Thursday, November 21, 2024

Toby Carrodus On the Virtues of a Systematic Approach to Trading

Toby Carrodus On the Virtues of a Systematic Approach to Trading

Toby Carrodus is an industry veteran and expert on systematic trading, and his insights are worth taking note of. In a recent interview, he explained why adopting a systematic approach to trading provides benefits beyond allowing one to trade while sipping proverbial Piña Coladas at the beach.

Toby Carrodus begins by discussing the human mind and its limitations, using the works of double-doctorate, Nobel-prize winning economist Friedrich von Hayek as a reference. Hayek’s 1952 publication of “The Sensory Order – An Inquiry into the Foundations of Theoretical Psychology” provides a solid foundation for understanding the limits of our reasoning ability. According to Hayek, the mind is essentially “an instrument of classification,” and perception is always an interpretation of reality, which can never be fully comprehended in its entirety. To cope with this inherent ignorance, humans have become reliant on implicit and explicit rules as a means of determining the appropriate behavioural response to a given situation.

Toby Carrodus Says Rules Simplify the Number of Factors to Consider Given the Limits of Human Reasoning

Rules simplify the number of factors that need to be considered in a given situation and allow us to free up mental capacity to address more challenging questions. The most useful rules have evolved through the spontaneous growth of society and hence embody the cumulative knowledge of the many trials and errors of generations before us. Given that humans cannot know all possible facts, choices, and outcomes related to a given situation and have limited mental capacity, Hayek argued that following rules is often the better choice than trying to maximize outcomes through discretionary judgement.  As Toby Carrodus points out, this has relevance for the world of trading.

“A systematic approach to trading can help you cut through the noise and distractions that come with being constantly bombarded with financial news and reports” – Toby Carrodus

By relying on rules and systems, we can overcome our cognitive limitations, improve our outcomes, and free up mental capacity to focus on the most important issues. A systematic approach to trading can help you cut through the noise and distractions that come with being constantly bombarded with financial news and reports. With a set of rules in place, you can focus on a smaller set of variables and make decisions without being swayed by the latest headline or rumour. This is a critical aspect of successful trading, as numerous studies have shown that having more information at your disposal doesn’t always lead to better results.

Simple Rules of Thumb Trump Complex Discretionary Decisions

In fact, collecting more and more information can often have the opposite effect, leading to overconfidence and poor decision-making. To support this claim, Toby Carrodus cites a famous study by Paul Slovic. In this study, professional bookmakers were given a list of 88 possible variables that could be used to rank the top 5 horses in a race. The result was that the bookmakers tended to perform better the fewer variables they selected and that forecast accuracy diminished as variable count increased.

Carrodus also cites Terrence Odean’s research in the stock market which observes that investors who have more information tend to become overconfident in their analysis, leading to poor performance. Similarly, German professor of psychology Gerd Gigerenzer’s work on ‘heuristics’ (or simple rules of thumb in decision-making) also shows that complex decision-making processes don’t necessarily produce better results compared to their simple counterparts. In fact, as Carrodus points out, in many instances the former were worse than the latter! For example, Gigerenzer’s research established that simple rules outperform the discretionary judgement of so-called expert stock pickers.

Focus on the Signal, Ignore the Noise, Says Toby Carrodus

Toby Carrodus points out that many traders get caught up in the noise of the financial world, lured by the belief that following the news and having more information will lead to better results. But this couldn’t be further from the truth. As is clear from Slovic’s, Odean’s and Gigerenzer’s research, simple rules of thumb can actually perform better than experts.

“Computers do not need to sleep, do not have emotions that influence their decisions and can use vast amounts of data to perform complex calculations faster than humans” – Toby Carrodus

Moreover, as Toby Carrodus rightly points out, systematic trading lends itself well to automation and leveraging technology. Computers do not need to sleep, do not have emotions that influence their decisions and can use vast amounts of data to perform complex calculations faster than humans. In addition, systematic trading allows you to test an idea on large samples of historical data to evaluate its statistical validity before risking any money in the market.

Toby Carrodus stresses the importance of adopting a systematic approach to trading, as it eliminates emotions, reduces bias, helps cut through the noise and has the added side-effect of improving your quality of life. By having a set of rules in place, you can focus on what is important in your life and make decisions based on data and evidence, rather than being swayed by emotions or outside factors. This approach leads to more consistent and profitable trading results and can help you navigate the often volatile and unpredictable world of financial markets. So, forget expert opinions and embrace a systematic approach to trading for better results – and enjoy sipping on that Piña Colada at the beach!