I think we all like to think of ourselves as being very rational and any strong beliefs
or understandings that we have are based on something that we can truly stand behind as
being fact. But what happens when there is overwhelming evidence that confirms something
we are convinced is the truth, is actually not true at all? This is where cognitive dissonance
comes into the equation and it's a really strange quirk that we have in the human psychology.
But the problem for us as traders and for any other area in our life where we want to
be improving and optimising our performance, is that it can really stop us from realising
our mistakes, learning from those mistakes and continuing to get better.
So let's get stuck in and explore that.
Towards the end of 2010, the U.S. Federal Reserve had just announced that it was going
to embark on its second round of quantitative easing, nicknamed QE2. That meant that it
was effectively going to start printing money again in an attempt to support and stabilise
the economy. However, not everyone was entirely supportive of the idea and it gained quite
a lot of criticism. Perhaps most public of all the criticism was a group of renowned
economists who were the leaders in their field. This even included billionaire fund managers
like Cliff Asness and Paul Singer. They wrote an open letter to Ben Bernanke, who was at
that time the chairman of the Federal Reserve. Good old Ben Bernanke, who always looked like
he was on the verge of tears. And they paid a lot of money to post the letter as a full
page advert in the New York Times. Bold move. In the letter the economists say: "We believe
the Federal Reserve's large-scale asset purchase plan (so-called "quantitative easing") should
be reconsidered and discontinued. We do not believe such a plan is necessary or advisable
under current circumstances. The planned asset purchases risk currency debasement and inflation,
and we do not think that they will achieve the Fed's objective of promoting employment."
As was noted by Matthew Syed the writer and researcher, at the time of the letter the
inflation rate was at 1.5% and the unemployment rate was at 9.8%. However, after four years
in 2014, the inflation rate had not only stayed low but it had actually fallen to 0.8% and
the unemployment rate had also dropped to 6.1% as the US created jobs at the fastest
rate since 2005. Needless to say, in that amount of time, the claims made by the economists
had certainly not materialised. In fact, the opposite had actually happened. So how do
you think these famous and highly respected economists reacted? Well Bloomberg set out
to find out in 2014 and surprisingly the economists they interviewed did not accept that they had got
it wrong and in fact, most of them even thought they got it absolutely correct. So rather
than just accepting that inflation and the unemployment rate had fallen, they instead
looked for evidence to justify that they were correct. This even included one economist
claiming that inflation had increased, but you have to look at Wall Street to see that
its increased on Wall Street, in other words the stock prices were going up. Which is clearly
not what they intended from their initial letter. You can rewind and have a look at it again.
They're not talking about stock prices. These economists were displaying signs
of cognitive dissonance. So this is a term that was proposed by Leon Festinger in 1957
who pointed out that humans strive to have consistency in their psychology and when that
can't happen, such as when there is compelling evidence that shows that they are wrong, this
is psychologically uncomfortable. So, in those cases rather than accepting the evidence,
they will instead either change parts of their original idea to make it appear to fit the
evidence, right, changing their story a little bit! Or actually avoiding accepting the evidence
or even facing it whatsoever. So a great example of where you can see this happening around
you every day, especially at the moment, is in politics. And I don't necessarily mean
the actual politicians being lying politicians, but the people who vote for them. It seems
that once someone has decided on who or what they are voting for, they somehow disregard
all evidence that it's a bad decision, or they are going to be more inclined to ignore someone's
shortcomings if they are voting for them even though it's obvious to everyone who didn't
cast their vote. I think we can all find examples of where this has happened recently, in the
US election between Trump and Clinton and of course in the Brexit referendum in the UK.
Now unfortunately this cognitive dissonance can be really harmful and particularly for
us as traders, it can lead to losses it can hold back our progress and many other things.
Now in terms of the losses, I think it's pretty obvious if we take a look at the example of
the economists with their letter to Ben Bernanke. There are many times when we will do our analysis
like they did and be certain that the market will do what we expect it to do and then it doesn't
and we can't figure out why that isn't the case. There might be heaps of evidence telling
us that we were wrong with our analysis, but we just can't see it and instead we're going
to cling onto the evidence that sort of works in our favour. This is a sure-fire way to
blow your account and to end up broke. Just ask the people, who quite rightfully, claim
that the stock market can't carry on rising forever and it's been propped up by fed stimulus.
