Be Careful What You Wish For

There is an old saying that goes along the lines of be careful what you wish for, it might come true. From my recent conversations with traders it seems as if this philosophy has started to creep into their psych.

The local market seems to have stabilized and commodity prices seem to be moving in the right direction. Domestically we seem to have a market that is made up of two prime drivers – banks and resource stocks. If either one stalls then the heavy lifting falls to the other, if both stall we tend to be stuffed.

Traders traditionally wish/hope/pray for a rising market but when they get one all sorts of interesting things begin to happen inside their heads. Small nagging doubts begin to appear about the integrity of the market and the potential for both continued gains and the possibility of holding onto what they already have.

Once this chain reaction of doubt and fear begins to take hold the trader is not long for this world as the discipline required to successfully execute a trading plan slowly dissipates. As the trader falls apart they snatch defeat from the jaws of victory and the wonderful comfort phrase – you wont cant go broke taking a profit is heard in conversations around the marketplace.

However taking a profit is precisely how you will go broke. Consider the following quote from Jesse Livermore.

“I did precisely the wrong thing. The cotton showed me a loss and I kept it. The wheat showed me a profit and I sold it out. Of all speculative blunders there are few greater than trying to average a losing game. Always sell what shows You a loss and keep what shows You a profit. That was so obviously the wise thing to do and was so well known to me that even now I marvel at myself for doing the reverse

Trading can be a scary business particularly when you have unrealised gains on the table as many traders have at present. However some of this fear can be neutralised if traders understand and reflect upon what is occurring between their ears.

Traders quite naturally engage the market as if they were trying to minimise their exposure to mistakes and the fear of mistakes. Ego defensiveness is a natural behavior. Trading is different other forms of investment because we face this as a problem on a regular basis simply due to the volume of transactions we engage in. It is doubtful that property investors would face this more than once in their career simply because their turnover or activity is so low.

This avoidance mechanism can take two forms both are equally destructive to the trader.

1.  As the market moves against the trader information that justifies the original decision will be sought out. Thereby delaying the loss. It is embarrassing to take a loss and our variety of ego preservation mechanisms will do almost anything to avoid this situation. So rather than acting in logical manner to preserve your capital and manage the trade you engage in the various mantra’s that traders have such as it is a good share and good shares always come back. Or my favourite, we still get the dividend.

2. As the market moves with the trader information that confirms the possibility of a pull back will be given added weight- whenever markets have been running for sometime crash theories abound as chicken little prognosticators run around yelling that the sky is falling.

This fear of losing open profits is a particularly powerful stimulus among traders so these stories are given extraordinary weight and profits are taken too soon.

Fear is an almost constant companion of the nervous trader. However fear does not usually exist in the present, it is an anticipatory response. The trader creates the fear in their imagination either by thinking back to previous events or by prequalifying the present fear by thinking forward.

Fear enters into our psyche in two forms.

Chronic fear.

This is more commonly referred to as worry and is of a relatively low intensity spread out over an extended period of time. It permeates all thoughts and all actions on an everyday basis. When Frank Herbert spoke of fear being the mind killer by guess is that this is what he was largely talking about.

Chronic fear is a motivation eater and will stifle attempts to move forward. Some of the things we worry about are important most are not. Many are outside the realm of a trader’s influence. To combat chronic fear drag you need to drag yourself back to the present. For example if you are fearful of a pullback in the market wiping out your open profits simply make certain that you have a well thought out stop loss plan.

This does not mean that you jam the stop so close to price action that you will be stopped on by the smallest perturbation. It means accepting that markets move and price will go both up and down and there is nothing you can do about it other than to ride the trend.

Acute fear.

Acute fear can be a tremendous impediment to the trader. It is short term, intense and can lead to a failure to act. Interestingly it often manifests itself in a failure to add to positions via pyramiding. It is felt in the present, but it is still anticipatory response based upon future perceptions of what might happen if you undertake a given course of action.

Markets are uncertain; at times they do things that take us by surprise. But uncertainty is the default setting for markets since no one can predict the future. However being profitable should not take us by surprise since this is the outcome of a robust system and is therefore something we expect. Being nervous in a market that is doing what you would like is an interesting phenomena and one that requires a great deal of self reflection by the trader. Once again we are back to trading being an internal rather than external problem.