Patience is a virtue, and no place does this truism hold more water than the stock market. When a trader allows doubt, a facet of fear, to inform his trading decision, he sets himself up for failure. The market does not care about the wants of an individual trader, whereas when making a turn across oncoming traffic, a mistake may result only in an oncoming driver slamming on his or her brakes in order to avoid an accident. The market will not extend such a courtesy. It will run over anyone and anything between it and where it is going without as much as an afterthought. It is the responsibility, not of the market to go where the trader wants it to go, but for the trader to determine the most likely course of the market and plan accordingly. Patience, achieved by a trader monitoring his internal dialogue, makes it possible.
Archives of “truism” tag
rssMetaphors and Similes
Similes and metaphors play an important role in both the internal thought-process of a day trader as well as in communication between two traders. To describe the emotional reactions coupled to the movement of a stock in likeness to a rollercoaster, or to compare averaging down in hopes of breaking even to digging one’s self out of a hole is to use simile to quickly illustrate a particular situation as clearly and succinctly as possible. Every trader uses these analogies, each having his own favorites, and they are used to add structure to an environment that often lacks useful tools for explaining particular occurrences.
Sports metaphors also play an important role in quickly passing information to another trader with a small chance for confusion. Traders use base-hit as a metaphor to describe a solid but ultimately small-scale win in the market, and home run for when a trade is “out of the park”.
Ultimately, metaphors and similes can be used by a trader to keep his mind in the right place, and maintain emotional control. By metaphorically comparing trading to baseball or basketball, the Michael Jordan truism about never missing a shot he didn’t take or Babe Ruth’s statistical record for strikeouts helps the trader keep in the back of his mind the inalienable reality that he won’t get a hit every time he swings the bat.
Some traders choose to relate trading to fighting a war, conducting scientific research, or any number of analogous endeavors. The best metaphors and similes are those with which the trader can most easily identify. These easily identified intellectual aids, when utilized to enhance trading and the trader’s sense of control, in the end, will increasable productivity, and most importantly, profitability.
Expect To Be Wrong
The reason I bring this up was to share with you two reactions I got when describing these recent trades and cash holdings. I had two separate conversations in July — one with a well known Trader, the other with a Fund Manager (known in the industry, but not a household name) — about our posture prior to yesterday’s drop.
The two responses were polar opposites, 180 degree apart.
The trader respected the discipline of honoring stop losses. Good traders know that opportunistic speculation is a process. Ignore any one single outcome, focus on the methodology that can consistently avoid catastrophic losses, manage risk, preserve capital. A good process can be replicated, a random spin of the wheel cannot.
The fund manager, who was having a decent year being long high vol names (at least before Wednesday), was having none of it. “Stops are for losers” is a quote I shall long remember (and email him after he blows up). Apparently, real men have the courage of their convictions.
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Rather than fight our foibles, people should admit this error stream is real, and repair the errors of our ways as soon as we discover them. I have noticed over the years the difficulty some people have in cutting losses, admitting an error, and moving on. Way back in 2005, I wrote a piece advising investors that they should Expect to Be Wrong (originally published 04/05/05). I noted that “I am rather frequently — and on occasion, quite spectacularly — wrong.” However, if we expect to be wrong, then there will be no ego tied up in admitting the error, honoring the stop loss, and selling out the loser — and preserving the capital.
This is a recipe for investing disaster. We humans make 6 billion errors per day, at the very least. The biggest one is not acknowledging this simple truism.
The reason I bring this up was to share with you two reactions I got when describing these recent trades and cash holdings. I had two separate conversations in July — one with a well known Trader, the other with a Fund Manager (known in the industry, but not a household name) — about our posture prior to yesterday’s drop.Zen of Trading-10 Rules
1. Have a Comprehensive Plan: Whether you are an investor or active trader, you must have a plan. Too many investors have no strategy at all — they merely react to each twitch of the market on the fly. If you fail to plan, goes the saying, then you plan to fail.