Well, they might be right eventually, but it's been the wrong move for years now, as we've seen
a massive bull market and people have practically set fire to their trading accounts like pyromaniacs
trying to catch the top of it and to short it. Been there, done that... I had a love
affair for a long time a few years ago with the Euro but because of my cognitive biases
about what I think's going to happen it led me to mistiming it and shorting it too early.
Luckily it got there in the end and I made a tidy packet from that trade. But I think
I'm still catching up on my sleep after all these years. That's why, probably, I look
like a badger all the time, it's that Euro trade still. But look that's just one issue
and we can resolve that one by following our good old 'adapt like water, absorb like a
sponge' approach which we've discussed before on this channel and we talk about it in the
online course. And in fact, we're going to be covering it again in a few weeks time on
this channel, which I seem to be saying quite a lot but we have a lot of things coming.
However, the more important issue with cognitive dissonance is how it can restrict our growth
and lead us to no longer improving. Now THAT is a disaster. Losses from your account balance
can be recovered, but if you can't keep improving, you're not going to make that happen. So let's
think about this for a second. Imagine if you lose some trades, there may be some clear
evidence that there's something you're doing that isn't working, there's something consistent.
Or perhaps even more dramatically, the whole system you're using might not be working.
But if, for example, you had a profitable run early on with the exact same approach,
you might not be able to accept that it's anything wrong with the way you're trading.
because it worked before it should be working now. But this is where cognitive dissonance
is holding you back. Because the only way we can improve is if we realise where there
are mistakes and to start focusing on those mistakes so that we can start fixing them.
Instead, in these situations people usually start trying to find other things to blame,
"oh the market wasn't moving in the way I wanted it to today", "Oh if it wasn't for
that economic data release then the trade would have been fine, that screwed everything up"
or here's the best one that investment funds use..."it was a Black Swan event, these
don't happen often there's no way to predict this happening" Yeah, sometimes the professionals
are actually the worst! In fact, that's a key factor of cognitive dissonance. It was
discovered even in hospitals. So with hospitals, they started being investigated for mistakes.
And it was found that doctors are so educated and put on a pedestal so much, that they consider
themselves to be infallible. So when there's a mistake, even a preventable one, they refuse
it exists and think it must be some other freak occurrence instead.Therefore, they can't
improve in the future and they can't help the progression of medical practices.
And you can imagine how many lives have been lost as a result of that. It's not stubbornness,
it's cognitive dissonance. So we can't allow ourselves to fall into that same mistake.
We need to accept evidence with an open mind and realise that our trading can only improve
if we look at where we're going wrong. If our aim is to be a profitable trader, there's
a very important fact we need to accept. No one can trade perfectly. It just doesn't
work that way. So in that case, we need to analyse the mistakes we make and we can't
hold on to any beliefs or ideas about our trading too strongly, if there is a way to
test it we should test it. In other words, if something is testable, we should test that
and let the evidence speak for itself. And that includes our results, that's a test in itself.
But anyway we'll leave that there for now. As I mentioned we have got some videos
coming up which will help you even more with this concept, but there are a couple in particular
that I think you should check out. So in the description box is a link to our series on
becoming a great trader, it's just 3 videos it doesn't take long to watch, and the lat
one in particular will help you with this area of mindset and psychology. We also have
a video coming out next month which will be talking you through the best ways to learn
from failure and mistakes, a topic everyone talks about. We'll be talking you through
an approach that's used by scientists. But until then, if you like this video please
do leave a thumbs up. I also always love to hear which parts you enjoyed most or which
parts you found most useful, so please leave a comment letting me know that. Subscribe
for more videos and check out the description box for all our social media links and a link
to join our free Inner Circle. It's been an absolute pleasure talking to you,
take care and have a great day. Bye-bye.