Trading on illusions

CreditViolet · #1 29th September 2007, 01:20 AM

Quote:

In this paper, we contribute to the debate about whether positive illusions are adaptive by showing that a particular positive illusion, illusion of control, may be maladaptive in a particular context: trading in financial instruments.

In the first half of the paper, we review the literature on positive illusions and control illusions. We argue that there is both a theoretical and empirical case that positive illusions, and illusion of control in particular, may be maladaptive in some circumstances. Next, we offer arguments and evidence that illusion of control may be treated as having a trait-like component and hence that individual differences in propensity to illusion of control may be meaningfully measured. Finally, we describe key aspects of the trader's task and environment and argue that these are particularly conducive to control illusions. Hence, we hypothesize that traders with high levels of propensity to illusion of control will perform less well than those with low to moderate levels.

In the second half of the paper, we report on a study of 107 traders in four investment banks in the City of London and demonstrate an inverse relationship between illusions of control and trader performance.

Is high perceived control adaptive or maladaptive?

Support within the literature can be found for both these positions. On the one hand, research on self-efficacy (Bandura, 1989), internal/external locus of control, and learned helplessness (Rodin & Salovey, 1989; Thompson, 1981) shows that high perceived (internal) control predicts increased personal effectiveness and psychosocial adjustment. On the other hand, several authors have pointed out the adverse consequences of high perceived control in circumstances where control is not possible (Burger, 1989; Thompson, 1993; Thompson, Cheek, & Graham, 1988; Whyte, Saks, & Hook, 1997).

Wannon (1990) and Zuckerman, Knee, Kieffer, Rawsthorne, and Bruce (1996) have drawn an important distinction between realistic and unrealistic control beliefs. Realistic control beliefs concern circumstances where control is objectively possible. Unrealistic control beliefs concern illusory perceptions of control in circumstances where control is not objectively possible. Several studies have demonstrated discriminant validity for these two dimensions of perceived control (Knee, Zuckerman, & Kieffer, unpublished; Wannon, 1990; Zuckerman et al., 1996).

An important distinction between control strategies is whether they involve primary or secondary control (Rothbaum, Weisz, & Snyder, 1982). Primary control involves attempts to control the external environment, whereas secondary control involves attempts to adapt psychologically to the external environment. This suggests that while high realistic control beliefs may be adaptive, high unrealistic control beliefs will lead individuals to persist in primary control strategies when secondary control strategies would be more adaptive.

However, some, most notably Taylor and Brown (1988), have argued that positive illusions are adaptive, as they increase motivation and persistence. This position is supported by Bandura's claim that:

optimistic self-appraisals of capability, that are not unduly disparate from what is possible, can be advantageous, whereas veridical judgments can be self-limiting. (Bandura, 1989, p. 1177)

However, we should note here Bandura's use of the qualification "not unduly disparate from what is possible". His argument is essentially concerned with the adaptive effect of optimistic beliefs about control and performance in circumstances where control is possible, rather than perceived control in circumstances where outcomes are genuinely noncontingent on an individual's behaviour. Bandura has also suggested that:

In activities where the margins of error are narrow and missteps can produce costly or injurious consequences, personal well-being is best served by highly accurate efficacy appraisal. (1997, p. 71)

There is also empirical evidence that high self-efficacy can be maladaptive in some circumstances. In a scenario-based study, Whyte et al. (1997) showed that participants in whom they had induced high self-efficacy were significantly more likely to escalate commitment to a failing course of action.

Taylor and Brown (1988) argue that positive illusions are adaptive, since there is evidence that they are more common in normally mentally healthy individuals than in depressed individuals. However, Pacini, Muir, and Epstein (1998) have shown that this may be because depressed people overcompensate for a tendency toward maladaptive intuitive processing by exercising excessive rational control in trivial situations, and note that the difference with nondepressed people disappears in more consequential circumstances. Knee and Zuckerman (1998) have challenged the definition of mental health used by Taylor and Brown and argue that a lack of illusions is associated with a nondefensive personality oriented towards growth and learning and with low ego involvement in outcomes. They present evidence that self-determined individuals are less prone to these illusions.

