​5 Skills Traders can Learn from Superforecasters

January 22, 2017 16:00

forecasting.png

Dear Traders,

All of us enjoy making forecasts to some degree. For instance, have you ever seen a sport match and said "I bet that person will miss"? If you have, this means you were trying to forecast a particular sequence of actions.

As a matter of fact, humans make a wide range of forecasts on a daily basis, from the expected weather to the morning traffic outlook. Nenad and I also make long-term forecasts at the start of each new trading year but our main focus is on trading itself and short- to medium-term analysis.

The main question is, can traders learn from talented forecasters? Let's dive right into it and see 5 most important lessons for becoming a better forecaster.

Is it possible to trade better when forecasting?

Forex and CFD traders do make short-term forecasts when they trade, which are often based on news events, technical analysis and wave analysis. And they are willing to take financial risk based on that forecast (enter and exit trade setups). Many forecasters shy away from such clear numbers and evaluations.

Probably, this is partly due to human fear because forecasters tend to receive negative attention when strong forecasts turn sour and end up inaccurate. However, having that said, the quality of the forecasting topics and forecasters is deep and broad.

Philip E. Tetlock and Dan Gardner took the challenge head-on and built a forecasting project to learn who and why some people were better equipped in forecasting. They revealed their findings in the book "Superforecasting: The Art and Science of Prediction".(*) Certainly a recommended read.

There are 10 specific skills which helped people improve their forecasting skills and made a few of them extraordinary superforecasters

This article reviews 5 skills which could help you, the trader, take your trading to the next level. Other than that, I'll try not spoil the findings from the book but, to sum up its results, all of us can improve our forecasting skills and results.

Skill 1: Look for clashing causal forces in each problem

A good skill to possess as a forecaster is to recognise the counter argument(s) of each problem before asserting the prediction. This helps forecasters reconfigure their opinion and formulate a nuanced view of future developments.

Lesson for traders:

Traders should critically review filters and double check their analysis, especially if the trade idea is spontaneously created. Ignoring contrary information and hoping for the best will not help in the long run. A better approach is to weigh the pros and cons before making a decision.

In case of any doubt, a good rule of thumb is to simply move on. However, once a decision is made, it is time for more action and less thinking (this particular phase can have a time limit too).

Skill 2: Strike right balance between inside and outside views

Forecasters improved their skill set if they were able to combine their own views and the views of the general public. Superforecasters often searched for comparisons with similar events in an attempt to comprehend the 'outside' view.

Lesson for traders:

There are a couple of items that traders can implement with this in mind:

  1. improve your pattern recognition skills, which allows for easier comparisons
  2. use our technical and wave analysis for comparison's sake
  3. check the trading sentiment tool.

market sentiment 2.png

Skill 3: Strike the right balance between under- and overconfidence, between prudence and decisiveness

Forecasters were much better with their predictions when they managed to balance their confidence. Traders will most likely recognise this warning from our regular weekly webinars.

Lesson for traders:

Traders need to keep their mental focus on staying confident without falling into the trap of arrogance or overconfidence. Handling both winning and losing streaks has its own share of hurdles and barriers.

A practical way of dealing with the ups and downs of an account is to:

  1. use clear risk management rules
  2. keep track of a trade journal.

Skill 4: Strike the right balance between under- and overreacting to evidence

Good performing forecasters were much better at gradually adjusting their opinion based on small bits of new evidence. They did not emotionally overreact to developing information and carefully weighed their options.

On the flip side, they did continuously update their forecasts, often by precise numbers and sometimes even drastically changing course when needed.

Lesson for traders:

Proactive trade management has more flexibility and more precision than set and forget strategies. Traders, however, must avoid emotional responses when managing those trades.

The biggest problems occur when traders do not cut their losses quickly enough (underreacting) or cut their trades too quickly (over reacting). The video below provides more information of finding the right balance.

Skill 5: Look for errors behind your mistakes but beware of rearview-mirror hindsight biases

Most forecasters retroactively view their forecasting in a much more positive light than reality proves - this is called hindsight bias.

The forecasters who performed best also learned best. Their focus was on avoiding this bias and improving their skills with each feedback cycle.

Lesson for traders:

Traders often justify their trading decisions after the fact (hindsight bias). It is an easy trap to fall into: "of course, I knew price was going to move up but I missed the trade". Taking a trading decision requires guts, but owning the decision for better or worse is even harder.

Shifting the blame to the markets, social media or your phone is easily done. The best forecasters and traders, however, learn decisively from each and every setup, win or loss, and mistake. Why? Because they confront their errors, search for answers, and avoid the hindsight bias.

Final thoughts

These are just a few tips that helped improve the forecasting of forecasters. Traders can also use these key pointers to improve their trading skills.

Do you think these forecasting lessons can help your trading? Let us know in the comment section below!

Also, feel free to visit Admiral Markets for more live analysis, webinars and software.

Cheers and safe trading,

Chris

MT4 Supreme Edition + Volatility Protection

(*) Superforecasting the Art and Science of Prediction by Philip E Tetlock and Dan Gardner, Crown Pusblishers, New York, 2015.