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Why is it sooo darn hard to become what Mark Douglas in ‘Trading in theZone’ calls – a consistently successful trader?
Well, because we are, without knowing it – fighting our own set of formidable paradoxes of psychology. These paradoxes are there to protect us,ironically for some rather ancient scares, not really visible on the trading floor, like sabre tigers and that lot ... As promised, in today’s article I will elaborate around risk aversion and risk seeking behavior and how to train your mind – to avoid being fooled by them.
If you are – which many people are not – an intensely introspective person; making yourself responsible for all your actions in life, minute as well as major; examining them on a daily basis, at home, in the market and elsewhere; keeping a log of your behavior in relation to what really is going on in the market; then you have the first psychological pre-requisites in becoming – a consistently successful trader. The need of this may even first be dawning on you after acquiring said 10.000 hourspractice (last article Part 1+2). From that future point on, of introspective awareness, you may really start learning why you are making the decisions you’re making, in relation to the market. Incidentally, that may well include the decisions you’re making among your loved ones, to the benefit of all. Because – it’s never about the market! It is about
Your behavior in relation to the market!
This is the most central aspect of trading psychology. So important, that this is what I call the
‘Central Trading Dogma’: "Your behavior in relation to the market".
There are tradable regularities in the market – and there is ignorance. Ignorance is an inherently psychological trait. You may e.g. still feel triumphant about yesterday’s wins; or because of experiencing mental fatigue; or simply because you’re so glued to the screen that you simply forgot to put the alarm bell on 2.30 CET, when US jobless claims arrive on every Thursday? Whichever it may be, ignorance stems from psychological inaptness or psychological laxity. In a great part, at least, both can be trained. But that requires work!
So we need to learn the regularities of markets and train the skills of what to do – and when! You need to watch yourself - when you’re in the relatively stable predictable market; and where actually the predictability is starting to fade; where that signal starts – saying to you – get out!
By the way, getting out at the right time is one of the most difficulttasks to master in trading, not far from putting your opponent into a chess mate with only one more move, but with the risk that the opponent has really mastered – by memory – another two moves out of the five you’re currently harboring in your mind, that ricochets you down the stairwell. Trading is the same.
You have to be exceptionally clear of what you’re doing and when you’re doing it. If you repeat this much disciplined work, and log it, noting each and every one of them as statistical outcomes of all your trades – and redraw or note them as Alexander Elder instructs – in a chart-book (a glimpse of my own chart book below) – you will come to the next level approaching consistency, namely
You’ll start trustingyourself.
You have to trust yourself to be able to be a consistently successful trader. This trust can be built on solid foundations, as e.g. understanding how the risk-aversion and risk-seeking-mechanism, described below, tries to get the better of you, every time you put on a trade.
This is the psychological paradox that fools every trader in every day. Humans usually, when reaching certain financial threshold levels become
Excuse me .., what?!
Haven’t we learned the opposite?! Page up - page down: "Cut your losses when losing and keep your winners running"? Yes indeed, and here is the deal, we get so much pain and problems with these issues because we try do the opposite of what is actually
the right way to act.
The mechanisms around the psychology around the losing trade, has been elaborated by Daniel Kahneman and Amos Tversky. Humans are naturally risk averse. In an experiment with surgical precision they could prove that we react in the opposite way we should. Consider the following
a) Win 900 $ for sure OR
b) 90% chance to win 1.000 $
What would you do? Well, statistically, if b is run enough times, the expectancy will be 900$. But, you would have the chance on the first draw to win another 100$, that is a chance 9/10 to win 1.000 $. So which one would you choose, because
there is also a 10% risk that you end up with nothing!
Well, I would certainly go for the first choice and win 900$ for sure! I would not take the 10% chance of getting zip ..! This – is also true for the larger majority of humans, proven by research.
Now try this on – note it has exactly the same symmetry and probability as the last examples - but inversed:
a) Lose 900 $ for sure OR
b) 90% chance of losing 1.000 $
Funny, ehh ...? Not that obvious. In this case, we wouldn’t choose a loss of 900$ - for sure. Would we? In the face of a certain loss, we are inclined to 90% chance of losing yes – more – i.e. 1.000 $.
