The backfire effect - One more reason for systematic investing

Every discretionary trader faces a challenge when he trades with any conviction. The interesting question is what happens when the trader is presented with new facts. The whole idea of trading with conviction is showing confidence in an idea that will allow you to risk sizable money. A correct conviction is what generates above average returns. However, conviction can go overboard if you are not willing to hear about new facts or alternative arguments. The best traders are ones that can change their minds when presented with new fact. Unfortunately, psychologies have found something called the backfire effect. 

The premise most work under is that when beliefs are challenged with facts, your opinions will be altered. In reality, when deep convictions are challenged by contradictory evidence, our beliefs actually get stronger. Most protect what is in their collection of beliefs. Over time, you become less skeptical of your beliefs. Perhaps Yogi Berra said it right, "Don't confuse me with the facts."

We know this effect to be true from our experience. Many don't want advice supported with facts. Researchers have found that this bias may be stronger the more knowledgeable someone is about a subject. Experts are less sensitive with changing your views. Trying to correct someone with evidence does not work. If you give both side of an argument, the opposing facts, even when true, are dismissed. This tells us much lot about human nature and also why there is failure with investing. Investors will hang onto their losers because alternative facts may only cause intransigence. You will hang onto those ideas until the pain of lose overwhelms. 

So what can you do to avoid this problem? Obviously, a stop loss will help. There is a point where you will cut your loses regardless of your views. You impose stopping behavior upon yourself. Of course, you have to execute when the stop is reached and not change your mind.

The broader issue is learning to follow a disciplined approach open to new facts. One of the great advantages with systematic trading is that as new information is received and updated, it will not be dismissed or discounted. It will be used in the exact way it was programmed. There is no backfire effect because there is no dismissing of new facts. Another good reason for systematic trading.