Systematic Relative Strength

If your teenage sends you a text with “TMI” in it, you’ve overshared. Unfortunately for investors, the financial markets overshare all the time. The flow of information can be so intense that your brain literally becomes overloaded. Between earnings releases, corporate news, talking heads on CNBC with gongs, sirens, airhorns, or a dramatic opinion about everything, it’s no wonder you are overwhelmed. No one can effectively process so much information.

Source: www.audiobooksonline.com

A Newsweek article on the science of decision making explains:

As the information load increased, she [Angelika Dimoka, director of the Center for Neural Decision Making at Temple University] found, so did activity in the dorsolateral prefrontal cortex, a region behind the forehead that is responsible for decision making and control of emotions. But as the researchers gave the bidders more and more information, activity in the dorsolateral PFC suddenly fell off, as if a circuit breaker had popped. “The bidders reach cognitive and information overload,” says Dimoka. They start making stupid mistakes and bad choices because the brain region responsible for smart decision making has essentially left the premises. For the same reason, their frustration and anxiety soar: the brain’s emotion regions—previously held in check by the dorsolateral PFC—run as wild as toddlers on a sugar high. The two effects build on one another. “With too much information, ” says Dimoka, “people’s decisions make less and less sense.”

That’s kind of scary—when you get information overload, your brain leaves the building and your emotions take over. It’s a double whammy because the two effects reinforce one another. It doesn’t matter how smart you are—the information overload is a neural reaction, not a decision that you make.

Source: www.tshirts.name

It’s well documented that emotional financial decisions are bad financial decisions. While gut feelings are often useful in a social context, they are lethal in the market.

The implications are obvious. 1) Shut off the ridiculous information flow. More information does not result in better decisions. Focus on the information relevant to your return factor, like relative strength or valuation. 2) Stay calm. In fact, cutting down the information flow will help you stay calm. The less distractions you have, the more likely you are to have a Zen-like focus on what really matters. Finally, you need to 3) systematically execute your investment process. All of your testing is worthless if you cannot execute transactions with conviction at the point of decision.

The nice thing about a systematic process (like our Systematic Relative Strength accounts) is that the process can be designed and tested without any psychological pressure. We find there is great peace of mind designing a process that adapts—when the environment changes, we don’t worry about the model breaking. We know it will be out of synch for a while at the turns, but then it will adapt to the new trends. Knowing that it will adapt makes it substantially easier to execute, I think. The whole goal is not to get emotions involved when you are interacting with the markets.