So – we may already find the conclusion here – when we win, we are pre-programmed to become risk averse! And going over a certain threshold, when we’re losing, we get risk seeking! (If you don’t care about losing 900$, why not try 9.000 or 90.000$ and do the same exercise).
We have arrived at the answer to one of the greatest mysteries in trading psychology. This is the reason why it is so difficult to cut our losses? Because, when losing we actually become risk seeking, i.e. when a loss exceeds a certain utility level or other arbitrary level. When that happens, we are in fact willing to risk more, to get even! To get back! But – alas – as we know this only rarely
happens in a moving market.
The winning trades we usually quit, far too early, because the proceeds make us risk averse. But the successful traders stay in the winners for a long time, even going for “the jugular” by increasing or doubling their positions. Losers, in their stead, become risk averse in winning streaks and, as I myself have done a few hundred times, even put on bets against the market, thinking that
“now” it “has” to be the market turning point.
TRAINING risk aversion/willingness
Here is an exercise – tough work – but rewarding – how to train your mind against being risk seeking in losers
.
I summarize this and last weeks’ articles in the following
ú Trading is a skill that can be learned – but it’s an immense undertaking
ú If you’re up for it – it will be one of the greatest challenges and rewards of your life
ú The psychology of trading can be assessed and even quantified
ú Success can only be founded on introspection of multiple layers of psychological paradoxes, some to be avoided some that can be trained to handle,like
o Not being risk averse, when winning (we’re doing the opposite)
o Train hard to become risk averse when losing (which is not natural to humans)
ú And the reason why Taleb and Kahneman are wrong about trading, is that itis in those ‘fat tails’, where in fact the market indulges into unrealistic exuberance, by indeed being highly in-efficient,the players who know the rules, learned by skill and years of training, make a lot of money! At these times, of rare events or fat tails (black swans to the losers and white swans for the winners), indeed statistics is very unreliable, but that doesn’t mean you can’t skillfully deploy a workable tool-shooting procedure – that keeps you on the winning side – time and time again!
I’ll return with a new article next week.
I wish you the very best for your success - be safe - in the markets!
Well, because we are, without knowing it – fighting our own set of formidable paradoxes of psychology. These paradoxes are there to protect us,ironically for some rather ancient scares, not really visible on the trading floor, like sabre tigers and that lot ... As promised, in today’s article I will elaborate around risk aversion and risk seeking behavior and how to train your mind – to avoid being fooled by them.
If you are – which many people are not – an intensely introspective person; making yourself responsible for all your actions in life, minute as well as major; examining them on a daily basis, at home, in the market and elsewhere; keeping a log of your behavior in relation to what really is going on in the market; then you have the first psychological pre-requisites in becoming – a consistently successful trader. The need of this may even first be dawning on you after acquiring said 10.000 hourspractice (last article Part 1+2). From that future point on, of introspective awareness, you may really start learning why you are making the decisions you’re making, in relation to the market. Incidentally, that may well include the decisions you’re making among your loved ones, to the benefit of all. Because – it’s never about the market! It is about
Your behavior in relation to the market!
This is the most central aspect of trading psychology. So important, that this is what I call the
‘Central Trading Dogma’: "Your behavior in relation to the market".
There are tradable regularities in the market – and there is ignorance. Ignorance is an inherently psychological trait. You may e.g. still feel triumphant about yesterday’s wins; or because of experiencing mental fatigue; or simply because you’re so glued to the screen that you simply forgot to put the alarm bell on 2.30 CET, when US jobless claims arrive on every Thursday? Whichever it may be, ignorance stems from psychological inaptness or psychological laxity. In a great part, at least, both can be trained. But that requires work!
So we need to learn the regularities of markets and train the skills of what to do – and when! You need to watch yourself - when you’re in the relatively stable predictable market; and where actually the predictability is starting to fade; where that signal starts – saying to you – get out!
By the way, getting out at the right time is one of the most difficulttasks to master in trading, not far from putting your opponent into a chess mate with only one more move, but with the risk that the opponent has really mastered – by memory – another two moves out of the five you’re currently harboring in your mind, that ricochets you down the stairwell. Trading is the same.
You have to be exceptionally clear of what you’re doing and when you’re doing it. If you repeat this much disciplined work, and log it, noting each and every one of them as statistical outcomes of all your trades – and redraw or note them as Alexander Elder instructs – in a chart-book (a glimpse of my own chart book below) – you will come to the next level approaching consistency, namely
You’ll start trustingyourself.
