2007 Christmas party at a dear Friend’s apartment in Azabu, Tokyo. He was the head of MacQuarie securities in Tokyo. Champagne was flowing and i was passably drunk. There was a bunch of Lehman, Morgan Stanley, Citi and other dudes, all smart articulate people.
They were talking about the current uncertainty saying it was an opportunity to buy on dips. I rolled in saying this would be the first time sh!t was about to flow uphill. All those delinquent loans would not end well. The two things that people buy on credit are homes and cars. If home loans turn delinquent, then the rest would follow, contagion. I happened to be tracking Japanese car manufacturers US car sales and watched them plummeting. They laughed at me and concluded that i was a drunken lunatic. Point taken…
1 year down the road, December 2008 same party, half the people. The Lehman dudes were gone or at Nomura. One of the guys ran up to me. I was about to duck and hit the floor as if chased by the police: “no
-“No i don’t do drugs anymore, no i did not do your wife, no i didn’t steal anything, you got the wrong guy” routine. He shook my hand and said:
-“You are the only one who saw it coming and had the courage to speak up. Whatever You say i do. What should i do now?”
-“Really?”, i said. “I don’t remember. I might have been seriously drunk”
-“You were a little more than tipsy, but you were funny and more importantly you were right”, he said
I had correctly predicted the crash, and was too drunk to even remember it. Sounds about right:
-“Hmm, Plausible”, i answered. “Alright, so buy when monetary authorities roll out the big guns”, i said.
-“OK, but Buy what then?”
-“Come on, do i really look like i know? Seriously? Monetary authorities are panicking. They are about to roll out the mother of all monetary bazookas. So, it does not matter what you buy, everything will rally”
-“Yeah, right. You are drunk again” and he walked away
He did not buy and I should have followed my own advice. I gave back a lot of performance in the 2009 rally. I insisted on shorting cyclical stuff when i should have shorted defensives. I was stubborn. I stopped trying to make predictions shortly thereafter.
Now, the implicit question is probably: are we in the same situation now? I don’t know and frankly, it really does not matter. I looked at my forecasting accuracy stats and concluded i should not be in the forecasting business anymore. Not encouraging for the rest of the industry considering i foresaw the crash and the ensuing recovery.
These are the main lessons:
- predict the next crash: you will sell too early. It is as useful as forecasting when you are going to get sick. Only hypochondriacs check themselves in hospitals before they get sick. Don’t listen to those market hypochondriacs telling you the mother of all bear markets is around the corner.
- Focus on why: what matters more? Why you got cancer or how to cure it?
- Duration and depth: when it happened, sell-side “quants” rolled out average duration tables. On average bear markets last for xx months. If You are sick, what would you think of a doctor who would say You will have 39,8 C fever and you will heal in 3 weeks 2 days, 17 hours?
- Recognise when it is there: build a system that tells you now it is time to sell and go short. To identify the top, use my floor ceiling method. It works objectively after the fact.
- Recognise when it is gone: Everyone got terminally beared up at the end of the bear market. They all, me included, missed the rally. Those who said they bought in March 2009 are like descendants of the Mayflower: deluded liars. To identify the bottom, use my floor ceiling method. It works objectively after the fact
- Have a bear market plan: bear markets are notoriously stressful. Not the brightest idea to devise an emergency exit plan when the building is on fire
Do you have any advice, analogies, or even abuse that you can give me so that I dont exit my winn… by Laurent Bernut
Answer by Laurent Bernut:
Now, that is an excellent question. You have the right approach to solve it. Change your beliefs and your reality changes. The reason you cut your profits is because you have been burnt with losses and wan to protect some profit. The reason you procrastinate on stop losses is your ego taking over. Awesome question, let’s have fun
Among the numerous studies on the “Tiger Mom” effect, one of the funniest and most interesting ones happened when they decided to test the mothers’ math aptitude. One university assembled a team of Asian mothers. They gave them a mathematical test. They were primed with dis-empowering stereotypes on females, mothers: “ladies, You may not like math. You probably don’t do a lot of calculus, algebra and trigonometry these days. Sorry about this…”. One month later, they gathered the same moms, administered the same level of test. This time, they primed them with empowering Asian stereotypes, emphasis on education“You are Asians, right? Asians are supposed to be good at math”. Voila, with simple priming, average score jumped 20%. Congratulations, Way to go Ladies!!!
