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  • Matrix Insights A Moment of Epiphany and Simple Connectedness

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Article

DR

A New Take On Risk — Why We Do What We Do

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“Reality is the leading cause of stress amongst those in touch with it.” ― Jane Wagner, Author

There are a slew of subjects that are at the top of my interest list which include the study of risk management,  useful ideas for trading, some philosophy, and strangely enough — neuroscience.

That last topic is a bit unusual for me given my general interests.  I have enjoyed reading books accessible to the general public (e.g.  Mozart and the Fighter Pilot) that provide insights into how the brain works. My interest in neuroscience has really increased this summer because my son has been shadowing a neurologist and comes home day after day with interesting insights about the brain and nervous system.  He had recently added neuroscience as a double major in his premed program.

So I was delighted when I stumbled upon an opinion article in the New York Times’ Sunday Review entitled “The Biology of Risk.”  It was written by Cambridge research fellow John Coates who was a trader at Goldman Sachs and Deutsche Bank.  He sheds light on the neuroscience behind traders’ risk-taking behavior revealed by some very interesting tests that have been conducted on traders. (If you want to read the article, I’ll warn that the first 2/3 is mesmerizing but the last third gets bogged down into Fed-speak and macro thoughts on bubbles and monetary policy.)

Insights Into Risk Behavior — It’s Not Just an Intellectual Activity

Humans do not handle risk purely through cold, rational information processing; rather, there are emotional and somatic, or bodily, responses that we often fail to take into account when faced with the uncertain or unknown.  In order to become better at managing risk while trading, it’s a helpful edge for traders to understand the way that the human brain and body react to uncertainty and fear.

This reaction begins with what is termed the stress response—although this can be a bit misleading, conjuring up images of that one coworker or friend who is always “stressed-out.”  In medical terms, stress is merely a response to a stimulus, the body’s way of dealing with a challenge, rather than distress, the feeling of being upset and overwhelmed.  The stress response is intended to prepare the body to handle any stimuli that may crop up; the brain is constantly filtering new signals and information and anticipating how to react.  Therefore, as Coates points out, a term with fewer negative connotations would be the challenge response.

As you may imagine, a familiarity with the challenge response provides some explanations for the behavioral and physical responses that accompany risk-taking—for example, heightened risk aversion during periods of uncertainty.  As part of the challenge response, the body releases the hormone cortisol.  During Coates’s research on the neuroscience of trading, he found that traders’ cortisol levels increased pretty dramatically as volatility rose.  Specifically, during an eight day period of increased volatility, a group of 17 traders showed a 68% increase in cortisol levels.

In a subsequent study, researchers pharmacologically raised the cortisol levels to similar levels in test subjects over an eight day period.  This test group showed a 44% decrease in willingness to take risks on a gambling simulation. 

Coats makes this keen observation:

Most models in economics and finance assume that risk preferences are a stable trait, much like your height. But this assumption, as our studies suggest, is misleading. Humans are designed with shifting risk preferences. They are an integral part of our response to stress, or challenge.

During periods when uncertainty (and therefore risk) is perceived as low, dopamine, the “pleasure neurotransmitter” mixes with testosterone in a way that increases our risk-taking behavior.  On the other hand, when we are unsure of the future, our subconscious signals that we may be in over our heads and shuts off our desire to indulge in risk.  One can observe this in the fearful behavior during a financial crisis when traders should be taking risks in order to take advantage of abundant opportunities, but are often too frightened by recent events to do so.

Vital Takeaways

Your psychological risk appetite fluctuates depending on circumstances — it does not stay at some fixed level in your personality.  The dynamic nature of risk appetite explains why economic models that insist on “equilibrium” just don’t work to explain market behavior.  Our risk appetite does not remain static and so the assumption of rational thought at extremes is usually far off the mark.