Consider how Roger Clemens approaches a game. He studies his opponent, constructs his game plan and goes to work.
Investors should write up a business plan, as if they were asking a Venture Capitalist for start-up money; just because you are the angel investor doesn’t mean you should skip the planning stages.
2. Expect to Be Wrong: We’ve discussed this previously, but it is such a key aspect of successful investing that it bears repeating. You will be wrong, you will be wrong often and, occasionally, you will be spectacularly wrong.
Michael Jordan has a fabulous perspective on the subject: “I’ve missed more than 9,000 shots in my career. I’ve lost almost 300 games. Twenty six times, I’ve been trusted to take the game-winning shot and missed. I’ve failed over and over and over again in my life. And that is why I succeed.”
Jordan was the greatest ball player of all time, and not only because of his superb physical skills: He understood the nature and importance of failure, and placed it appropriately within a larger framework of the game.
The best investors have no ego tied up in a trade. Those who refuse to recognize the simple truism of “being wrong often” end up giving away unacceptable amounts of capital. Stubborn pride and lack of risk management allow egotists to stay in stocks down 30%, 40% or 50% — or worse.
3. Predetermine Stops Before Opening Any Position: Sign a “prenuptial agreement” with every stock you participate in: When it hits some point you have determined before you purchased it, that’s it, you’re out, end of story. Once you have come to understand that you will be frequently wrong, it becomes much easier to use stop-losses and sell targets.
This is true regardless of your methodology: It may be below support or beneath a moving average, or perhaps you prefer a specific percentage amount. Some people use the prior month’s low. But whatever your stop-loss method is, stick to it religiously. Why? The prenup means you are making the exit decision before you are in a trade — while you are still neutral and objective.
4. Follow Discipline Religiously: The greatest rules in the world are worthless if you do not have the personal discipline to see them through. I can recall every single time I broke a trading rule of my own, and it invariably cost me money.
RealMoney’s Chartman, Gary B. Smith, slavishly follows his discipline, and he notes that every time some hedge fund — chock full of Nobel Laureates and Ivy League whiz kids — blows up, the mea culpa is the same: If only we hadn’t overrode the system.
In Jack Schwager’s seminal book Market Wizards, the single most important theme repeated by each of the wizards was the importance of discipline.
5. Keep Your Emotion In Check: Emotion is the enemy of investors, and that’s why you must have a methodology that relies on objective data points, and not gut instinct. The purpose of Rules 1, 2 and 3 is to eliminate the impact of the natural human response to stress — fear and panic — and to avoid the flip side of the coin — greed.
Remember, we, as a species, were never “hard-wired” for the capital markets. Our instinctive “fight or flight response” did not evolve to deal with crossing moving averages or CEOs resigning or restated earnings.
This evolutionary emotional baggage is why we want to sell at the bottom and chase stocks at the top. The money-making trade — buying when there’s blood in the streets, and selling when everyone else is clamoring to buy — goes against every instinct you have. It requires a detached objectivity simply not possible when trading on emotion.
6. Take Responsibility: Many folks believe “the game is fixed.” To them, I say: get over it. Stop whining and take the proper responsibility for your trades, your losses and yourself.
Your knowledge of the game-rigging gives you an edge. So use your hard-won knowledge to make money. (more…)
Market Mind Games
Denise Shull, founder of the risk and performance advisory consulting firm ReThink Group, argues that traders and investors will improve their bottom lines if they better understand their emotions. Numbers, she writes, “look you in the eye and lie.” Both rationalism and empiricism come up short. The key to market success lies in leveraging emotional introspection and analysis into informed trading behavior—first and foremost, risk management.
In Market Mind Games: A Radical Psychology of Investing, Trading, and Risk (McGraw-Hill, 2012) Shull argues that we would “be able to extract a powerful advantage if we spent more time logically analyzing what the numbers cannot tell us.” (p. 20) Quantitative analyses are merely clues, not answers to what all traders are trying to figure out—other players’ future perceptions.