Morales of the story:
- if You want to solve the Fermat theorem, something that has eluded mathematicians for centuries, round up a bunch of Tiger Moms. Remind them that if wasn’t for them balancing the family budget, looking after the education of kids, making sure future generations will be financially well off, they would all live under bridges and tunnels, courtesy of their drinking, gambling husbands. In addition, tell them that solving that simple problem will guaranty entrance to top schools for their children. Leave a stack of application forms to Harvard for inspiration and motivation. Come back before it is time to pick up the kids for their piano, math, and karate/ballet lessons. Problem solved. Anything else?
- Change your beliefs, they will change your reality. Impact goes as far as muscular mass and oxygen retention in muscles
You are facing a common problem: Cut your winners, ride your losers. (BTW, have You considered a position in the mutual fund industry? Popular skill set You have here)
How to reverse it? Re-parent the orphan
First, You need to know that abuse will not work. Part of your problem is ego fighting back. Ego, in the Jungian archetypes, is the orphan. In your brain, this is the amygdala, one of the most primitive defense mechanisms. Any attack will push the orphan deeper. Not a good idea. Forgive yourself for your mistakes. This will soothe the amygdala
Have You ever wondered why we memorize stories instead of abstract concepts? So, using metaphors will definitely help You.
In a world where You want to ride your winners and cut your losers, the latter will come quicker than the former. That means your account will drop before it rises. This time difference is a feature You must accept. That is part of the game. It takes time for good trades to mature.
Exit is like divorce. No-one wants to but. So, if You don’t think about it before getting married, it may get a lot more expensive than You think. There is a reason “divorced Barbie” is so much more expensive than all the other Barbie dolls out there. She comes with Ken’s house, cars, boats.
The point is You need to have a clear uniform exit plan. There is no such thing as customised exit plan for that particular stock or that particular case. This nonsense will confuse your inner idiot. Complexity is a form of laziness.
Switch from outcome to process orientation
May i suggest You read this piece on the psychology of stop loss.. Look at Bill Ackman and Valeant for a great counter-example. Ego took over and clouded his judgement. No-one is immune.
Your new metaphors must emphasize process over outcome
The way i did it: trap price in a box
I remember the day when i moved from semi-discretionary to 100% systematic. I remember it because the next day i was not stressing about all open positions.
That day, i made a commitment that until stop loss, partial exit, time exit were triggered i had nothing to do. After entry, there are only 3 ways stock can go: up, down or nowhere (x-axis: time). Price is boxed.
Of course, things did not always look good. But i thought of those exits as booby traps. until one of them gets tripped, no need for premature action.
I remember that day, because in the afternoon i started watching Shaolin flicks on Youtube to cut the boredom. While my colleagues waiting for announcement, my computer made some awesome Bruce Lee sounds. I was at peace following the exit plan.
Once you decide on an exit plan, commit to doing nothing until one of those booby traps gets triggered. It will bring immense peace.
Stock market is a highly competitive sport. Every hundredth of percentage point counts. If you put every single position in a their individual exit box, they will be no need to stress over them. The right exit will show up. This will save terabytes of mental bandwidth
If 90% of traders lose and 10% wins, are those 10% disproportionally made up of very high IQ peop… by Laurent Bernut
Answer by Laurent Bernut:
No, but for different reasons that the instructive and brilliant answers given by people far more intelligent than yours truly. Making money in the market is a side effect. Yes, You read correctly. Would You like to know why ?
(An entire section of my upcoming book on short selling is devoted to this topic so stay tuned)
To all of You who believe markets are efficient and think of yourselves as rational investors, how many times did You check your mails today ? 10–20 times. That is Dopamine in action. This is the reward circuitry. Not even Paris Hilton has a life exciting enough to check mails continuously. We do so because our brain releases dopamine (feel good hormone) for mild uncertain rewards.
Have you ever found yourself overriding your risk limit just right around the wrong time? Overconfidence is the ubiquitous plague of traders. Rational investor, would You like proof of overconfidence? Divorce statistics, i rest my case with your multiple ex-wives
Now, when your performance sinks and you can’t think straight, do you pass up trades? Do you find yourself exhausted, irritable? Cortisol
Your average pension fund manager is the direct descendant of someone who woke up in a cave and started running after mammoths for breakfast. Not exactly savvy with probabilities but the survivors got the girls…
The hard wired mind of trading
In the 60s Michael Gazzanika developed the theory of split brain. We, humans, pre-consciously rationalise our decisions. Take a look at the junk in your portfolio. A solid third of it would not even be there if you had to do it all over again.
