3/02/2010

New traders and cognitive load


You have  a cognitive load problem if: 

  1. you feel overwhelmed by the trading process
  2. you are struggling to set up scans or tabs in Telechart. You do not know how others do the scans so fast.
  3. you can not find information like eps, sales, sector rank etc which others can find in a snap
  4. you feel most methods are too complicated when you try to make them work
  5. you feel everyone is running at 100 miles per hour and you are just trying to catch up
  6. you don't know where to start
  7. you do not understand things like how to set stops, how to use your brokers scanner, how to calculate position size and so on
  8. you don't know how you will have time to do analysis while juggling your girlfriend/boyfriend, kids, jobs and so on

Most traders give up on most methods before they can even overcome their problem of cognitive load. So you have traders flirting from one style to another style, from one scan to another scan, from one site to another site, from one guru to another guru and so on. Soon they give up on trading or become cynics and start believing that everyone is out to get their money. 

If you are one of those person your problem is cognitive load. 

Each task involved in trading or the tools to be used in trading involve a learning curve. A series of proficiencies needs to be built before you can attempt trading. For those who have been trading for a long period of time most of those task are routine task. They do not understand why beginners struggle with those simple things. But for beginners the problems are big from where they are starting.

Couple of weeks ago I spent few hours helping someone set up scans on Telechart and explaining how to use the software to scan on daily basis. For someone who has used the software for years the questions and the issues the person was struggling with are small potatoes, but for that person his or her progress gets stalled over such small issues. 

Supposing you were a beginner trader and read say William O'Neil's book and decided to trade CANSLIM method, you are going to struggle at first. Why because you have limited short term memory and you have to try and remember hundreds of things  to make the method work. Unless you have perseverance to persist and learn and master the intricacies involved in the method ou will give up at some stage. In most cases you would blame the method for failure. 

This is also one of the reason there is so much market for simplistic systems which may or may not work but appeal to those facing cognitive load. So you have systems like go long when green triangle shows up and go short when red triangle goes up, or many other variations of the basic idea being sold in the market. They create an illusion that trading is simple.

The thing about most profitable trading ideas is that they are simple but not easy. Growth investing is a simple idea but to make it work is not easy. Similarly value investing as a concept is simple but to make it work is not easy. Same is true of momentum or swing trading or day trading. 

The problem can be solved if you understand the cognitive load theory. 

The "cognitive load theory" was proposed by John Sweller, an Australian psychologist from the University of New South Wales. Cognitive load theory basic premise is that humans have limited short term memory but unlimited long term memory. 

Because short term memory is limited it puts constrain on our ability to do tasks requiring multiple steps and multiple sources of information. This poses a fundamental constraint on human performance and learning capacity. So you need strategies to decrease cognitive load.

What strategies are used to decrease cognitive load. The most useful strategy to decrease cognitive load is practice. Overlearning is another very useful strategy to overcome cognitive load. Watching others do a task and then trying to replicate the task is another strategy for decreasing cognitive load.

Couple of weeks ago I wrote a detailed post on cognitive load theory and how it can be used to learn skills and especially skills involving implicit memory. After that a member wrote back:

I enjoyed your post on repetitive learning - as a beach Lifeguard - we train a lot - different scenarios- different equipment etc - we actually do way more training than actual rescues - so it becomes

 second nature - and we actually look forward to a rescue - to test/prove our skills.

From a email sent by a member. 

Why are lifeguards over trained. 
To reduce cognitive load.
How would you like it if the guard started referring to a manual when someone is sinking. 

Exactly the same principle is used when training  marines or soldiers. Those of you who have been through such training would understand how it is done. The first thing you learn on first day is "repetition". Every task involved is done over and over again. Marines spend time mastering their weapons. The process is repeated so many times that it becomes part of their implicit memory. They can assemble their weapons in a flash. They can find things they need for actual combat in a flash. Progressively more difficult tasks are taught. The entire principle behind training marines is based on overcoming cognitive load when they are in actual fight. They are over trained.  


The "cognitive load theory" was proposed by John Sweller, an Australian psychologist from the University of New South Wales. Cognitive load theory basic premise is that humans have limited short term memory but unlimited long term memory. 

Because short term memory is limited it puts constrain on our ability to do tasks requiring multiple steps and multiple sources of information. This poses a fundamental constraint on human performance and learning capacity. So you need strategies to decrease cognitive load.

You know what is involved in trading say Episodic Pivots or Top 25 breakouts, or CANSLIM, or growth investing or value investing or trend following or many other methods. Then why cannot you make those things work for you. 

Because you are looking at it as a series of steps to be done. So you are spending lot of cognitive energy on concentrating on remembering the rules. When we try to do a task in which we are not expert we become task conscious and try and do it  step wise. Our cognitive process get loaded and as a result we can not efficiently do the task. We get overwhelmed, confused, frustrated and dejected. 

When we engage in a purposeful expertise building phase what happens is instead of knowledge being in short term memory it gets transferred to long term memory. When knowledge is stored in long term memory, it is stored as chunks or schemas (or information networks) and not as individual units. So the entire process of finding and trading Episodic Pivot (EP) gets stored as schema and not as series of steps. As a result when you look at possible EP in the morning in few seconds you can make a buy or not to buy decision. 

Schemas, no matter how large or how complex, are treated as a single entity in the working memory.  When this happens you will be able to recall the entire schema in one go while making a decision on EP. You will not be conscious of steps involved. You will perform the process  without having a cognitive overload. 

At some stage of expertise building such schemas become automated. This  mechanism helps us overcome the limits of working memory by drawing on our long-term memories, which are very detailed and powerful.  

So if you want to become an expert at trading you have to build such schemas and gain automaticity. When that happens you will process information 

in chunks and not as separate units. 

Building automaticity is the key to trading any method be it EP or CANSLIM, or momentum, or any other method. Many traders do not survive long 

enough to reach that stage. They get wiped out before that or give up. 

People with high self efficacy beliefs persist  in face of such setbacks and that is why they gain expertise in trading. That is the reason the perceived self efficacy beliefs is such critical to becoming successful trader or to succeed in life in general. 

Next: Why setup selection is key to decreasing cognitive load





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