As it turns out, we all can predict (some admittedly better than others—perhaps an explanation for those seemingly natural born traders) what other people are going to do. This “pattern recognition of likely human behavior” is called “theory of mind,” or ToM. It is “the key to accurately reading markets.” (p. 63)
Looked at from another perspective, trading is a case study in dealing with uncertain scenarios (as opposed to risky situations). A 2005 study found that the brain handles risk and uncertainty differently; confronted with risk, blood takes a different route through the brain than it does when dealing with uncertainty. The researcher “proffered the idea of an ‘uncertainty circuit’ or the idea that a sort of red flag went up saying ‘more information needed.’”
Shull argues that this research undercuts “maybe the second most repeated rule of trading—‘plan the trade and trade the plan.’ … This supposed truism assumes a computer model of thinking. In practicality, it leaves very little room for context and certainly none for a warning flag that more information must be obtained. Traders try to do exactly what they planned while their brain fights them to find more information or to scramble in the face of a clear, but maybe only subconsciously perceived, threat.” (p. 77) That is, although it is important to start with the right type of game plan, “good judgment on the fly will be ultimately what wins the game (remember your brain when faced with uncertainty will make judgment calls whether you ask it to or not.)” (p. 117)
To be a successful trader it is not enough to read the markets. Traders must also read themselves to figure out (not control) what feelings, physical and emotional, are fueling their judgment calls.
Feelings should be viewed as data to be captured and then analyzed. “Just like if you had any new data set to work with, first you would try to get the scope of it, look at it from different angles to get a sense of what you were dealing with, and then go about ways to monitor, track, and categorize.” (p. 125) Knowing yourself and knowing how you feel (your emotional contexts) at any given time will give you a risk management edge. It will help you avoid those “What was I thinking?” moments.
Shull spends several chapters describing some of the most common emotions traders bring to their decisions. For instance, she asks the reader to determine where he is on the spectrum between the fear of losing money and the fear of missing out. (more…)
"Ten Steps to Wealth and Happiness For Traders "
1. Have a Plan: If you are going to actively trade, you must have a comprehensive plan. All too many investors I deal with have no strategy at all — its strictly seat of the pants reaction to each and every market twitch. The old cliche “If you fail to plan, than you plan to fail” is absolutely true.
I suggest that traders write up a business plan for their strategy, as if they were asking Venture Capitalists for money for a start up; In fact, you are asking an investor for capital — just because that investor is someone you know a long time (you) doesn’t mean you should skip the planning stages.
2. Expect to be Wrong: Accept this fact: You will be wrong, and often. The plea for help is at least a tacit recognition that you are doing something wrong — and that means you are a giant leap ahead of many failing traders.
Egotists who refuse to recognize the simple truism of being wrong often give up unacceptable amounts of capital. It is only stubborn pride — and lack of risk management — that keeps people in stocks down 50% or more.
Even the best stock pickers in the world are wrong about half the time.
Michael Jordan has the best quote on the subject: “I’ve missed more than 9,000 shots in my career. I’ve lost almost 300 games. Twenty-six times, I’ve been trusted to take the game winning shot and missed. I’ve failed over and over and over again in my life. And that is why I succeed.”
Mike is the greatest player of all times not merely because of his superb physical skills: He understands the nature of failure — and its importance — and places it within a larger framework of the game
3. Predetermine Stops Before Opening Any Position: Once you have come to understand that you will be frequently wrong, it becomes much easier to use stops and sell targets.
I suggest signing a “prenuptial agreement” with every stock you participate in: When it hits a predetermined point, regardless of methodology — below support or a moving average or a specific percentage amount or the monthly low or whatever your stop loss method is — that’s it, you’re out, end of story. No hopin’ or wishin’ or prayin’ or . . . (Apologies to Dusty Springfield)
The prenup means you are making the exit decision before you are in a trade, and when you are neutral and objective. (more…)
Metaphors and Similes
Similes and metaphors play an important role in both the internal thought-process of a day trader as well as in communication between two traders. To describe the emotional reactions coupled to the movement of a stock in likeness to a rollercoaster, or to compare averaging down in hopes of breaking even to digging one’s self out of a hole is to use simile to quickly illustrate a particular situation as clearly and succinctly as possible. Every trader uses these analogies, each having his own favorites, and they are used to add structure to an environment that often lacks useful tools for explaining particular occurrences.