We argue, as do Gollwittzer and Kinney (1989), that while illusory beliefs about control may promote goal-striving, they are not conducive to sound decision-making. Illusions of control may cause insensitivity to feedback, impede learning, and predispose toward greater objective risk-taking (since subjective risk will be reduced by illusion of control).

Illusion of control

The predominant paradigm in research on unrealistic perceived control has been Langer's (1975) `illusion of control'. Langer showed that people often behave as if chance events are accessible to personal control. In a series of experiments, Langer demonstrated first the prevalence of the illusion of control and second that people were more likely to behave as if they could exercise control in a chance situation where `skill cues' were present. By skill cues, Langer meant properties of the situation more normally associated with the exercise of skill, in particular the exercise of choice, competition, familiarity with the stimulus, and involvement in decisions.

Trait-like or state-like?

Most work on the illusion of control has focused on contextual variables that induce illusion of control in a population. In this study, we seek to understand control beliefs within an individual difference framework. This section sets out our rationale for doing so. There is some precedent for an individual difference approach: for example, one study found that individual differences in illusion of control predicted individual and team differences in risk perception and behaviour in a scenario exercise. Higher illusion of control being associated with lower risk perception and greater risk-taking (Houghton, Simon, Aquino, & Goldberg, 2000).

Taylor and Amour have argued against taking an individual differences approach to such illusions. They argue that positive illusions are state-like not trait-like. They reason:

It is possible to create circumstances ... in which upwards of 94% of respondents demonstrate positive illusions. It is also possible to create circumstances in which almost no one demonstrates positive illusions (Taylor & Armor, 1996, p. 890).

We suggest that their argument is flawed and leads them to an erroneous conclusion. Both personality traits and situations that govern behaviour may vary in `strength'. As Mischel (1968) pointed out, each can override the other according to their relative strengths. Personality is most determining of behaviour in `weak' situations, and vice versa. That the influence of a trait on behaviour can...

http://goliath.ecnext.com/coms2/summ...99-2771857_ITM

franktrader · #2 29th September 2007, 05:30 AM

Excellent post - CV

"as usual"

( can some one post a link to the complete article

)

oilman5 · #3 29th September 2007, 06:34 AM

dear cv, thanks for coming back & putting a bang on practical trading as usual way
btw...+ive illusion has its role to play.so far over confidence....not act as bug........its good.
a totally mechanical trader......can put right....also under controlled supervison equity curve shows better return.
yes...highly perceived control improves......performance of an individual
....other things r pure subjective and debatable...........on case to case basis study has only some validity........otherwise sample itself skewed...........NO GENERALISATION POSSIBLE.
[u as a programmer know.....why among them it has some predictive characteristic in crude sense......however......as a successful daytrader like urself......model is not applicable for protrader.....as individual subjective illusion plays havoc in free environment]
adaptive variable model......not applicable for a country like india
hope u dont mind for this synopsis

oilman5 · #4 29th September 2007, 07:31 AM

those who like to read regarding india
.................................................. .
http://www.uticm.com/Cmc/PastCMC_2002.asp
.................................................. .
none of them i feel useful as a trader........but may help to improve horizon /job hopping

kuriako · #5 29th September 2007, 09:40 AM

"Just got back with some loot???"

Was missing ur comments and chat sessions! Plz...Plz come to chat room once in a while...Plz continue the usual Saturday massacres and friendly chat... Really missing it!!!

Atleast as everybody did the Y! mark on top is for the usual ***** messenger... or PM that wonderful id...PLZZZZZZZZZZZZZ....

BTW going thru John J Murphy for the second time!!!

With jelly brain!!!
Kuriako

uasish · #6 29th September 2007, 10:00 AM

Awaken with a slap.

