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The Stock Market as a Beauty Contest

“The stock market is the type of beauty contest  in which you choose the girl that most others will find most beautiful, not the girl you find most beautiful.” most difficult.

This points to a key difference between long-term investing using fundamental analysis and trading. In essence the trader/speculator skill’s lies in seeing how others will view events and makes his bets accordingly. This is the case even if someone with an intermediate term horizon relies on fundamentals in their analysis. In contrast the long-term investor (horizon measured in next few years) implicitly trusts not in his or her ability to anticipate how others will react but assumes superior knowledge in anticipating the future fundamentals of a company will enfold and considers if the security is likely to provide a superior return over that longer horizon given how the market usually perceives such a future state on the assumption that the usual influences on a stock short-term will at some point reflect the future values perceived by such an investor. To the extent that the market is driven by the former, opportunities can occur. For example, in a market downturn long-term opportunities may arise but the market could continue falling because of a near-term focus of most market participants. Accumulating a position over time would allow one to avoid buying the possibility of buying at even better future prices while avoiding the possibility of not taking advantage of current prices entirely should the market have reached bottom. Naturally a long-term investor has to be prepared to hold (avoid leveraging) his or her position and for periods of low or negative returns. Naturally that same fundamental investor will improve his or her performance to the extent that he or she can predict how traders will react and impact near to intermediate term price movements to time their own transactions.

Repetition Repetition Repetition

In Daniel Coyle’s The Talent Code we learn the three rules of deep practice.  Rule number two is Repeat It.

“Nothing you can do – talking, thinking, reading, imagining- is more effective in building skill than executing the action, firing the impulse down the nerve fiber, fixing errors, honing the circuit.”

This explanation reveals why it is impossible to transfer trading prowess from one person to another.  You can’t talk, think, read, or imagine your way to elite performance.  The key lies in the “doing”, going through the motions.  Now that’s not to say talking or reading about trading isn’t helpful.  It is.  I pick up tons of insight from talking with other investors and traversing the trading blogosphere.  I’m like a hungry orphan hiding below the tables of successful traders just hoping they’ll drop a few morsels of wisdom I can chew on.  Yet it’s not a substitute for “executing the action”.  Nothing replaces sitting in front of my computer, monitoring positions, assessing  potential trades and most importantly pulling the trigger. (more…)

Fragile Traders vs. Anti-Fragile Traders


Reading Nassim Taleb’s newest book Anti-Fragile really got me thinking about how traders are broken.
Traders can become fragile and be broken in several ways:

  1. They can quit because they believe that trading successfully is impossible.
  2. They can lose half their account or all of their account and just give up.
  3. They can become emotionally traumatized by one huge loss or a string of losses and just not be able to trade any more due to the pain going forward.
  4. A trader can lose faith in them self as a trader.
  5. A trader can lose faith in their system.
  6. A trader can trade too big and blow up their account, they want to trade, they believe they can make it back but have no money.

A trader can become anti-fragile they can benefit from adversity at times by:

  1. Having 100% confidence that they will be in the 10% percentile of  consistently winning trades, it is just a matter of time.
  2. They do not give up after losing the majority of their very first account  they just accept it as paying tuition and start again this time with faith they will win.
  3. The anti-fragile trader trades small, their emotions do not bleed into their trades, each trade is just 1 of the next 100. They risk 1% of capital per trade.
  4. The successful trader identifies themselves as a successful trader, losing trades do not change who they are.
  5. The trader believes that time is on their side and draw downs are just temporary, short term losses do not change the trader’s belief in long term success.
  6. Successful traders know that their trading account is their life blood, guarding  it against big losses is their #1 priority.

Fragile traders are inevitably  broken, anti-fragile traders are not only not broken but benefit from circumstances by learning, growing, and becoming more resolved to win. Adversity makes them stronger.

10 Points -Why Traders Lose Their Discipline

  • Environmental distractions and boredom cause a lack of focus – All of us have limits to our attention span and these are easily taxed during quiet times in the market;
  • Fatigue and mental overload create a loss of concentration – The demands of watching the screen hour after hour make it difficult to be sharp, creating fatigue effects that are well-known to pilots, car drivers, and soldiers;
  • Overconfidence follows a string of successes – It is common for traders to attribute success to skill and failure to situational, external factors.  As a result, a string of even random wins can lead traders to become overconfident and veer from trading plans–especially by trading too frequently and/or trading excessive size;
  • Unwillingness to accept losses – This leads traders to alter their trade plans after trades have gone into the red, turning what were meant to be short-term trades into longer-term holds and transforming trades with small size into large trades by adding to losers; (more…)