“…extreme brevity of the financial memory. In consequence, financial disaster is quickly forgotten. In further consequence, when the same or closely similar circumstances occur again, SOMETIMES IN A FEW YEARS, they are hailed by a new, often youthful, and always extremely self-confident generation as a brilliantly innovative discovery in the financial and larger economic world. There can be few fields of human endeavor in which history counts for so little as in the world of finance.” [emphasis mine].
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rssEmotions In Trading -Anirudh Sethi
For many traders emotional trading is a problem and it stops them from being consistent in the market. We see what causes emotional trading in this article and I share six steps to greatly help reduce it, or stop it entirely.
Emotions in trading have always been one of the main causes of losses, and at the same time − the main driving force for all types of money. Remember the classic idea: buyers push the price up because of greed, and sellers sell because of fear of losses?
It still works perfectly in any market.
Popular training materials on market trading almost do not pay attention to managing emotions. This is understandable: any broker is the first participant in the trading process, which is vitally interested in having you leave your deposit to the market.
That is why most newcomers, especially those who passed the super-fast and super effective training in various brokerage kitchens, remain psychologically unprepared for trading. And even good technical training will not help such players save their money.
Assessing and reacting to market risk is one of the most important things you’ll have to do as a trader. Sadly, human being as a whole are so mediocre at this task, investors and traders reliably make decisions that economists consider “irrational.”
So obviously these are commonly more referred to as emotional trading.
Six Steps to Help You Stop Emotional Trading
Financial markets are a by-product of modern era and, in the grand scheme of things, our brains have evolved over millions of years for survival out in the open. They haven’t had the time to get good at making sound and perfectly rational financial decisions.
We have brain processes; an emotional one and a logical one that are constantly competing against one another for our future expression in the market. And normally, for the trader that has little to no market experience, who trades money they can’t afford to lose, or who has a short fuse overall, the stage is set for an incident.
But also more seasoned traders tend to make emotional trading decisions that they consider stupid in hindsight. Perhaps less often than inexperienced traders do, and with minor consequences, but those errors do happen.
Many a times, although we know with the logical part of our brain that we will get better results if we follow our trading rules, so many of us do exactly the opposite, despite clear knowledge of what we should do.
We remove stops, we cut winners short, we go in with too big of a size… I mean, we’re clearly
not purely rational beings ― and we can’t be because that would make us robots, not humans.
Observation, Experience, Memory and Mathematics
“Observation, experience, memory and mathematics – these are what the successful trader must depend on. He must not only observe but remember at all times what he has observed. He cannot bet on the unreasonable or the unexpected, however strong his personal convictions may be about man’s unreasonableness or however certain he may feel that the unexpected happens very frequently. He must bet always on probabilities – that is, try to anticipate them. Years of practice at the game, of constant study, of always remembering, enable the trader to act on the instant when the unexpected happens as well as when the expected comes to pass. “A man can have great mathematical ability and an unusual power of accurate observation and yet fail in speculation unless he also possesses the experience and the memory. And then, like the physician who keeps up with the advances of science, the wise trader never ceases to study general conditions, to keep track of developments everywhere that are likely to affect or influence the course of the various markets. After years of the game it becomes a habit to keep posted. He acts almost automatically. He acquires the invaluable professional attitude that enables him to beat the game – at times! This difference between the professional and the amateur or occasional trader cannot be overemphasized. I find, for instance, that memory and mathematics help me very much. Wall Street makes its money on a mathematical basis. I mean, it makes its money by dealing with facts and figures.” |
Don't Get Trapped
1) Anchoring trap. The mind gives a disproportionate amount of weight to the first information received on a topic. Keeping an open mind and avoiding premature conclusions is a way to avoid this trap.
2) Status quo trap. Forecasts tend to perpetuate recent observations. If inflation has been high, it is expected to remain high. It is a psychological risk to assume something different. The authors suggest rational analysis within decision-making to avoid falling into this trap.
3) Confirming evidence trap. Individuals give greater weight to information that supports an existing point of view. Being honest to oneself about one’s motives, examining all evidence with equal rigor, and enlisting independent-minded people to argue against you are ways of mitigating this bias.
