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The Power of Regret

  
  Education
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Everyone knows that chasing price is usually not beneficial, we either end up catching the move too late, or we get poor trade location, which makes it more difficult to manage the trade.

However, there are other forms of chasing that are just as common, maybe more common, and just as counter-productive.   As a trading psychologist I see these all the time.

Traders who are not profitable are often too quick to chase after new set-ups and indicators, or a different chat room, if that’s your thing.  Obviously, we need to have a trading edge, whether it is from the statistical perspective of a positive expectancy, or simply the confidence in a particular discretionary strategy such as tape reading, following order flow, market profile, etc.

Chasing a trade is the fear of missing out. The fear of missing out is associated with various emotions, including regret. In my work with traders and in my own trading, I’ve seen the incredible power of regret. There’s a lot of talk about fear and greed in trading, but the power of regret is often overlooked. Some of my own worst trades, and those of my clients, often have a ‘regret from missing a prior opportunity’ component. When I finally finish my book on the psychology of financial risk taking, I will include much about this overlooked but very powerful emotion.

Somewhat related to chasing a trade, is impulse trading.  They both have in common the underlying feeling of the fear of missing out.  It’s tempting for me to talk about impulse trading here, but it really deserves its own piece.

Top Ten Side Effects of Greedy Trading

  
  Education
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  1. Greed causes the trader to only look at the best case scenario for profits and ignore the worst case scenario for losses in every trade.
  2. Greedy traders trade WAY to big a position size.
  3. A Greedy trader’s #1 priority is getting rich quick while ignoring the risk of ruin.
  4. Traders that are greedy tend to believe they can have returns bigger than the best traders in the world right at the beginning.
  5. Greed makes traders have absurd targets for their trades.
  6. Greedy traders tend to buy stocks that are down 50% believing they will double and go back to where they were.
  7. Greed distorts a trader to focus on the money not the homework involved to make the money.
  8. Traders take trades where the odds are way against them because of the greed of wanting to make huge returns on one trade. (Far out of the money options)
  9. Greedy traders trade with no plan and no method they are just pursuing profits randomly.
  10. Greedy traders are always looking for the easy path to money not to the real path of hard work and experience.

The market is both carrot & stick

  
  Education
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Over the past year of my trading life I have identified several interwoven cycles of learning. The most obvious being that knowledge and practice combine into your overall understanding. Knowledge alone (book learning) does not equate to understanding – you also need to practice in the market. The two combined give you what we generally call experience. Experience seems to be the thing that makes the difference. Someone who has experience tends to do better over someone who has no experience, in any field. If you were having brain surgery, would you rather have a surgeon doing it who has experience or no previous experience? Yeah, enough said.

So over time, our understanding increases (our experience). But you may also notice that your ability to act on what you know seems to lag far behind, and this can be incredibly frustrating and puzzling. Don’t you wonder at it, every time you make the same stupid mistake over and over? Whats going on here?

The fact is that we have two brains (more actually, but lets stick to two for now) – an intellectual brain and an emotional brain. In the East, there is a common analogy of rider and horse. The horse (emotional brain) is stupid and only knows such things as fear, hunger, punishment and reward. The horse understands the difference between a carrot and a stick, but not much else. The rider struggles to make the horse go where he wants to go.

This is our problem in trading. Our emotional brain (the horse) understands fear and greed, and unfortunately these fight or flight level of instincts are stronger (and faster) than our intellectual brain; they have to be. If a mugger jumps out of the bushes you don’t have time to decide if its a mugger or your friend playing a trick on you, you just run.

In the market however, this mechanism is the cause of all our woes. The market provides both a carrot and a stick. A sudden break out (carrot) lures us into buying long, and then suddenly reverses and stops us out (stick). We are lead all over the charts in a random walk, one minute its carrot, the next minute its stick; we are the dumb money.

Who then is the smart money? Surely based on the above it is simply those individuals who can actually control the horse and act according to a trading plan. There is no conspiracy by the major institutions to steal your money from you – you simply hand it over to them or other traders (and they happen to be willing to take it). In the case of the smart money, the rider is in charge, but in the case of the dumb money the horse goes where ever his instincts take him, and the rider simply hangs on (until he falls off that is).

MindTraps-Great Book

  
  Education
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I read a great book on trading psychology, called MindTraps by Roland Barach. MindTraps focuses on how the average person tends to think, compared to how we need to think to make money over time in the markets.

