The psychological barriers (Hurst)

Who this entry is for — "Your techniques can be mastered to perfection and you can still get into trouble." The reasons are psychological, and the most important single thing you can do to overcome them is one: recognize that they exist. Here are all six, with the book's antidotes.

Source: J. M. Hurst, The Profit Magic of Stock Transaction Timing, Prentice-Hall, 1970 — Chapter 10, §§ Recognizing Psychological Barriers → In a Nutshell (pp. 160–167).

Prerequisites

The method (Ch. 1–8) and, for the deeper why, the X motivation: whatever moves the masses of investors moves you too.

The map

Chapter 10's six barriers — each with its watchword.

Tap the six tiles

1 · The outside influence

In plain words — The broker's phone call, the Barron's article, the earnings item in the paper: anything that plants doubt and stops you acting when price is telling you what it will do next. Barrier number one, especially for anyone who has just switched methods.

The book tells it with two stories. In the first, you have just set up scan, stable and analysis — and the phone rings: the broker strongly recommends XYZ, an acquisition target, "now at 21, prospects 32". Last time he tipped you, you made a thousand dollars in three days; your self-confidence drains, and the waiting funds go into XYZ. Whether you win or lose is irrelevant: you have reverted to the old method — the one that demonstrably delivers mediocre results.

"You can only expect a system based on probabilities to develop the expected degree of success if it is followed with utter consistency! It requires remarkably little deviation from consistency to radically affect the odds."

The ABC story (the lost 30%) — This time you have sworn to follow only your own analysis. ABC breaks its downtrend: the non-real-time envelope shows a low two points higher than the old trend would allow, every other construct confirms, and the signal is worth 30% in a week and a half. You call to buy — but the Dow is up 25 points in six days, and your broker, in good faith, advises waiting "for the market to take a breather". You waver and pass. What neither of you noticed: ABC had been falling during exactly those six up days — its short components were slightly out of sync, and ABC's last leg had started two weeks before the index turned, soaring 20% under cover of a down market. "Defeated by the psychological impact of respected outside influences." That is the true meaning of the Wall Street line: "this is a market of stocks, not a stock market."

The antidotes, in order: remember that in the paper tests the method worked without your knowing the date or the stock's name; unlimited analytical practice ("you simply cannot apply these methods on paper too often"), keeping meticulous records and "leaning over backward not to cheat"; tell your friends you do not want to hear investment news; pre-make your decision about how you will react when the influence sneaks in anyway; and if you succumb at first, follow the trade both ways and record the results — then look at how it would all have worked out had you resisted.

2 · Greed

In plain words — The "almosts": everything says buy, except some confusion on the 13-week cycle. And finding better candidates would cost days of work. The book's rule comes in capitals: don't trade on the issue where confusion is present.

You can work diligently three and a half weeks without trading at all, discarding prospect after prospect, before finding the situation that leaves no doubt — and it is perfectly possible for that single trade to capture 10% in half a week. The callback is to Ch. 1's arithmetic: starting with $10,000, just one 10% trade per month compounds to over $1,000,000 in something like four years. Trade all the "almosts" that come along instead, and some losers are guaranteed — and "each time you lose you will diminish self-confidence".

The same applies to sales: ride your profits only as long as there is no doubt about what the techniques are telling you. "If doubt occurs — take your profit, and be content." The barrier bites hardest when the discarded "almosts" go right ahead and do what you expected: the temptation to jump on the next one grows fierce. The trait at fault has one name, greed — "and greed can defeat you just as effectively in the market as if you attempt to trade without system".

3 · The persimmon effect

In plain words — The ideal time to buy a stock is exactly when it looks the least interesting. And the ideal time to sell short is when it looks as though it will never stop going up.

The stock is in your stable, you wait for the signal: the price keeps dropping, the daily range dries up along with volume. Your cyclic analysis expected exactly this — but it certainly looks as though all investor interest has vanished, and convincing yourself to act when the signal arrives is very hard indeed. Hence the analogy that names the barrier: with persimmons, the sweet fruit are the ones that look nearly rotten — and the penalty for biting the smooth, firm, desirable-looking fruit is severe.

