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Nobel prize winning author Daniel Kahneman in his book “Thinking, Fast and Slow” Chapter 21 “Intuition vs. Formulas” warns us against relying on feelings and experts judgements. He has given several examples that simple formulas have outperformed predictions by experts.
- Simple formula based on average temperature, rain in harvest year and the total rainfall in previous winter, did better than Bordeaux wines experts to predict future prices of these wines.
- Formula based on high school grades and one aptitude test was found to be more accurate in predicting student’s future grades than the trained counselors who interviewed students for more than 45 minutes.
- Every day thousands are babies are being saved by APGAR test that comprises of a standardized formula to confirm which babies need immediate medical intervention after birth. The APGAR test is still used every day in every delivery room.
The following statements are from the book “Thinking, Fast and Slow”.
- Experts try to be clever, think outside the box, and consider complex combinations of features in making their predictions. Complexity may work in the odd case, but more often than not it reduces validity.
- Simple combinations of features are better. Several studies have shown that human decision makers are inferior to a prediction formula even when they are given the score suggested by the formula!
- They feel that they can overrule the formula because they have additional information about the case, but they are wrong more often than not.
- Another reason for the inferiority of expert judgment is that humans are incorrigibly inconsistent in making summary judgments of complex information. When asked to evaluate the same information twice, they frequently give different
- Given the same input, formulas always return the same answer. When predictability is poor, inconsistency is destructive of any predictive validity.
- Statistical algorithms greatly outdo humans in noisy environments for two reasons: they are more likely than human judges to detect weakly valid cues and much more likely to maintain a modest level of accuracy by using such cues consistently.
Market experts explain the past with ease using historical information. These make us believe that market movements are predictable. But this is an illusion created by media. Every day both bullish and bearish information is available to market expert. If market moves up, he uses bullish information explain the rise. If market moves down, he uses bearish information or events to explain the market fall.
Trading system do not analyze the past market movement. They uses simple formulas (algorithms) to make daily trading decisions. They do not predict future prices as stock experts do. It is a reactive system that uses formulas based on few market parameters. Hence over long run, it tends outperforms even the market experts. We teach trading systems that can be used in Indian markets. Join our share market course in Mumbai to become top trader.