 Here’s a summary of points that can benefit you as a trader:

  1. 1.Before entering any trade, you should consider the other side of the trade and state the reasons you’d take the other side of the trade.  This helps you objectively enter a trade with a full understanding of the major risks that involved.
  2. Analyze your behavior from the beginning to the end of the trading process (from idea generation to entry and finally to exit) – what are the areas you can improve to help your trading profitability the most?
  3. Keep a trading journal of your thoughts on open positions and new ideas – writing things down helps you objectively look back and see where you went right and wrong.
  4. Fear blinds us to opportunity; greed blinds us to danger – emotions cause “perceptual distortion” where we only see the part of the picture that our beliefs allow us to see.
  5. We are likely to continue doing things for which we are rewarded -this can cause us to get too bullish after the bulk of the uptrend has occurred, or get too bearish near the lows.
  6. Fear of regret slants stock market behavior toward inaction and conventional thinking –  the person who is afraid of losing is usually defeated by the opponent who concentrates on winning (an analogy for sports fans is the Prevent defense in football – playing “not to lose” only prevents you from winning).
  7. Can’t have a personal agenda to prove your self-worth in the markets –  the focus must be on following your plan to maximize the ability to make money.
  8. Don’t get overly attached to any one view on a stock or market – don’t talk to others about open positions; it just makes it that much harder to exit when your plan says it should.
  9. Our predictions are only as good as the information available to us – objectively look at the indicators and data you use, to get the best quality of information and focus available
  10. People prefer for gains to be taken in several pieces to maximize their feeling good about their ability, while they prefer to take all their losses in one big lump to minimize the pain they feel.
  11. People prefer a sure gain compared to a high probability of a bigger gain, so they can say they made a profit; in contrast, people will speculate on a high probability of a bigger loss over a sure smaller loss, because they don’t want to feel like a loser.  In trading, we must flip around the conventional emotions to allow us to let profits run while cutting losses shorter.

Ten Side Effects of Greedy Trading

  
  Education
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  1. Greed causes the trader to only look at the best case scenario for profits and ignore the worst case scenario for losses in every trade.
  2. Greedy traders trade WAY to big a position size.
  3. A Greedy trader’s #1 priority is getting rich quick while ignoring the risk of ruin.
  4. Traders that are greedy tend to believe they can have returns bigger than the best traders in the world right at the beginning.
  5. Greed makes traders have absurd targets for their trades.
  6. Greedy traders tend to buy stocks that are down 50% believing they will double and go back to where they were.
  7. Greed distorts a trader to focus on the money not the homework involved to make the money.
  8. Traders take trades where the odds are way against them becasue of the greed of wanting to make huge returns on one trade. (Far out of the money options)
  9. Greedy traders trade with no plan and no method they are just pursuing profits randomly.
  10. Greedy traders are always looking for the easy path to money to the real path of hard work and experience.

Psychological problems

  
  Education
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There are two parts to fixing any psychological problems:
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1. Recognizing that it exists
2. Accepting it so you can move on
In trading, this is where it’s so crucial to take responsibility for your own actions because it induces change and you can start making improvements. If you don’t recognize and accept a problem, then you won’t get anywhere!
What are some of these issues  ? Here are a few along with their causes and/or effects:
1. Anger over a losing trade – Traders usually feel as if they are victims of the market. This is usually because they either 1) care too much about the trade and/or 2) have unrealistic expectations. They seek approval from the markets, something the markets cannot provide.
2. Trading too much – Traders that do this have some personal need to “conquer” the market. The sole motivation here is greed and about “getting even” with the market. It is impossible to get “even” with the market.
3. Trading the wrong size – Traders ignore or don’t recognize the risk of each trade or do not understand money management. There is no personal responsibility here.
4. PMSing after the day is over – Traders are on a wild emotional roller coaster that is fueled by a plethora of emotions ranging throughout the spectrum. Focus is taken off of the process and is placed too heavily on the money. These people are very irritable akin to the symptoms of premenstrual syndrome. (more…)

Courage and Trading

  
  Education
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According to Plutarch, “Courage stands halfway between cowardice and rashness…” Clearly, we don’t want to be reckless; and clearly, we don’t want to be hesitant and timid. What we need is a balance. As we go about our trading moderating our greed and our fear to a combination of healthy desire and clear minded caution, we use courage to go forward.

Courage doesn’t mean closing your eyes, holding your nose, and jumping into the deep end. It does mean moving forward with clean and clear perception as well as steadfastness of purpose.