This is what i learnt from Jesse's article:=

In activities where the margins of error are narrow and missteps can produce costly or injurious consequences, personal well-being
is best served by highly accurate efficacy appraisal.

a lack of illusions is associated with a nondefensive personality oriented towards growth and learning and with low ego involvement in
outcomes. They present evidence that self-determined individuals are less prone to these illusions.

that while illusory beliefs about control may promote goal-striving, they are not conducive to sound decision-making. Illusions of
control may cause insensitivity to feedback, impede learning, and predispose toward greater objective risk-taking (since subjective
risk will be reduced by illusion of control).

Personality is most determining of behaviour in `weak' situations, and vice versa.

visagar · #7 29th September 2007, 02:40 PM

A man in a hot air balloon realised he was lost. He reduced his altitude and saw a man below.

"Excuse me, but can you help me?I promised a friend I would meet him an hour ago but I don't know where Iam," he said.

The man below replied:"You are in hot air balloon hovering approximately 30 feet above the ground.You are between 40 and 41 degrees North latitude and between 56 andd 57 degrees longitude" To which the balloonist replied:"You must be a broker." To which the man on the ground said:"Iam, but how did you know?"

The reply came from above:"Everything you told me is technically correct but I have no idea what to make of your information, and the fact is, I am still lost.Frankly , you have not been much help so far."

The man below responded:"You must be a trader." To which the balloonist replied:"Yes , I am, but how did you know?"

To which the man on ground said:"You don't know where you are or where you are going, You have risen to your current position due to a large quantity of hot air.You made a promise which you have no idea how to keep and you expect me to solve your problem. The fact is , you are in exactly the same position you were in before we met ,but now somehow, it is my fault."

uasish · #8 29th September 2007, 07:26 PM

Quote:

Originally Posted by visagar

A man in a hot air balloon realised he was lost. He reduced his altitude and saw a man below.

"Excuse me, but can you help me?I promised a friend I would meet him an hour ago but I don't know where Iam," he said.

The man below replied:"You are in hot air balloon hovering approximately 30 feet above the ground.You are between 40 and 41 degrees North latitude and between 56 andd 57 degrees longitude" To which the balloonist replied:"You must be a broker." To which the man on the ground said:"Iam, but how did you know?"

The reply came from above:"Everything you told me is technically correct but I have no idea what to make of your information, and the fact is, I am still lost.Frankly , you have not been much help so far."

The man below responded:"You must be a trader." To which the balloonist replied:"Yes , I am, but how did you know?"

To which the man on ground said:"You don't know where you are or where you are going, You have risen to your current position due to a large quantity of hot air.You made a promise which you have no idea how to keep and you expect me to solve your problem. The fact is , you are in exactly the same position you were in before we met ,but now somehow, it is my fault."

Nice one.

CreditViolet · #9 30th September 2007, 06:39 PM

Quote:

Originally Posted by oilman5

dear cv, thanks for coming back & putting a bang on practical trading as usual way
btw...+ive illusion has its role to play.so far over confidence....not act as bug........its good.
a totally mechanical trader......can put right....also under controlled supervison equity curve shows better return.
yes...highly perceived control improves......performance of an individual
....other things r pure subjective and debatable...........on case to case basis study has only some validity........otherwise sample itself skewed...........NO GENERALISATION POSSIBLE.
[u as a programmer know.....why among them it has some predictive characteristic in crude sense......however......as a successful daytrader like urself......model is not applicable for protrader.....as individual subjective illusion plays havoc in free environment]
adaptive variable model......not applicable for a country like india
hope u dont mind for this synopsis

Thanks oilman for the comments

CreditViolet · #10 30th September 2007, 06:43 PM

Quote:

Originally Posted by kuriako

"Just got back with some loot???"

Was missing ur comments and chat sessions! Plz...Plz come to chat room once in a while...Plz continue the usual Saturday massacres and friendly chat... Really missing it!!!

Atleast as everybody did the Y! mark on top is for the usual ***** messenger... or PM that wonderful id...PLZZZZZZZZZZZZZ....

BTW going thru John J Murphy for the second time!!!

With jelly brain!!!
Kuriako

Hello Kuriako

Too much on my plate right now to be a regular here these days. And yes the Y! mark above works, I am not a regular at ***** as well though.Looking forward to see you there

And continue reading Murphy till you are sick of it

Cheers