Sports metaphors also play an important role in quickly passing information to another trader with a small chance for confusion. Traders use base-hit as a metaphor to describe a solid but ultimately small-scale win in the market, and home run for when a trade is “out of the park”.
Ultimately, metaphors and similes can be used by a trader to keep his mind in the right place, and maintain emotional control. By metaphorically comparing trading to baseball or basketball, the Michael Jordan truism about never missing a shot he didn’t take or Babe Ruth’s statistical record for strikeouts helps the trader keep in the back of his mind the inalienable reality that he won’t get a hit every time he swings the bat.
Some traders choose to relate trading to fighting a war, conducting scientific research, or any number of analogous endeavors. The best metaphors and similes are those with which the trader can most easily identify. These easily identified intellectual aids, when utilized to enhance trading and the trader’s sense of control, in the end, will increasable productivity, and most importantly, profitability.
The Zen of Trading
This is the “Zen of Trading;” It is more than an overview — it’s an investment philosophy that can help you develop an investing framework of your own.
1. Have a Comprehensive Plan: Whether you are an investor or active trader, you must have a plan. Too many investors have no strategy at all — they merely react to each twitch of the market on the fly. If you fail to plan, goes the saying, then you plan to fail.
Consider how Roger Clemens approaches a game. He studies his opponent, constructs his game plan and goes to work.
Investors should write up a business plan, as if they were asking a Venture Capitalist for start-up money; just because you are the angel investor doesn’t mean you should skip the planning stages.
2. Expect to Be Wrong: We’ve discussed this previously, but it is such a key aspect of successful investing that it bears repeating. You will be wrong, you will be wrong often and, occasionally, you will be spectacularly wrong.
Michael Jordan has a fabulous perspective on the subject: “I’ve missed more than 9,000 shots in my career. I’ve lost almost 300 games. Twenty six times, I’ve been trusted to take the game-winning shot and missed. I’ve failed over and over and over again in my life. And that is why I succeed.”
Jordan was the greatest ball player of all time, and not only because of his superb physical skills: He understood the nature and importance of failure, and placed it appropriately within a larger framework of the game.
The best investors have no ego tied up in a trade. Those who refuse to recognize the simple truism of “being wrong often” end up giving away unacceptable amounts of capital. Stubborn pride and lack of risk management allow egotists to stay in stocks down 30%, 40% or 50% — or worse.
3. Predetermine Stops Before Opening Any Position: Sign a “prenuptial agreement” with every stock you participate in: When it hits some point you have determined before you purchased it, that’s it, you’re out, end of story. Once you have come to understand that you will be frequently wrong, it becomes much easier to use stop-losses and sell targets.
This is true regardless of your methodology: It may be below support or beneath a moving average, or perhaps you prefer a specific percentage amount. Some people use the prior month’s low. But whatever your stop-loss method is, stick to it religiously. Why? The prenup means you are making the exit decision before you are in a trade — while you are still neutral and objective.
4. Follow Discipline Religiously: The greatest rules in the world are worthless if you do not have the personal discipline to see them through. I can recall every single time I broke a trading rule of my own, and it invariably cost me money.
RealMoney’s Chartman, Gary B. Smith, slavishly follows his discipline, and he notes that every time some hedge fund — chock full of Nobel Laureates and Ivy League whiz kids — blows up, the mea culpa is the same: If only we hadn’t overrode the system.
In Jack Schwager’s seminal book Market Wizards, the single most important theme repeated by each of the wizards was the importance of discipline. (more…)