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The Law of Averages

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I am enjoying getting back into the trading scene; analysing traders performance and speaking with traders about their edge and trading style. One thing I repeatedly notice is how we as humans often make mistakes because of our need to understand the world in easy to compute averages.

You may have heard about the man who drowns crossing a river that is on average 3 feet deep. Clearly the consequences here are pretty dramatic but there is an obvious lesson to be learned. When you don’t know how to swim, not knowing the depth of the water where you are crossing a river can be fatal.

This is a common mistake that I believe traps a large number of traders and investors who don’t really understand the risk they are taking. Human nature prefers to hide ones trading sins in the comfort of averages. I believe working with averages is important and can help one get a long term overall view of performance, but it should never be looked at in isolation. Rather it should form a base for further analysis of previous performance outliers.

I will show you in another example how misleading averages can be. When Bill Gates walks into a room of 20 random people, the average wealth of every person in the room goes above $1 billion. You can clearly see from this that averages can present a distorted reality when you do not understand all the variables in the equation.

I believe this is a good segue to introduce a new feature of returns on our main dashboard’s intraday equity chart. As of today you can see a visual histogram of your trading performance. The PsyQuation team hopes this subtle new feature will help provide you with a clearer visual prompt to avoid the mind tricks we are all prone to look for in averages.

Drawdown Leads to Triple Penance 2018 FOCUS IS INCUBATING TRADERS - AXISELECT