One of the common struggles in new and experienced traders is outlined in this excerpt from James O’Shaughnessy:

We also prefer the complex and artificial to the simple and unadorned. We are certain that investment success requires an incredibly complex ability to judge a host of variables correctly and then act upon that knowledge. Professor Alex Bavelas designed a fascinating experiment in which two subjects, Smith and Jones, face individual projection screens. They cannot see or communicate with each other. They’re told that the purpose of the experiment is to learn to recognize the difference between healthy and sick cells.

They must learn to distinguish between the two using trial and error. In front of each are two buttons marked Healthy and Sick, along with two signal lights marked Right and Wrong. Every time a slide is projected they guess if it’s healthy or sick by pressing the button so marked. After they guess, their signal light will flash Right or Wrong, informing them if they have guessed correctly. Here’s the hitch. Smith gets true feedback. If he’s correct, his light flashes Right; if he’s wrong, it flashes Wrong. Since he’s getting true feedback, Smith soon gets around 80 percent correct, since it’s a matter of simple discrimination. Jones’s situation is entirely different. He doesn’t get true feedback on his guesses. Rather, the feedback he gets is based on Smith’s guesses!

It doesn’t matter if he’s right or wrong about a particular slide, he’s told he’s right if Smith guessed right and wrong if Smith guessed wrong. Of course, Jones doesn’t know this. He’s been told there is a true order that he can discover from the feedback. He ends up searching for order when there is no way to find it. The moderator then asks Smith and Jones to discuss the rules they use for judging healthy and sick cells. Smith, who got true feedback, offers rules that are simple, concrete, and to the point. Jones, on the other hand, uses rules that are, out of necessity, subtle, complex, and highly adorned. After all, he had to base his opinions on contradictory guesses and hunches.

The amazing thing is that Smith doesn’t think Jones’s explanations are absurd, crazy, or unnecessarily complicated. He’s impressed by the brilliance of Jones’s method and feels inferior and vulnerable because of the pedestrian simplicity of his own rules. The more complicated and ornate Jones’s explanations, the more likely they are to convince Smith. Before the next test with new slides, the two are asked to guess who will do better than the first time around. All Joneses and most Smiths say that Jones will. In fact, Jones shows no improvement at all. Smith, on the other hand, does significantly worse than he did the first time around, since he’s now making guesses on the basis of the complicated rules he learned from Jones.

Process Is Key

A young boy traveled across Japan to the school of a famous martial artist. When he arrived at the dojo he was given an audience by the sensei:

“What do you want from me?”, the master asked.
“I wish to be your student and become the finest karateka in the land,” the boy replied. “How long must I study?”
“Ten years at least,” the master answered.
“What if I studied twice as hard as all your other students?”
“Twenty years,” replied the master.
“Twenty years! What if I practice day and night with all my effort?”
“Thirty years,” was the master’s reply.
“How is it that each time I say I will work harder, you tell me that it will take longer?”, the boy asked.
“The answer is clear. When one eye is fixed upon your destination, there is only one eye left with which to find the way.”

What the Bavelas Experiment Reveals About Trading Systems

The Bavelas experiment is the most direct available demonstration of why complex market analysis produces worse trading outcomes than simple rules. Smith’s 80% accuracy with true feedback comes from simple, concrete rules. Jones’s elaborate theoretical framework comes from random noise. The critical moment is what happens next: Smith, exposed to Jones’s complex framework, adopts it and performs worse. The complexity did not improve Jones’s performance. It degraded Smith’s.

Financial markets are full of Jones-equivalent analysts. Portfolio managers who have been exposed to false feedback throughout their careers because the feedback they received, market prices, reflected many participants’ actions rather than their own analytical quality, have built elaborate frameworks to explain their results. The frameworks feel profound because they were developed by intelligent people in response to genuine uncertainty. But the uncertainty they were built to explain was genuine randomness, not genuine signal. The frameworks explain noise. Adopting them makes Smith worse.

The Smith equivalent in trading is the systematic trend follower. The feedback is direct: price either moved in the direction of the signal or it did not. The rule that fires when price exceeds the 20-week high gets unambiguous feedback on its output. Over thousands of iterations, that feedback produces a simple, concrete rule set calibrated to what the data actually shows. The simplicity is not a sign of shallow thinking. It is the result of having access to true feedback over a large enough sample to identify what actually works.

The sensei story addresses the other direction of the same error. The boy wants to maximize effort toward the destination. The sensei’s answer is that fixing one eye on the destination leaves only one eye to find the way. In trading, the equivalent is the trader who focuses so intensely on producing profits that they lose the attention required to execute the process correctly. Process is the way. Profits are the destination. Fixing attention on the destination while executing the process is the two-eyed approach. Fixing attention on the destination while sacrificing process attention is the one-eyed approach the sensei describes.

Systematic trend following resolves both problems simultaneously. The rules are simple because they were built from true feedback over large samples. The process is the entire focus of daily trading because the destination, profits, is defined to occur at whatever time the system produces it, not at a calendar-driven target. The trader who follows the rules correctly is doing everything that can be done. The profits arrive when the markets produce the trends. The effort goes into the process, not into staring at the destination.

Frequently Asked Questions

What does the Bavelas experiment prove about complex trading systems?

That complexity arising from false or noisy feedback produces elaborate frameworks that feel profound but perform no better than random, and that exposing traders with sound simple rules to complex frameworks degrades their performance. Jones’s complex rules were built from noise and could not improve because they had no signal to optimize. Smith’s simple rules were built from true feedback and performed well until contaminated by Jones’s complexity. The experiment demonstrates that simplicity from genuine feedback outperforms complexity from noisy feedback.

How does the martial arts parable apply to trading?

By illustrating that fixing attention on the destination leaves insufficient attention for the process that produces the destination. The trader who is focused on making money today, this week, or this quarter is using one eye for the destination and one for the process. The trader who focuses entirely on executing the process correctly trusts that profits will follow over the statistical distribution the system produces. Process focus is the two-eyed approach. Destination focus is the one-eyed approach that slows progress.

Why do traders prefer complex systems despite simple systems performing better?

Because complexity signals effort and sophistication. The Jones-equivalent’s elaborate framework appears more rigorous than Smith’s simple rules, and most observers, including Smith himself, interpret the appearance of rigor as evidence of quality. This social and psychological dynamic causes competent practitioners to abandon their accurate simple frameworks and adopt impressive complex ones, producing worse outcomes. Systematic trend following’s resistance to this pressure is one of its structural advantages: the simplicity is a feature, not a limitation.

Trend Following Systems
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