You have to trust yourself to be able to be a consistently successful trader. This trust can be built on solid foundations, as e.g. understanding how the risk-aversion and risk-seeking-mechanism, described below, tries to get the better of you, every time you put on a trade.
This is the psychological paradox that fools every trader in every day. Humans usually, when reaching certain financial threshold levels become
- Risk averse while winning , and
- Risk seeking when losing ….
Excuse me .., what?!
Haven’t we learned the opposite?! Page up - page down: "Cut your losses when losing and keep your winners running"? Yes indeed, and here is the deal, we get so much pain and problems with these issues because we try do the opposite of what is actually
the right way to act.
The mechanisms around the psychology around the losing trade, has been elaborated by Daniel Kahneman and Amos Tversky. Humans are naturally risk averse. In an experiment with surgical precision they could prove that we react in the opposite way we should. Consider the following
a) Win 900 $ for sure OR
b) 90% chance to win 1.000 $
What would you do? Well, statistically, if b is run enough times, the expectancy will be 900$. But, you would have the chance on the first draw to win another 100$, that is a chance 9/10 to win 1.000 $. So which one would you choose, because
there is also a 10% risk that you end up with nothing!
Well, I would certainly go for the first choice and win 900$ for sure! I would not take the 10% chance of getting zip ..! This – is also true for the larger majority of humans, proven by research.
Now try this on – note it has exactly the same symmetry and probability as the last examples - but inversed:
a) Lose 900 $ for sure OR
b) 90% chance of losing 1.000 $
Funny, ehh ...? Not that obvious. In this case, we wouldn’t choose a loss of 900$ - for sure. Would we? In the face of a certain loss, we are inclined to 90% chance of losing yes – more – i.e. 1.000 $.
So – we may already find the conclusion here – when we win, we are pre-programmed to become risk averse! And going over a certain threshold, when we’re losing, we get risk seeking! (If you don’t care about losing 900$, why not try 9.000 or 90.000$ and do the same exercise).
We have arrived at the answer to one of the greatest mysteries in trading psychology. This is the reason why it is so difficult to cut our losses? Because, when losing we actually become risk seeking, i.e. when a loss exceeds a certain utility level or other arbitrary level. When that happens, we are in fact willing to risk more, to get even! To get back! But – alas – as we know this only rarely
happens in a moving market.
The winning trades we usually quit, far too early, because the proceeds make us risk averse. But the successful traders stay in the winners for a long time, even going for “the jugular” by increasing or doubling their positions. Losers, in their stead, become risk averse in winning streaks and, as I myself have done a few hundred times, even put on bets against the market, thinking that
“now” it “has” to be the market turning point.
TRAINING risk aversion/willingness
Here is an exercise – tough work – but rewarding – how to train your mind against being risk seeking in losers
- Put up an account, live or demo
- Trade small positions or as large so they start to give you pain – against the market – yes – i.e. voluntarily put on losers!
- As soon as you realize that it's as loser – get out!
- Do it a couple of hundred times, until you never question or even ‘invent’ some “novel creative perspectives” of why you should still be in that losing trade!
. I summarize this and last weeks’ articles in the following
ú Trading is a skill that can be learned – but it’s an immense undertaking
ú If you’re up for it – it will be one of the greatest challenges and rewards of your life
ú The psychology of trading can be assessed and even quantified
ú Success can only be founded on introspection of multiple layers of psychological paradoxes, some to be avoided some that can be trained to handle,like
o Not being risk averse, when winning (we’re doing the opposite)
o Train hard to become risk averse when losing (which is not natural to humans)
ú And the reason why Taleb and Kahneman are wrong about trading, is that itis in those ‘fat tails’, where in fact the market indulges into unrealistic exuberance, by indeed being highly in-efficient,the players who know the rules, learned by skill and years of training, make a lot of money! At these times, of rare events or fat tails (black swans to the losers and white swans for the winners), indeed statistics is very unreliable, but that doesn’t mean you can’t skillfully deploy a workable tool-shooting procedure – that keeps you on the winning side – time and time again!
I’ll return with a new article next week.
I wish you the very best for your success - be safe - in the markets!