Framing

Framing is a term used in both psychology and communications theory and leads to other terms such as cognitive bias. This is a useful subject to study as framing was a problem of mine when I first became a trader. One of my main faults as a trader in oil and index futures was the inability to stop looking at the prices. A sudden reversal in the price would have me making the opposing trade to close out for a loss. Minutes later the price would correct and continue trending as I had expected it to when I put the first trade in.

I have corrected this fault of mine through automated trading. All I have to do is come up with back-tested trading rules and leave my bots to do the work of placing the trades. With this hands-off approach there is no chance of my risk aversity from making a mess of things. In the case of commodities trading I had set up rules to trade on moving averages that looked at prices every so often. By permitting myself to look at prices between the time frame of the moving average I was disobeying the trading rule. There is a lot of noise in time series data and allowing that noise to hide a trend will destroy any winning trading rule.

Another use of the term framing is in the framing of a gamble. For example, if I say, "You will lose £50 if you call heads but you might win £100 if you call tails" then that may have those who are risk averse declining the bet. The thought of losing overrides the positive expectation of the gamble. If we analyse the gamble we see that the expectation is indeed positive.

Expected Value = (pWin * sWin) - (pLose * sLose)

where p is the probability and s is the sum to be won.

In our example above the expected value is

(0.5 * 100) - (0.5*50) = 50 - 25 = £25

In the time frame of 1 toss of the coin you might worry about losing £50 but over the time frame of 100 tosses you might expect to win in the region of £2500. This is an example of cognitive bias caused by irrational thought.

People who manually trade tick data can quite easily get caught by the framing effect. A sudden news item can spook a market one way or another and there will be a major price change before the market settles down. Doing this repeatedly will make a winning trading rule turn into a losing one.

Moving averages or other such sampling algorithms can smooth out the noise and generate manageable frames to trade upon. For those with third party Betfair trading software, slowing the rate of price updates down from say 1 second to 5 seconds (or slower) can make a difference. Now, all that is required is a successful strategy to trade with.

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2 comments:

  1. you would be better off hiring someone to manually trade the set rules at a certain profitability level, getting a bot to place bets leaves a lot of edge on the table imo

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    Replies
    1. My bots see exactly what a manual trader would.

      If I hired a manual trader I would leave a lot of edge in his pocket.

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