4) Overconfidence trap. Individuals overestimate the accuracy of their forecasts. Widening the range of expected possible outcomes is one way to mitigate this tendency.
5) Prudence trap. There is a tendency to temper forecasts that appear extreme. If a forecast turns out to be extreme and then wrong, it could be damaging to one’s career. Therefore, sticking to the herd is safer. The authors again suggest widening the range of expected possible forecasts to avoid falling into this trap.
6) Recallability trap. Individuals are overly influenced by events that have left a strong impression on a person’s memory. These events tend to be catastrophic or dramatic. To avoid falling into this trap, individuals should ground their conclusions in objective data rather than emotion or memories.
Papillon teaches trading
I watched the film ‘Papillon’ a few days ago and enjoyed it very much. From memory, the film captures the sense of place, feeling of utter desperation, and cruelty of both the people and environment, found in the book on which it is based. It doesn’t follow the story to the letter – few films do – but this becomes a non-issue considering that many people question whether the author truly experienced all these adventures and hardships, or whether he ‘borrowed’ stories from other prisoners. Whatever the truth may be, I highly recommend reading the book and then watching the film.
In one scene, fellow inmate Louis Dega (played by Dustin Hoffman) is talking to Papillon (a role superbly executed by Steve McQueen) and makes a statement of the ‘somebody once said’ variety, that really struck home:
“A temptation resisted is a true measure of character.”
Last Suppers for a Lifetime
I was reading Da Vinci’s notebooks recently, and was intrigued by his method for learning to paint. I thought it might be interesting to try to adapt his model to learning to trade. I’m not sure how useful my little Saturday afternoon research has been but it was fun. Listed below is the sequence Da Vinci recommended for young men to learn how to paint, followed by my own interpretation of the general learning outcomes, and then their trading applications.
Leonardo Da Vinci’s model for learning to paint, from his own notes:
1. Imitate a masters work — best to imitate an antique.
2. Draw objects from relief but not from memory.
3. Familiarity of the human form — seeing each muscle in every possible position.
4. Do stick drawings from nature and expand them at home.
5. “Thus I say to you, whom nature prompts to pursue this art, if you wish to have a sound knowledge of the forms of objects begin with the details of them, and do not go on to the second [step] till you have the first well fixed in memory and in practice.”
6. Keep the company of people who share the outlook of being mirror like in their observations. If such people cannot be found then keep your speculations to yourself.
7. “I myself have proved it to be of no small use, when in bed in the dark, to recall in fancy the external details of forms previously studied, or other noteworthy things conceived by subtle speculation; and this is certainly an admirable exercise, and useful.”
8. “Winter evenings ought to be employed by young students in looking over the things prepared during the summer; that is, all the drawings from the nude done in the summer should be brought together and a choice made of the best [studies of] limbs and body.”
9. He is a poor disciple who does not excel his master.
10. “Some may distinctly assert that those persons are under a delusion who call that painter a good master who can do nothing well but a head or a figure. Certainly this is no great achievement.
11. “Nature has beneficently provided that throughout the world you may find something to imitate.”
12. The mind of the painter must resemble a mirror.
13. “When, Oh draughtsmen, you desire to find relaxation in games you should always practice such things as may be of use in your profession”
14. “The sorest misfortune is when your views are in advance of your work.”
General Learning Statements:
1. Copy the work of someone who has done great work before.
2. Copy the actions of a master.
3. Look at each part of the work and see every permutation and how it fits with the other parts.
4. Do basic models of the whole process, to practice.
5. If you wish to have a sound knowledge of the task or subject then study the details and memorize them and practice them.
6. Don’t become clouded by other peoples views and thinking processes.
7. “I myself have proved it to be of no small use, when in bed in the dark, to recall in fancy the external details of forms previously studied, or other noteworthy things conceived by subtle speculation; and this is certainly an admirable exercise, and useful.
8. When ‘out of season’ you should study past actions and commit them to memory and learn from them.
9. Look to excel past the people you learn from, but without arrogance.
10. Always learn and practice all elements of your skill.
11. Look in other areas of your life and world opportunities to learn and transfer observations to your study.
12. Only observe.
13. Make games that will help you learn better your skill.
14. “The sorest misfortune is when your views are in advance of your work.”