Understanding that we have real neurological reasons for avoiding risk in times of uncertainty and embracing it in times of complacency helps us see in real terms the underpinnings of one of Warren Buffets rules: Be fearful when others are greedy and be greedy when others are fearful.

As always, your thoughts and comments are always welcome — please send them to drbarton “at” vantharp.com

Great Trading,
D. R.

About the Author: A passion for the systematic approach to the markets and lifelong love of teaching and learning have propelled D.R. Barton, Jr. to the top of the investment and trading arena. He is a regularly featured guest on both Report on Business TV, and WTOP News Radio in Washington, D.C., and has been a guest on Bloomberg Radio. His articles have appeared on SmartMoney.com and Financial Advisor magazine. You may contact D.R. at "drbarton" at "vantharp.com".

Disclaimer


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Trading Tipflorian

GOLD & SILVER

Update 24th of June 2014

chart1

chart2

chart3

Arguments for lower prices:

  • 3-year downtrend: Overall Gold still is in a downtrend. US$1,525.00 remains the line in the sand. Gold will need much more time to break through this heavy resistance. Only a move above US$1,390.00 and especially US$1,430.00 will indicate that the mid and longer-term trend indeed has changed.
  • Gold Monthly Chart: MACD sell signal active since November 2011 (this is extremely powerful and needs to change before one can really call the bottom). It looks like MACD could create a buy signal within the next 1-2 months. RSI still below 50 and in bear market territory.
  • Gold Weekly Chart: Gold moving sideways and into a triangle. No bullish indication yet. The chart remains basically neutral.
  • Gold Daily Chart: Gold for the 3rd day outside Bollinger Bands and RSI already overbought.

Arguments for higher prices:

  • Short Squeeze: After a nasty shakeout and mini crash end of May, Gold found support at the long-term uptrend line around US$1,240.20. Since then, Gold did not only recover towards the 50-MA (US$1,285.25) and the 200-MA (US$1,288.92) but posted an explosive US$45.00 gain on last Thursday due to heavy short covering.
  • Higher Low: The uptrend since the beginning of the year is still valid. The correction since March did not reach a new low below last December´s US$1,180.00, instead Gold turned higher from US$1,240.20. This is extremely positive because we now have a series of higher lows. The market will soon want to figure out if the lower high at US$1,395.00 (from March) is still valid.
  • Gold Monthly log-Chart: Long-term trend-line has held recent test at US$1,240.20. Any move below US$1,240.00 — US$1,250.00 is highly unlikely and would mean the end of this bull market!
  • Gold Weekly Chart: Since May 2013 Gold is moving sideways between US$1,180.00 and US$1,434.00. The current triangle still offers more upside potential for the bulls. Maximum would be the upper Bollinger Band (US$1,264.96) where we can find the downtrend line of the triangle. Also parabolic SAR has issued first buy signal since mid of March. RSI neutral while Slow Stochastic oversold and with a new buy signal.
  • Gold Daily Chart: Yesterday Gold has closed for the third day outside its Bollinger Band (US$1,314.76). Bulls are clearly in charge and could push prices higher. But five to six days in a row above the Bollinger Band is the absolute maximum and the move will become very unsustainable. So expect this Wednesday (Gold option expiration) or latest Friday the start of larger consolidation/correction targeting at least the 200-MA (US$1,288.92).
  • Gold Daily Chart: Slow Stochastic with both signal lines above 80 = embedded Status and therefore locking in the uptrend.
  • Gold/Silver Ratio: Down from 67.46 to 63.01. Silver clearly outperforming Gold since end of April. Double top around 67.40 confirmed but uptrend not yet broken. Short-term, the ratio is clearly oversold and could snap back soon.
  • Gold-Stocks: Clearly leading the sector now. HUI Goldbugs Index is up around 18.3% in the last 3 weeks! Slow Stochastic is embedded, strengthening the uptrend. 
  • Sentiment: Kitco´s weekly Gold survey shows over 69% bulls for next week. There is still some more room to the upside until extreme sentiment but already current readings a sign to become careful and defensive soon.
  • Inflation: As I have argued a couple of times since January I continue to expect higher inflation rates due to rising commodity prices in the second half of the year. Oil prices for example neared nine-month highs late last week. The oil price risks due to the rapid advance of militants in Iraq will put inflation back in focus. Iraq is the second-largest OPEC producer and could destabilize oil markets.
  • Seasonality: Best time of the year starts in July and should typically last until next spring. After 3 years with heavy corrections in autumn I think this year we could see a sustainable rally into December.

