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The Alchemy of Decision
Anguel Grigorov
I. Introduction
The conventional economictheory goes to a great length in preaching that
people are rational when makingtheir decisions, be it an investment or a
divorce. Yet many economists and decision-making theory scientists do
notsubscribe one hundred percent to this paradigm. They claim that while
most people <i style='mso-bidi-font-style:normal'<strive to be rational
decision-makers, they are still subject tomany psychological limitations and
traps that may distract them from theirgoal. Some scientists claim that
thesepsychological traps are a manifestation of millions of years of
evolutionduring which the mankind had developed herd instincts in order to
survive. It is essential to notice that the influenceof these common biases
increases when uncertainty is present in the decisionsituation.
In thisarticle we will list a number of common psychological
biases that werediscussed in a recent book by three Harvard professors.

II. The Biases

1. TheAnchoring Trap-in considering a decision, the mind gives a
disproportionatelylarge weight to the <i style='mso-bidi-font-style:normal'<
first informationit receives-anchoring effect. Anchors can take many
forms-statistical results,biased wording of the decision problem, past
events, trend availability, etc.
2. The Status Quo Trap-most decision makers display a strong biastoward
alternatives that perpetuate the current situation.
3. TheSunk-Cost Trap-Past decisions prey on our psyche.
4. TheConfirming Evidence Trap-We seek only information that supports our
point ofview while avoiding information that contradicts it. In a word one
sees whatshe wants to see.
5. TheFraming Trap-The way you ask a question can profoundly influence
the answer youget. If you ask whether you can smokewhile praying, the answer
is likely to be emphatic No. But if you ask whether you can pray
whilesmoking, you may get Yes.
6. TheOverconfidence Trap-On average people tend to set too narrow
confidence levelsfor an uncertain event.
7. TheRecallability Trap-One focuses on barely probable but dramatic
events.
8. TheBase-Rate Trap-One tends to neglect relevant information by
referring to somestereotype (on average) image. Example: Mr. Jones is either
librarian or a salesman. He is also retiring. Whatis he? Most people would
answerlibrarian, although in the US salesmen outnumber male librarians by 100
to 1.
9. The Prudence Trap-You assign larger (than what is
reasonable)probability to an uncertain event. Basically you account for
uncertainty by being overly prudent andplaying conservatively.
10. TheOutguessing Randomness Trap-You see patterns where purely random
phenomenaexist.
11. TheGoing-Mystical-About-Coincidences Trap-If someone wins twice 1 in
1,000,000lottery, this does not necessarily mean that there is not randomness.
III. Improving Our Judgment
The above are only someof a number of bad jokes our brain can play to us. I
believe that once we are aware that our mind is not perfect,the most sensible
thing to do is to accept this. Mind traps can be systematically studied,
quantified and used toconstantly improve our judgment. Here I will throw
some ideas of how this canbe done.
To begin with, we maytry to quantify our susceptibility to each of the known
traps. Of course there is no objective way to dothis, but in my view this
doesn't mean that such an exercise is a futileone. For example prior to
making adecision we may try to assign ourselves a score from 1 to 5 on our
perceptionof the influence of the anchoring trap on our decision. We can do
this with every otherpsychological trap.
Then we will wait and recordthe result from our decision. Say ifthe result
turned out to be as we had hoped to, we would put 1, and otherwise0. This
exercise should be done for anumber of decision situations (say 100 trading
decisions). At some point of time we will be in asituation in which we will
have quantitative information on our biases at thepoint of making a decision
and the results on our decision. There are mathematical techniques
(saylogistic regression, neural networks, etc.) that can help us combine the
differentpieces of <i style='mso-bidi-font-style:normal'<a priori information
into asingle index that is associated to the largest possible extent with
thebeneficial final result. We can alsoextract the probability of having a
beneficial result given some set of initialperceptions. At the very least we
willbe able to put some weights on our pre-decision perceptions.
IV. Conclusion
The main idea of thisarticle is that one's brain is susceptible to a variety
of psychologicalbiases. This is a fact of life andshould be understood and
studied. Psychologists have already discovered a number of such biases. If
we subscribe under the statement thattrading is not only a mechanical
manipulation of statistical data, but alsojudgment, insight and human
psychology, we may want to use and benefit fromsuch information.
The never-ending questfor designing an objective score based on publicly
available information thattells us how the market will behave in the future
may be quite doomed. Indeed, the publicly available informationrepresents
either historical data or the average public opinion about thefuture. There
should be some correctivefactor between public opinion and reality. In my
view this factor can be our judgment. Judgment can be understood, cuddled,
educated and developed.
A crucial moment in anyjudgment improving effort will be the seriousness and
sincerity in quantifyingthe pre-decision perceptions. This maybe controlled
(to a certain extent) by creating a system of well-designed questionnairesto
the decision makers.

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