Stock Market Learning:
1. Read the works of Soros, Jesse Livermore, William O’Neill, Warren Buffett and Nick Darvis.
2. Choose one and copy exactly what they do.
3. See each stage they go through to reach their conclusions and the actions they take and the inferrences they derive from the outcomes.
4. Pick stocks and plan out the course of action and all the permutations of what will happen in all price scenarios and put them into practice.
5. Memorise the details of the great coups and all the rules the masters have made in trading.
6. Keep all your trading a secret and don’t let others’ views interfere with your own. Keep your mind totally on the facts at hand and the details of what you see.
7. Before going to sleep look at the coups of other traders and of your own. Talk with the masters you are studying and meet them in your mind for interviews.
8. When the markets are not open or the market isn’t acting right for you then study past trades and memorise the actions you took and piece together the trade again looking for the lesson.
9. Be a better trader than your teachers and ask yourself how you can do better.
10. When you have practiced and ‘perfected’ position entry, move to exits, patterns, money management, probability theory, etc..
11. Look at situations and look at them as you would a trade. What would you do? Are there any interesting things to learn here that can be used in the markets?
12. See what’s happening rather than guess.
13. Play games like the one played in Liar’s Poker, where you invent scenarios and ask each other what you would do in that situation. E.g. nuclear explosion in Tokyo…
14. Be aware of views you are taking on a trade. Look at it always as if it’s the first time you have seen it and review an open trade every day as if you have just placed it.
3 things that will kill your trading success.
Not having a plan. Get a plan, who cares if it is bad, start with something. You can build off of it and refine it. You have to be willing to spend the time to make the plan yours. You do not start anything without some level of planning. Trading is hard; your brain spends a lot of time in fast forward, affecting your memory. You can slow it down by having a plan and increase your brains ability to remember.
Thinking trading is easy. It is not, there are times when it can be slightly less difficult after a lot of time, patience, and hard work. When I think to myself “this is easy” I lose my sharpness. My focus is adverted from my goal. I will lose. It may not be on that trade but maybe the next.
Thinking you have finished. There is only one thing that every trade is guaranteed to give me: a chance to learn about myself, the market, and the interaction between the two. You have to be willing to be relentless in your learning. It will enable you to learn the cheapest.
3 Mistakes that will kill your trading success
Not having a plan. Get a plan, who cares if it is bad, start with something. You can build off of it and refine it. You have to be willing to spend the time to make the plan yours. You do not start anything without some level of planning. Trading is hard; your brain spends a lot of time in fast forward, affecting your memory. You can slow it down by having a plan and increase your brains ability to remember. Thinking trading is easy. It is not, there are times when it can be slightly less difficult after a lot of time, patience, and hard work. When I think to myself “this is easy” I lose my sharpness. My focus is adverted from my goal. I will lose. It may not be on that trade but maybe the next. Thinking you have finished. There is only one thing that every trade is guaranteed to give me: a chance to learn about myself, the market, and the interaction between the two. You have to be willing to be relentless in your learning. It will enable you to learn the cheapest. |
Does your brain accept randomness?
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.
The story of 2 monks and the power of letting go
I believed you have heard of many versions of the story about 2 monks. No? Let me refresh your memory, and explain to you how it is applicable to trading.
There were two Buddhist monks walking along the bank of a river, making their way to back to the temple.
As they were walking, they came across a beautiful lady standing at the side of the river. She stopped them and asked if one of them is willing to help her across the river. The junior monk did not bulge but the senior monk without any doubt, carried her on his back and across the river. The senior monk put her down on the other side and she thanked him profusely and hurried off. The junior monk was taken aback by the gesture but kept to himself. The senior monk returned and they carried on with the journey.
As they walked, the junior monk kept brooding about the incident until it was unbearable and broke the silence, “why did you carry that woman across the river? Knowing that our religion forbid us to touch women!”
The senior monk replied peacefully, “I put her down a moment ago and you are still carrying her.” (more…)