- You absolutely must have an edge. In the short run, you can get lucky and make money doing something that has no edge, but expected value will catch up with you. Don’t gloss over this point, because it might just be the single most important thing we can say about trading–you have to have an edge.
- You must be consistent. You must trade with discipline. Nearly everyone who writes anything about trading says these things, but the why is important: you must be consistent because the market is so random. You cannot change your approach based on short-term results because those short term results are confounded by the level of noise in the market. In other words, you can lose doing the right thing and make money doing the wrong thing. Too many traders make adjustments based on evaluating a handful of trades, and this is likely a serious (fatal) error. See point 1: have an edge, and, now, apply that edge with consistent discipline. Markets are random; you don’t have to be.
- Luck matters. There’s no denying that, but so does skill and so does edge. In fact, the more skillful you are as a trader, paradoxically, the more luck matters. (See Mauboussin book and video link near the end of this post.) You can be successful without luck, but the wildly successful traders (who are outliers) always have some significant component of luck. If the overall level of investment skill in the market is rising (far from a certain conclusion, in my opinion), then performance will converge and luck will play a bigger part for the top performers.
- If you understand the part luck plays in your results, you will realize that emotional reactions to your results are largely inappropriate. Yes, that sentence sounds like something a Vulcan (from Star Trek) would say, but it’s true. Too many traders ride the emotional roller coaster from euphoria to depression based on their short term results, and this really doesn’t make sense because you’re letting luck (random fluctuation) jerk your emotions around. (It is worth considering, though, that this works for some traders and may actually help their performance.)
Archives of “Luck” tag
rssBY IGNORANCE THE TRUTH IS KNOWN
Whether we choose to believe it or not we do not know the future, nor can we predict it with any consistency. When the future does play out exactly as predicted luck must be credited.
We stock traders love to predict. When we are right (which is not very often) we are quick to pat ourselves on the back, staking our claim on expert technical and/or fundamental analysis. When we are wrong we are just as quick to deny responsibility, usually blaming the “market” for its ignorance. All too often we justify our losses because we mistakenly believe the market is wrong.
But if the truth be known we are the ones who are ignorant and we choose to remain so. Ignorance can only be used as an excuse until the truth is discovered. The truth is we are wrong. The market is always right.
So, here is the truth.
We are ignorant of randomness and uncertainty. We are ignorant of the many reasons others have for buying and selling, oftentimes diametrically opposed to our own. We are ignorant of the hidden forces that move markets both intra-day and day to day. We are ignorant of unforeseen news and how the “market” will interpret it. We are ignorant of our many and varied biases, too numerous to mention here. In a word, we are ignorant.
But in ignorance we find truth; in ignorance we find opportunity. We traders can use our ignorance as a tool for profitability. But can we handle it?
Can we accept that our expert analysis can be wrong? Can we accept uncertainty? Can we admit that our decision making processes are often flawed because of our psychological makeup? Can we accept that the market is always right? Can we handle the truth?
If we dare confront our ignorance we can then proceed to admit to and accept our flawed biases. We can admit that luck plays a major role in our success.
We can actually exit losing trades. We can take profits without getting greedy. We can cease to fear the future. We can accept, and even learn to embrace, uncertainty. We can then use technical and fundamental analysis as tools to manage our emotionally based biases, not confirm them. We can become consistent in our decisions. We can become profitable.
We can discover the truth by our ignorance.
Role of Luck and Skill
There is still an element of luck or randomness in the markets. You can research a trade extensively and be absolutely convinced that it will work—but still end up losing money on it. No matter what you do, you won’t be right on 100% of your trades. What does this mean for traders?
As Michael Mauboussin writes in a white paper for Credit Suisse, “Where there is luck, focus on the process”. You can’t control the outcome, because it is subject to some randomness—but you can control the input, which is the process. You want to have a process that allows for the element of randomness but which is still robust and which you can adhere to.
If it’s helpful, think about the distinction between a well thought-out trade that happens to lose money versus one that makes money. The first is a losing trade, while the second position is a winner, because it makes money. That is just talking about the outcome. But they are both good trades, in the sense that they were put on with careful consideration. Contrast that with a trade that is a winner—i.e. it made money– but was basically an impulsive decision and thus a bad trade. By focusing on the process over the outcome, we should be trying to make a series of good trades and avoiding bad trades like the plague. Over time, the results will take care of themselves.
James H. Simons: Mathematics, Common Sense and Good Luck -Must Watch Video
Michael Mauboussin talks about The Success Equation: Untangling Skill and Luck in Business, Sports and Investing -video
Managing your luck
You absolutely must have an edge. In the short run, you can get lucky and make money doing something that has no edge, but expected value will catch up with you. Don’t gloss over this point, because it might just be the single most important thing we can say about trading–you have to have an edge.
You must be consistent. You must trade with discipline. Nearly everyone who writes anything about trading says these things, but the why is important: you must be consistent because the market is so random. You cannot change your approach based on short-term results because those short term results are confounded by the level of noise in the market. In other words, you can lose doing the right thing and make money doing the wrong thing. Too many traders make adjustments based on evaluating a handful of trades, and this is likely a serious (fatal) error. See point 1: have an edge, and, now, apply that edge with consistent discipline. Markets are random; you don’t have to be.
Luck matters. There’s no denying that, but so does skill and so does edge. In fact, the more skillful you are as a trader, paradoxically, the more luck matters. (See Mauboussin book and video link near the end of this post.) You can be successful without luck, but the wildly successful traders (who are outliers) always have some significant component of luck. If the overall level of investment skill in the market is rising (far from a certain conclusion, in my opinion), then performance will converge and luck will play a bigger part for the top performers.
If you understand the part luck plays in your results, you will realize that emotional reactions to your results are largely inappropriate. Yes, that sentence sounds like something a Vulcan (from Star Trek) would say, but it’s true. Too many traders ride the emotional roller coaster from euphoria to depression based on their short term results, and this really doesn’t make sense because you’re letting luck (random fluctuation) jerk your emotions around. (It is worth considering, though, that this works for some traders and may actually help their performance.)