You don’t need courage if you’re totally confident and unafraid. Courage, according to John Wayne, is being scared to death and saddling up anyway. Because people tend to fear the unknown, and the unknown is all that is certain about any given trade, we need to employ courage. Since trading is always new, since anything can happen and it often does, since the wildness lies in wait, we need to overcome uncertainty and fear so that we can appropriately enter, exit, and remain in trades.

When asked what he meant by “guts”, Ernest Hemingway told Dorothy Parker in an interview “grace under pressure”. Trading is all about grace and gracefulness under pressure.

The good news is that courage is like any muscle. It grows and becomes stronger the more you use it. Often as I trade I’m unaware of utilizing courage. I know I’m extremely alert. I may even be excited. I’m not aware of any fear until something starts to go wrong. However, that alertness and excitement is a product of adrenalin running. Excitement or fear comes from the interpretation you give to the adrenalin high. The more you act as if you’re unafraid, the less afraid you become. It all gets easier. Act the part and become the part. Make it your goal to trade with increasing grace under pressure.

The difference between excitement and fear depends of what you are imagining.

Are you imagining loss or are you imagining profit? Of course, you always have to keep the alternative in mind as trading is all about balancing the alternatives, profit with loss. But you don’t have to put loss into the foreground of your mind, because you never would put on a trade unless profit was the probable outcome. Direct your imagination towards profit, and suspend all thoughts of loss–once you’ve put your stops in.

“Don’t cry before you’re hurt.” says a proverb. I would add, don’t mourn a loss before you experience it. Don’t even mourn it after you take it, get on with the next trade, and the next, and the next. Anticipate profit. That’s what you’re there to experience. Ah yes, and as another proverb states: “Fortune favors the brave.”

30 Rules for Traders

  
  Education
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  • Buying a weak stock is like betting on a slow horse. It is retarded.
  • Stocks are only cheap if they are going higher after you buy them.
  • Never trust a person more than the market. People lie, the market does not.
  • Controlling losers is a must; let your winners run out of control.
  • Simplicity in trading demonstrates wisdom. Complexity is the sign of inexperience.
  • Have loyalty to your family, your dog, your team. Have no loyalty to your stocks.
  • Emotional traders want to give the disciplined their money.
  • Trends have counter trends to shake the weak hands out of the market.
  • The market is usually efficient and can not be beat. Exploit inefficiencies.
  • To beat the market, you must have an edge. (more…)

Does your brain accept randomness?

  
  Education
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Everybody knows this feeling and also knows it is a false feeling. You’re in a casino, and the roulette hits red. Then again and again. After three, four maybe five times red in a row, you start to think it’s time for the roulette to hit black. Now, in this simple case, you know that’s not true.

The roulette has no memory and we assume it’s fair. So every round offers an equal chance for red and black (as well as green, 0, the casino takes it all). So the roulette may hit red 20 times in a row. The chance of that happening is very small, but once it has reached 19 times in a row, going from 19 to 20 is just as likely as going from 1 to 2 times red in a row.

Although we know this, our brain doesn’t feel comfortable accepting it. If you had to write down a random sequence of ‘red’ and ‘black’, it would probably not be as random as the roulette. Our brain is a bad randomizer, it wants the sequence to look ‘realistic’ and ‘fair’.

Now look at the markets where things are only a bit different. Unlike the roulette, the market has a memory. That market-memory determines where a feeling of greed pushes the feeling of fear away or vice versa. In between major greed/fear moments, there are up and down days. When we look at several up days in a row, a trader may expect a down day very soon simply because the market went up too many days in a row. This is our brain saying it’s ‘not fair and not realistic’. The brain wants the up and down days to be more alternating to make it ‘more realistic’. What this hypothetical trader is trying to do is go short in strong uptrending market. Not good for your trading account.

Trading Rules to become Great Trader

  
  Education
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Time for another list of Trading Rules . Make it a habit to reread these trading rules  every now and then.
TRADINGRULES-1
1. Buying a weak stock is like betting on a slow horse. It is retarded.
2. Stocks are only cheap if they are going higher after you buy them.
3. Never trust a person more than the market. People lie, the market does not.
4. Controlling losers is a must; let your winners run out of control.
5. Simplicity in trading demonstrates wisdom. Complexity is the sign of inexperience.
6. Have loyalty to your family, your dog, your team. Have no loyalty to your stocks.
7. Emotional traders want to give the disciplined their money.
8. Trends have counter trends to shake the weak hands out of the market. (more…)

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