There is no place for arrogance on the trading floor. The stock market has the uncanny ability to identify and humble arrogant traders. The best traders respect the market at all times. Traders are most susceptible to arrogance after an extended winning streak. It’s amazing how weeks of disciplined trading can be wiped out by one bad day. Arrogance is a virus in your trading, as it eats away at the edges of your discipline. Without proper discipline, the market will eat you for lunch.
One book that I frequently recommend is Justin Mamis’ The Nature of Risk: Stock Market Survival and the Meaning of Life (1). I believe this book to be foundational to new traders because it discusses, what else?, the nature of risk in the market. What I love about Mamis’ book is the unique way that he writes about market risk, and the way that he juxtaposes two seemingly opposing ideas, that are not in opposition at all. From that juxtaposition he illuminates. (Read on for an example). Given some of the conversation at the Slope, I wanted to do a brief post on some of his concepts from Chapter 6, The Emotions of Risk. I think that some will find some resonance. I particularly wanted to share some of these concepts that might engage your brain into thinking about risk differently. Mamis posits: “Under pressure, emotions determine our action.” (p. 72) Because risk is typically defined as a peril, fear is one of the primary emotions. “Fear is long-term, an underlying pervasive emotion, like the underlying primary trend of a bear market. It doesn’t go away until it changes.” (p.73) Mamis makes a simple, yet powerful, statement about the pervasive fear needed for stocks to go up. Yes, you read that…to go up. For there to be buyers, there must be sellers. And it is the fear of the sellers that creates the proverbial wall of worry to provide supply for those who have a different perception of current market risk. He also notes that the operative portion of fear is anxiety. Anxiety is what paralyzes and prevents you from taking action. It is this anxiety that “gets in the way of taking a risk.” The flip side of fear is the emotion of greed. The operative emotion of greed is envy. Mamis notes that “. . . whereas anxiety paralyzes, envy cause one to act. . . ” It is difficult to see the spectacular trades/success of others, and not feel a small bite from that evil twin of jealousy, envy. Envy can cause very risk behavior which is simply, “the risk of ‘denial of risk’.” Both greed and anxiety often lead to doing the wrong thing. My sense of this wrong thing is “inertia.” : failing to buy when one should buy; failing to sell when one should sell. These emotions and their operative manifestations into our action (or inaction) govern all market participants. The emotional impetus for buyers/sellers is reversed in bear/bull markets. Regardless of the market participant regalia you dress in each day, it is best to understand both your own and others’ motivations and perceptions of the current risk environment. Mamis’ book came along for me when I was feeling ‘inertia’–that inertia having been brought about by the overwhelming need to have more information, more certainty, more sense of direction. Granted, there is nothing wrong in standing aside when there is great murkiness…but my inertia was spanning a time when there was some market direction, but my emotional state prevented my seeing that. Providence must have set this book into my hands, because it helped me come to terms with that inertia. As market participants, we have to balance the two opposing points off view of being free enough to take risk and while not falling into the trap of ‘the risk of ‘denial of risk.’ (more…)
The composite profile of a losing trader would be someone who is highly stressed and has little protection from stress, has a negative outlook on life and expects the worst, has a lot of conflict in his/her personality, and blames others when things go wrong. Such a person would not have a set of rules to guide their behavior and would be more likely a crowd follower. In addition, losing traders tend to be disorganized and impatient.”
The profitable trader is able to manage stress, has a positive outlook on life and expects the best from themselves and their trading. They take responsibility for their wins and losses. They know who they are and are in touch with their goals. They have specific rules to guide their trading and are organized and patient.
“The simple truth is that most people are risk-aversive in the realm of profits – they prefer a sure, smaller gain to a wise gamble for a larger gain – and risk-seeking in the realm of losses – they prefer an unwise gamble to a sure loss. As a result, most people tend to do the opposite of what is required for success. They cut their profits short and let their losses run.”
Most traders are unprofitable because they take profits quickly but let losers run. Many traders can have a nice winning streak or be profitable in a bull market only to give back their profits with one big loss or lose all their bull market profits during the next bear market.
“Most people approach trading to make a lot of money, and that is one of the primary reasons they lose.” (more…)
Many investors are familiar with the skirt length stock market theory or indicator, where the current fashion for length of skirts determines which way the markets will go. The flappers during the roaring 20’s had very short dresses, and the stock market was roaring. During the depression of the 1930’s, the length of skirts and dresses dropped. During the 1960’s, the mini-skirt came out and the stock market took off. Then floor length dresses came into vogue, and stocks tanked. And so on.
But now we have a unique fashion trend. Supposedly in Japan, skirts are being worn with paintings on the back which make it appear that the skirts are transparent. (PG-13 rated)
If you think this kind of clothing might look good on your wife or girlfriend (or yourself, if you are a woman), you can actually buy this type of clothing from an apparel company in Germany, Alba D’Urbano Couture. (R rated)
However, the important issue is what this means for the stock market. If this type of apparel catches on in the United States, then analyzing the stock market from the skirt length theory is somewhat difficult.
This would be my take. A stock market with lots of fake-outs, appealing opportunities which don’t work out, investments that turn into bummers, and no way to analyze figures as you can’t tell what’s real or not.
Wise quotes from Bernard M. Baruch:
Bernard Baruch was a stock market speculator who became a millionaire by age 30 in the early 1900’s and eventually a statesman and advisor to multiple Presidents during WWI and WWII.
To eliminate the emotional risk of trading, you have to neutralize your expectations about what the market will or will not do at any given moment or in any given situation. You can do this by being willing to think from the markets perspective. Remember, the market is always communicating in probabilities. At the collective level, your edge may look perfect in every respect; but at the individual level, every trader who has the potential to act as a force on price movement can negate the positive outcome of that edge. To think in probabilities, you have to create a mental framework or mind-set that is consistent with the underlying principles of a probabilistic environment. A probabilistic mind-set pertaining to trading consists of five fundamental truths.