Conclusion:

  • Last month, my assumption for a breakout of the triangle to the upside was wrong. Shortly after publishing my analysis, Gold broke down from a triangle and fell 6 days in a row down to US$1,240.20 (Lesson learned: No matter what, every year before the June low we will see a sell off first!!). 
  • After 2 days of bottom building Gold has strongly pushed higher since then. 
  • But in my eyes the recent big up day on last Thursday is a bull trap. There is still potential for the bulls to push prices higher either towards US$1,335.00 or even up to US$1,355.00-US$1,365.00 until end of this week.
  • First week in July, I think Gold will start a correction down to 200-MA (US$1,289.16) and later maybe even lower to test the long-term trend-line on the logarithmic monthly chart one more time.
  • This should give us the final opportunity to buy Gold below US$1,300.00 (probably around US$1,270.00) in the first week of august. From there I expect a volatile but sustainable rally towards US$1,525.00 until November.
  • Swing traders could start selling Gold short between US$1,355.00 and US$1,365.00 with a first target at US$1,295.00. 
  • Investors with a long-term perspective need to be patient now and should continue to accumulate physical Gold below US$1,300.00 and physical Silver below US$20.50. 

Long-term:

  • Nothing has changed
  • Precious Metals bull market continues and is moving step by step closer to the final parabolic phase (could start in summer 2014 & last for 2-3 years or even longer).
  • Price target Dow Jones/Gold Ratio ca. 1:1
  • Price target Gold/Silver Ratio ca. 10:1
  • Fundamentally, Gold should soon start the final 3rd phase of this long term bull market. 1st stage saw the miners closing their hedge books, the 2nd stage continuously presented us with news about institutions and central banks buying or repatriating gold. The evolving 3rd and finally parabolic stage will end in the distribution to small inexperienced new investors who will be subject to blind greed and frenzied panic.

 

Click here to see Florian's report in it's original format.

 

About the Author: Florian Grummes (born 1975 in Munich) has been studying and trading the gold market since 2003. In addition to his trading business, he is a very creative and successful composer, songwriter and music producer.


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Matrix Insights

A Moment of EpiphanyMatrix

"Trading Beyond the Matrix" is a wonderful book that made me think about things that had been buried inside me for decades. I've had a strong interest in trading and have been active in the markets for about 15 years with varying levels of success. This included periods during which I stayed clear of the markets altogether because of strong emotional associations from past experiences. However, during the past year I've been trading once again with mixed results. This time, I did create a business plan and a strategy, although I know now (after reading this book) that they are inadequate and need much work. Needless to say, I've stopped trading for now since I started reading your book.

Every book I've read about trading in the past has taught me something useful. These lessons have always (until now) focused on one goal, i.e. to help the reader figure out a way to become a better trader. Naturally, I was expecting the same from "Trading Beyond the Matrix", but it seems to have somehow crossed that threshold, and has done so in a powerful way. I can best describe it as a moment of epiphany, and here is why. I grew up in a religious society where a well defined relationship with God was prescribed. Although religion wasn't consciously drilled into me, it was all around me on a daily basis because it is a way of life where I come from. As I approached adulthood I questioned religion and everything about it, eventually deciding it was not for me. Even still, I've had an inherent affinity toward spirituality. I've lived with this belief (hence my reality) for over a decade, wondering if I was somehow being hypocritical. As I read your book, I learned that others have had similar beliefs and found paths that work well for them. Quite suddenly I realized that I needed to find a Oneness Blessing giver near me and I did, and let me tell you it was a heart warming experience.

