The Impact of Explosive and Gradual Change – Its Effect on You and Everything Else

Gerald Ashley: Two Speed World

Gerald Ashley, author of 2 Speed World and Financial Speculation, talks to Kenny of www.tradersdaytrading.com. Gerald is an advisor, a writer and a speaker on business risk and decision making. Gerald has over thirty years of experience in international finance, having once worked for Baring Brothers in London and in Hong Kong, as well as for the Bank for International Settlements in Basel, Switzerland

Kenny: Hello Gerald and welcome to Tradersdaytrading.com…. Your two books Financial Speculation and more recently Two Speed World cover a topic that is of great interest to me, and I believe that most traders would benefit from gaining a better understanding of the psyche of the markets and how we ourselves tend to react in certain circumstances.

Gerald: Thank you ? Firstly Financial Speculation will be on much more familiar territory to your readers as I try to give an insider?s view of markets having been in them for over 30 years.

Kenny: What do you believe that readers can learn from reading Two Speed World?

Gerald: The latest effort, Two Speed World opens up the wider issue of how we make decisions and deal with risks and uncertainties and what are the best approaches. This is not just about markets but business, innovation, running organisations etc. As such it?s a business book rather than just focussed on markets

Kenny: As I am talking with you, it has been an extremely turbulent couple of weeks in the markets with the Dow Jones Industrial Average losing nearly 2000 points, the S&P500 250 points, and the Ftse100, 1000 points or so…..some very large moves in a very short space of time, is this a classic example of a 2 speed world ‘disruptive’ event?

Gerald: Yes ? In general, the financial markets do demonstrate the two modes of ?incremental? change & ?disruptive? change. This is clear to anyone who trades them, we look at this in Two Speed World though there is much more research to be done. Readers need to start focusing on Complexity Theory and Complex Adaptive Systems….these ideas demonstrate how markets and general social groups can suddenly ?flip? from one mode to the other. It?s the future of finance and trading and very fascinating.

Kenny: What I see time and time again in these large moves is many traders trying to buck the trend by trading against it, is this because they have failed to adapt quickly enough to the changing circumstances?

Gerald: Yes the old phrase ?The Market is Wrong!? In general traders suffer from confirmation bias, i.e. they only believe the facts that suit their view, this can be a quick way to lose a lot of money. Successful traders listen to the market

Kenny: Is it possible for us to train ourselves to adapt more quickly to rapidly changing circumstances?

Gerald: There is a tension between racing around for the sake of it and being able to change your views and positions when the facts change. This is a skill not easily obtained ? experience and knowledge are vital. The less emotional you are the better trader you will become ? don?t see trading as ?exciting? (it isn?t) and have realistically low aims (a consistent 10-15% annual return would be an excellent record)

Kenny: What is the single one thing that we can do to learn to adapt our mindset more quickly to cope with the new circumstances?

Gerald: Be less opinionated about the markets, listen to what the market is telling you and stop trying to tell the market what it should be doing! In fact having virtually no opinion can be a strong plus in trading ? but staggeringly hard to do!

Kenny: Financial markets are always going to be volatile at times, we as traders are looking for certainty in an environment where certainty is impossible, what can we do to cope better with this lack of certainty where a mistake can become extremely costly?

Gerald: It is the human condition to want certainty ?in fact we crave certainty. (Maslow?s hygiene factors explain this well) We are gripped by those that promise certainty and can ?predict? the future. But we must learn to ?let go? and accept that its the uncertainty that generates the profit potential.

Kenny: It is my experience that Fear and Greed are the main drivers of market movements, where markets ‘climb a wall of worry’ and go down the ‘Slope of hope’….what is your version of this?

Gerald: Very similar but in fact I label the emotions slightly differently, I think markets climb a Wall of Fear (when all fear has gone and only sublime confidence is left we are normally very close to a market crash) and you are right we slide down the slope of hope (only when all hope is extinguished does a market turn)

Kenny: It is commonly recognised that the ‘majority’ sell at market bottoms and buy at market tops, the exact opposite of what they should be doing, why do you think this is, what causes us to do this?

Gerald: Traders are very influenced by noise, screaming headlines etc. Keynes (himself a very successful speculator) identified that the successful investor is good at anticipating what everyone else is going to anticipate! Most investors fail to think through this process and end up following the initial herd rather than the underlying prospects for the marketplace. I would say they are not listening properly to the market.

Kenny: Are there patterns to this behaviour and if so what creates these cycles?

Gerald: Yes ? essentially these were examined at least a century ago and still hold good. As Jesse Livermore said Wall Street never changes because human nature never changes. I cover much of this in Financial Speculation

Kenny: Are any of these cycles more important than others?

Gerald: I think the Business Cycle can be tied to the major asset classes, it?s not perfect but the same overall patterns repeat time after time. The trouble is they are often of long duration, sometimes 10 years plus, and the collective market memory is far shorter. Also the credit Cycle is particularly persistent, dare one say predictable?

