The Hour Between Dog and Wolf: How Risk Taking Transforms Us, Body and Mind

by John Coates

A couple of points follow from this discussion of intuition and hunches and our data on the Sharpe Ratio. First, there does appear to be such a thing as trading skill. The financial markets seem to meet Kahneman and Klein’s criteria for an environment in which intuitions can be trusted. It is not surprising therefore that discussions between traders frequently compare the current market to something they have traded through before—“This credit crisis feels just like the Russian default in ’98. I bet the yen rallies.” Most of a trader’s dialogue, however, remains internal and preconscious, a good trader listening attentively to whispers from the past. Second, the question that often crops up in discussions of intuition—which is more reliable, intuition or conscious rationality?—is something of a red herring. We inevitably use both. If we tried to use nothing but conscious rationality, tried to emulate Spock, we would find ourselves uncontrollably thrown back for most of our decisions on fast, online thinking. The question of whether the resulting decisions are trustworthy is not one that can be answered once and for all—“Yes, always trust your hunches,” or “No, work out a decision tree.” Its answer will depend on your training. We should not be asking if we should trust our intuitions; we should be asking how we can train ourselves to possess a skill that can be relied on.