THINKING FAST AND SLOW

If you missed this interview with Daniel Kahneman on Charlie Rose I would highly recommend having a listen here.   Kahneman is the Nobel Prize winning author of “Thinking Fast and Slow”.  I also highly recommend the book.  In the book Kahneman describes how human beings are designed to think fast and slow.  That is, we operate with two sets of systems.

System one is more intuitive.  It allows us to make rapid and efficient decisions without having to waste time or analyze our surroundings excessively.  It’s why we can perform multiple simple tasks or “zone out” while driving without veering into a ditch.  This is where the survival instincts of our brain reside and it is what I believe leads to most investing mistakes.

System 2 on the other hand, is a deliberative system.  It is our slow system where we carefully analyze and rationalize our actions.  I like to think of the slow system as stepping outside of our minds and viewing system 1’s responses from an unbiased and objective perspective.  System 2 can catch the errors that system 1 makes and ultimately generate optimal decision making.  In trading and investing system 1 will generally revert to our survival instincts and your emotions will often lead you to make irrational decisions.  I build system 2 into my investment approach by creating system 2 in an algorithm.  My analytical side builds the system and then the system is litetrally run by an external mechanism.  You might of it as putting your system 2 on autopilot….

Anyhow, it’s a good talk.  Kahneman says traders can’t really use system 2 to help their investing approach, but I clearly disagree.  Have a listen here.

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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  • Greg

    Just finished the book myself on my trip to India. Loved it.

    I think Kahneman makes that statement about traders because, as he says in his book, system 2 is lazy. Most people will not do the hard work, additionally some of the things they might put hard work into are not those things which remove system 1s biases.

    So I think he’s right in aggregate but certainly there are those (you possibly/probably) that can use system 2 to help their investing approach.

  • Cy Hailow

    Thanks Cullen,

    this is a most interesting interview with apps way beyond mere investing.

  • http://www.pragcap.com Cullen Roche

    Agreed Greg. The problem with creating a system 2 that helps your investment approach is that you have to create a system 2 to help your investment approach! :-)

  • http://breedinginstability.com Mountaineer

    Kahneman’s work is brilliant. Few people have done more to deconstruct homo economicus than him and Tversky.

    Anyone who enjoys this kind of thing and is interested in having a kind of pseudo reference guide for the most well-researched cognitive biases should consider downloading this:

    http://www.scribd.com/doc/30548590/Cognitive-Biases-A-Visual-Study-Guide

  • johnb

    Thanks Mountaineer for posting it.. BTW I spent 15 minutes trying to find it on my old blog. Havent seen the interview, but I read recently maybe 5 articles about DK. Im gonna to read the book ASAP

  • B Ferro

    Does system 2 work in a run-away bull market though?

    In effect, when the majority of market participants are employing a “system 1″ mechanism, does your “system 2″ mechanism still work?

    I’m surprised you aren’t working for Ren-Tech given the apparently divinity of your algo in calling big market turns…

  • http://www.pragcap.com Cullen Roche

    Divinity is a bit much. And no, it isn’t designed to chase crowds. That was the point of the system. To avoid the crowds. Running with crowds is a great way to run off cliffs in this business….

  • http://www.pragcap.com Cullen Roche

    Yeah, thanks Mteer. Good stuff.

  • http://breedinginstability.com Mountaineer

    No problem.

  • Kobayachi

    Thank you so much! Mountainer, great stuff.

  • freemarketeer

    Have yet to read the book, but I read about similar book 6 years ago that referred to “online” and “offline” thinking. I have yet to figure out the tangible difference that makes this book a best seller now vs the other I can’t even find online.

  • BJM

    B Ferro – you still buying these 18-point dips?