And a precious operational detail: "quite often when the cyclic situation is ripe, a full day's trading all at one price and on vanishing volume will signal in advance a buy signal the very next day".

4 · Time distortion

In plain words — On a chart, months of prices are perceived in seconds; in the stock, time crawls. The objectivity you enjoy over all the past vanishes exactly where you need it: on the datum being added today.

It is the problem of every technical approach: charts work because they compress time — and that very compression is what deceives. The book's analogy is film: frame by frame, all fluidity and even the reality of motion cease to exist; at normal speed, it all comes alive. With charts the situation is reversed: the past runs at projection speed, but real life adds data frame by frame.

The fan experiment — Take a series of past Mansfield chart issues, clip the weekly DJIA chart from each front page, staple them in chronological order along the left edge — and fan them before your eyes like shuffling a deck of cards, concentrating on the 18–20 week cycle. You will know in advance what motion is coming: the charts come to life with cyclic motion. And at the last sheet, you will retain a strong impression of what comes next.

The training: analyse issues on charts from the past, then add one datum at a time (daily or weekly) and repeat the analysis, striving to give each new point its full weight within the whole fabric. Better still in real time: carry a set of fully analysed issues along day by day before you start to trade. "It is truly difficult to over-emphasize the importance of this barrier to your success."

5 · The scale effect

In plain words — The data are unique; the chart is not. The same time-price pairs, drawn to different scales, tell different stories — to the point that you and a friend might not believe you are looking at the same stock.

The choice of scale factors can suppress or exaggerate what you are looking for. The book's guidelines:

#	Rule
1	Daily charts for components of 1 to 13 weeks
2	Weekly charts from 13 weeks to 9 months
3	Monthly charts from 9 months up
4	Scales such that the motion of interest forms a nearly square chart
5	To damp short components: less space for price, same time scale
6	To damp long ones: more space for price, same time scale
7	A pattern (say, a triangle) seems insignificant? Enlarge both scales
8	Attention riveted on phenomena you know are insignificant? Reduce both

In chart services the problem reverses: space and time span are fixed, so the volatile issue comes out compressed and the sluggish one expanded (with undue emphasis on short fluctuations). It is the very fact Ch. 7 exploits in reverse, reading the Mansfield scale as a volatility gauge. For analysis you replot anyway; for scanning and selection, train yourself to negate the scale change from chart to chart.

6 · Emotional cyclicality

In plain words — Real or not, assuming your market mood swings cyclically "does no harm" — and helps beat the persimmon effect. Because the mood that makes money is the exact opposite of the natural one.

The reasoning closes Ch. 9's circle: decisions are effects demanding causes; without sufficient facts, emotion decides; and if masses of investors produce cyclic motion in unison, "it becomes a fair assumption that the emotional attitudes of masses of investors vary in a cyclic manner — and that cyclicality in stock prices is nothing more than a reflection of this".

However the theory stands, one fact is certain: "people in general do not get more and more in the mood to buy stocks as prices go down. Conversely, the mood to sell does not strike harder as prices rise. Yet the exact opposite of this mood is absolutely mandatory if we are to buy low and sell high." The recipe: behave as though something cyclically swings your emotional outlook, and consciously combat those assumed forces — you will find yourself "in a frame of mind to sell into rising markets and buy into falling markets". Alone it guarantees nothing; "combined with a workable timing theory it can work wonders".

Summary card

Card — "In a Nutshell" (p. 167)

Nothing is perfect: analysis can fail for three technical causes — and TLLs protect in most cases.
The most important antidote to the psychological barriers is awareness of their existence.
Outside influences, however well meant, upset the system's statistical balance.
Greed is fought with knowledge of profit compounding: you don't need much per trade.
A stock seldom looks interesting at the ideal time to buy; it usually looks too good to be true when it's time to sell.
There is a psychological effect of chart time versus real time; and chart scale factors matter.
You must train yourself emotionally to sell into rising markets and buy into falling ones.