I am thankful to you for exploring spirituality so extensively in this book because it has given me the insight that becoming an awakened being by reconnecting with my spiritual Self and living in the present, is precisely what I've been wanting for over 15 years. As I make progress on this life journey, successful trading will simply be a by-product of this larger endeavor. Thank you for rekindling what I didn't know was buried inside.

Gratefully,
Tarun

----------------------------------------------------------------------------------

Simple Connectedness

My key insight from Trading Beyond the Matrix is: I can’t do it all on my own, I’ve never even needed to, in fact, it’s impossible!   Your personal story, and those of your super traders, convinced me we all have constant inner guidance directing each of us to the outcomes we desire. 

Although I already had an inkling this was the case, I failed to truly believe it; essentially because I was not seeing outcomes that matched any of my desires. Encouraged by the personal stories, I challenged some of my own beliefs and realized I too could tap into this guidance. It gave me clarity to see that wayward outcomes are not because of a lack of guidance, but in fact driven by concealed beliefs that need addressing. Not only did your book uncover this for me, it clearly set out simple techniques to address it. I now see all the little requests for guidance that I was continually making are, in fact, being answered:  answers I had been overlooking because they seemed too simple.

As a recent example of this simplicity, I’ve been keen to try forex trading again.  I had already bought and read several books on forex trading, but none of the methodologies fit with my lifestyle: I don’t want to spend hours staring at the screen waiting for a set up. Anyway, a couple of weeks ago I had a meeting in town.  Before leaving, I diligently wrote in my journal as I do most mornings.  In my jottings that morning, I let off steam about not being able to work out a short term forex system that would fit around my day.  I went off to my meeting only to realize I had mixed the dates up, it had been held a day earlier and I’d missed it.  I was furious with myself. So, rather than waste my bus trip into town, I decided to visit the city library. 

I browsed the shelves and read some magazines off the rack. Then, as a last minute thought before leaving, I decided to check the trading section for any interesting books.  Sure enough, the first book I picked up was excellent book on forex trend trading. It set out eight very simple trend trade set ups including where to set stops and targets—exactly what I had been looking for!  I browsed a few more books but none compared to this first one.

I have since been paper trading the techniques described in the book, and found them to fit very well with my lifestyle. Producing profits forex trading is a separate issue, which at this stage, I’m not even sure I’m capable of.  So, I’ll continue to paper trade while I address this belief, all the while knowing I was guided to the information, giving me the confidence to persevere.

As simple as this example is, the underlying principle has unlocked a powerful connectedness, replacing the helplessness of feeling merely buffeted by the winds of random chance. I am extremely grateful that you had the courage to write this book.  You dared to put your mainstream reputation on the line, and it has allowed me to accept inner guidance as real, and not just some sort of hippy, dippy out there idea.  I also felt encouraged to start A Course in Miracles, which has served well to reinforce this principle.

The clear impact of all this is: I am no longer trading on my own as my confidence in my inner guidance grows deeper.  Your book taught me to ask for guidance for each step of the journey, and acknowledge and reflect on the outcome. The impact has spread into my everyday life as I notice more and more requests answered. 

I am aware this only the beginning, and diligent practice is required if I am to break permanently free of the matrix holding me to the most limiting belief of all: that I am on my own.

Kindest regards,

Sharyn P.

 

Editor's Note: These letters were sent to us in response to a contest we have been running in which we asked to hear about the one most profound insight that you got from reading Van's new book, Trading Beyond the Matrix, and how it has impacted your life. In the next few weeks, we will pick our favorite submissions and ask you to vote on them. The winner will receive a free workshop! Stay tuned for more information on this phase of the contest. If you haven't purchased Trading Beyond the Matrix yet, you can do so here.


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