had the experience of working very hard on a problem and being unable to solve it during the work session, and then the answer coming spontaneously after a break or a night’s sleep.
The answer seems to come easily and naturally, with no effort at all, but this is not quite true. The sudden flash of intuition is really the result of a lot of hard work and an extended period of focused effort that activated the cognitive machinery on another level. There are two important elements to building intuition. One is repeated exposure to consistently structured data, which is the focus of much of this book.
Equally important, though, is that the work be approached in the right emotional context, which is basically an open, receptive, and almost playful attitude. This is something that is so profound, but is often ignored. Most adults understand the need for hard work and focus, but they are not so in touch with the need for novelty and play. Perhaps this is one reason why children find it easier to acquire new skills, particularly in the artistic/intuitive/right brain domain.
There is a large and growing body of research on neuroplasticity, which says that high-level skill acquisition actually depends on physical changes in the brain—the brain rewires itself to accommodate these new skills. There are structural differences, for instance, between the way a chess grandmaster’s brain processes chess patterns and the
way a typical person’s brain works. They fundamentally see and think differently because their brains are different, and this difference is the result of intense training. This also explains why skill acquisition does not happen overnight: It takes time for the brain to build and reinforce these new structural connections, which requires intense work over a long period of time. Teachers of high-level skills have known for generations that the correct emotional context and environment facilitate high-level skill development, but they did not realize that students were actually, physically rewiring their brains.
Learning should be fun, not only because the student will be motivated to work harder, but because the emotional charge of this enjoyment actually encourages the physical changes needed for skill development. It is very difficult to excel at something unless you love it. This is a real problem for newer traders, for whom the market is an out-of-control emotional roller coaster. Until those emotions are brought under control, it is impossible to approach the market with the correct, receptive mind-set.
Where Does Intuition Come From?
There have been many studies in the social sciences and in psychology that have established the reality of human intuition. Focusing specifically on trading and market-related intuition, Bruguier, Quartz, and Bossaerts (2010) structured a set of experiments designed to “better define what is meant by ‘trader intuition,’ and to understand why some traders are better than others.” They did this by creating a number of scenarios representing markets that both had and did not have trading by informed insiders, with the goal of seeing if novice traders could intuit the intentions of these informed insiders through price movements.
This paper is one of many that confirm the reality of intuition, but these results are particularly interesting because they suggest a fairly mundane explanation for the phenomenon. Intuition is not some mystical skill that only supertraders have; it is a retooling and reapplication of normal human abilities built from our social interactions. However, the most important point is that intuition is not special. Even inexperienced, uninformed traders quickly begin to develop intuition about market patterns (a fact that has been confirmed in many other experiments.) If everyone has it, intuition cannot, in itself, be a source of a trading edge.
Using Intuition
A discretionary trader is someone who trades based on a strong understanding of the fundamental principles of price behavior. Many outsiders and developing traders assume that discretionary traders rely on a nearly supernatural sense of what will happen next. In general, this is not true, as most discretionary trades are placed according to more or less clearly defined rules. Good discretionary traders have a passion for understanding how the market really works and for what drives unfolding price movements, and they are also willing to let go of preconceptions and theories immediately if they are disproven by the market. All good discretionary traders are statistics junkies, whether they know it or not. Some are attracted to hard-core statistical methods, but many others spend hours studying charts and keeping records and journals of market behavior. What are they doing if not internalizing the patterns of the market? I would suggest that a rigid analytical framework has the advantage of objectivity and scope, but dedicated traders can accomplish many of the same goals with charts, records of their own trades, and pencil and paper.
Even though much can be quantified, most traders will experience periods of knowing that go beyond the statistics. Sometimes there is a strong gut feeling or emotional reaction associated with a pattern; maybe, for instance, you are considering a trade in three markets and one objectively is less attractive on the chart, but you keep coming back to it for some reason you cannot define. It is also common to experience intuition on a longer time frame. Maybe you have a trade that is working well, but you find yourself thinking about it when the market is closed and you are unduly concerned. In each of these cases, this could well be a message from some part of your mind beyond your conscious grasp. It takes an enormous amount of emotional balance and experience to separate the real messages from the noise; this is one reason why the learning curve for traders is measured in years and not months. New traders simply have too much emotion and too many conflicts to be responsive to the still small voice of intuition or to separate it from their rampant fear and greed.
Trusting Intuition
In general, the most important questions about intuition concern how to balance intuition against reason. There is no simple answer to this; the answer will be different for a trader at different points in her development, for different markets and market environments, and perhaps even for different kinds of trades. In addition, many traders find it constructive to weight intuition more heavily when considering exits from existing trades rather than entries into new trades. The reason is that most discretionary traders find it easier to read a market when there is a position and fluctuating P&L involved. These factors tend to be powerful cues for intuition, but it is also important to guard against emotional distortions due to fear and greed.
The interplay of emotion and intuition is poorly understood. Intuition often communicates its message through sensations in the body, which is why it is often described as a gut feeling. It is ineffable and ephemeral, and it operates on the margin between thought and feeling. The problem is that emotions essentially communicate on this same channel, and emotions can cloud and distort the message of intuition. It is difficult or impossible for an emotional trader to respond to intuition, which is one reason why new traders should actively ignore any intuitive sense and should instead focus on building a rational analytical framework based on the inherent statistical properties of the market. Once the emotional charge is gone from the trading process, intuition will become more trustworthy, and this will probably also come at a time when the trader has finally been exposed to enough market patterns to have begun to develop some valid intuition.
For most developing traders, the most important points to remember are as follows: Intuition is real, but it is not special. Everyone who has interactions with the market quickly develops some degree of intuition, so the presence of intuition is not a trading edge. There are far more people who have intuitions about the market’s movements than there are profitable traders. Also, realize that intuition relies heavily on heuristics, so it is absolutely critical that it be trained correctly. Last, realize that it will often not be possible to walk through logical steps that fully explain your intuitive conclusions. In fact, intuition will be at odds with logic and reason at times, creating a dissonance that the trader will have to resolve. Intuition is fallible and will sometimes be wrong, so it is critical that all intuitive impressions are subject to rational review and evaluation.