Kenny: How reliable are these cycles in the financial markets?

Gerald: Reasonably, they are better suited to long term asset allocation than the usual trading horizons though.

Kenny: How do we cope when it goes wrong and the market action does not conform to the current cycle?

Gerald: Badly ? because we are wrong and most players rather be right than necessarily make money. Cycles ?fail? usually when we over optimise them, try to make ludicrous pin point decisions and lose patience.

Kenny: Is there a difference between Risk management and money management, or are they effectively different terms for the same thing?

Gerald: They are essentially the same thing, and the hardest part of the business. I always say trading is 10% direction, 20% timing and 70% money management. In fact in Financial Speculation I recall how used to trade by tossing a coin AND then managing the resultant position!

Kenny: How important is risk management to a trader and what can happen if we don’t understand risk management properly?

Gerald: It?s pretty much the only thing that counts. It?s often fairly easy to call the direction, and it?s possible to be average or lucky with timing ? but money management is a brutal discipline that takes years to master.

Kenny: So why is it that some traders are more successful than others, what qualities make the difference between being successful or not?

Gerald: Successful traders have three qualities, patience, realistic expectations and a ruthless ability to admit when they are wrong and to take action. They are not attached to positions or ideas and can cut losses very easily.

Kenny: Can we learn to become a successful person or is it something that we either have or do not have within us?

Gerald: Yes ? BUT it is extremely hard. It takes hard work, dedication and discipline to develop the skills I mentioned above.

Kenny: Is there a formula that we can use to become successful, a systematic process for analyzing problems to come to the right decision?

Gerald: Possibly but I sense that it is different for each individual. You have to understand a lot about yourself before you can successfully trade. We all see problems through a personal prism, that is why it is so hard to create a ?formula? for successful trading. Each individual will have a different approach.

Kenny: Gerald, coming back to current markets, how have we managed to get ourselves into such an economic mess?

Gerald: Overspending politicians, myopic Central Bankers financing too much debt with cheap money and misguided regulators. The ?No more boom & bust? culture was fatuous. Now we are paying for it.

Kenny: So who is to blame for the situation that we find ourselves in now with the banks and the massive government debts?

Gerald: All of the above ? and ourselves. We borrowed too much, indulged in fantasy economics of ?equity release? from housing etc. Basically we spent more than we earned.

Kenny: Is it true that the constant warnings about the impending debt crisis was a self fulfilling prophecy, created by putting people off from spending, or was it already a runaway train that could not be stopped?

Gerald: No ? It was already fulfilled because anyone who chose to look could see the calamity coming. Many people warned about the situation for years ? but no one listens when the party is in full swing!

Kenny: What is your opinion of how the worlds governments have coped the crisis, have they successfully saved us from something much worse, have they made the situation worse, or are they simply passengers on that runaway train?

Gerald: They found themselves in a hellish position in 2007/08 as things started to spiral. They had to prevent a depression, but the cost of supporting economies through that period will be a sideways grind in growth (or lack of it) for possibly a decade

Kenny: What are the main mistakes that they have made and why were the mistakes made?

Gerald: Failure to correct the massive global economic imbalances ? these will be sorted out, but the longer it takes the more painful it will be.

Kenny: Markets have taken quite a beating over the last couple of weeks, is the worlds economies now in a terminal spiral or can it still be saved?

Gerald: Things always recover the problem is it takes time ? I think Mervyn King of the Bank of England is completely correct in predicting a ?lost decade?. It is clear that a lot of the wealth generated n the ?noughties? was flimsy debt fuelled spending, not real wealth. Now the debts are being repaid and we will shrink back to a poorer reality. This will have long-term effects.

Kenny: What is does the future now hold for the major currencies such as the USD and the Euro, can they be taken back from the brink?

Gerald: Currencies are just a price ? They will go up and down in free markets. To my mind the US Dollar is not ?finished? though clearly the US are trying to devalue as much as possible to boost their own economy. The trouble is everyone else wants a weak currency as well. The Euro is a busted flush ? It will break up as it?s simply not credible ? it was a harebrained scheme from day one,that was always going to be tested to destruction in any prolonged economic downturn.

Kenny: What steps do we need to see taken from here to rescue us all from the current economic disaster?

Gerald: I should like to quote Cicero from 55BC! ?The budget should be balanced, the Treasury should be refilled, public debt should be reduced, the arrogance of officialdom should be tempered and controlled, and the assistance to foreign lands should be curtailed lest Rome become bankrupt. People must again learn to work, instead of living on public assistance.”

Kenny: Clearly, nothing changes then! So the big question is, are our governments up to the task in hand?

Gerald: Doubtful ? politicians have short term horizons determined by the electoral cycle, this means they often blunder around with short term initiatives that can make things worse!

Kenny: Thanks Gerald.