Do You find it hard to execute stop losses (Oh, the chapter on the psychology of stop loss is worth the entire book multiple times, i will refund anyone who does not have a aha moment there) ? Ego prevails over profits. Valeant (VRX), case in point…
Subconscious beliefs and fears
Fears exist in the shadows. In his book, Daniel Goleman (the EQ dude) describes elf deception as a built in mechanism that covers its own tracks. we rationalise all the time. Proof? when was the last time you got laid (Maslow pyramid about reproduction)? when was the last time you rationalised a decision ?
Market participants do not trade to make money. Proof?Look at the junk that fester in your portfolio… Some of us trade to prove to someone dead 20 years ago (i-e father, mentor, bully at school, whatever) that they are worthy individuals. Dude, You are beautiful, You are worthy of love.
The floating world of beliefs and fears
Finally, floating at the surface like ice cubes in a single malt are conscious beliefs and fears. Fears of losing your job, fear of missing out, fear of pulling the trigger, fear of inadequacy (smart guys are buying that Enron thing so i will join the party)
Of course, there is the belief You cannot time the market. Who told you that? Journalists and analyst who hug the mike and more importantly yourself when the thing you just bough went south…
Now, let’s quip the IQ myth. Self deception is a mechanism that covers its own tracks. High IQ dudes always have spectacular excuses. I know two types of traders: those who make money and those who have excuses. Which one are You
Bottom line: born to lose
Bottom line, your biology f@#ks you up. Your beautiful mind comes delivered with amazing features, most of which will get You killed on the markets (try fairness for instance). Then, your ego, your subconscious deep rooted fears will supersede your best intentions. Then, there is this floating junk of unchecked beliefs irrational fears.
So, no wonder 90% of the people lose money.
Now, why do 10% succeed? The hero’s journey
They succeed simply because of their inner alignment of their biology all the way up to their daily routines. Great traders are not smarter, they have smarter trading habits. Making money is just the yardstick of inner alignment.
Would You like to know about the three scientifically proven methods to re-align yourself? Then, please follow, or subscribe to my (free) website, or help launching the book
As Arnold, Ze Great Governator said: “Ze hardest part of putting on muscles is getting to ze gym, jaa”
How significant is following the news for forex trading? by Laurent Bernut
I know two types of traders: those who trade the newsflow and those who make money. 1) How the brain perceives news 2) What news matters and what does not and how to know which is which 3) Stop Loss and newsflow
- The engineered poison of newsflow: Mice on cocaine, fight flight or freeze
A. Play this game to know how brainwashed You really are
Every day, write down whether you agree with the market comment of the chrematocoulrophone (1) “du jour” on Bloomberg TV. They do a superb feat. When market tanks, they dust off some perma-bear and when markets roof it they fish out some perma-bull. Those financial jesters (1) perfectly rationalise what is happening.
Now, take a piece of paper and write whether 1) you agree with the dude 2) whether he is bull/bear. At the end of the week/month, line up agreement and compare the results with your bullish/bearish view of the world. This is confirmation bias in real time.
B. How the brain perceives news
I want to be the first subscriber to a news channel that reports financial trains arriving on schedule. Currently, financial trains have to either beat their consensus timetable or derail to show up on the news. Until then, Disney Channel is good
News is engineered to elicit reaction: sell paper, trade. It activates the mesolimbic reward circuitry (think mice on cocaine) and/or the stress response: fight, flight or freeze. It is crafted to be sensational. The brain picks up on the noise, the flashes, the tone of voice (try and speak like a newscaster to your friends and see how weird it actually sounds)
The problem with either brain trigger is that it distorts reality. Reward circuitry is dopamine which creates cravings, hence the strong addictive mechanism. This is the euphoria superman drug. Bad news for risk management
The stress response releases a powerfully corrosive drug named cortisol that kills libido, constricts bowel movements, triggers panic attacks and inhibits the pre-frontal cortex, otherwise referred to as the thinking brain. So, Yes, science says that being glued to the newsflow actually makes You dumb. Two ways to prove it: anyone who has been on a trading floor when there some “major news” breaks out knows what i am talking about…
More importantly, when you unplug from the matrix, isn’t your thinking any clearer ? You start to have ideas, think more strategically. The brain fog dissipates. This brain fog comes from staring at the newsflow all day.
Newsflow is literally neurotoxic
2) News that matter, those that don’t and how to spot them
Here is a simple test to assess whether news and more importantly their source have worth following:
- news can reverse a trend: if any news does not have the power to stop and reverse a trend, then it has no market impact
- Persistence: some news cause knee jerk reactions, but then trends resume their course as if nothing happened.
So, in terms of importance, these are the 3 major news that we follow each month
- FOMC: everything in the world is priced of the US 10 year bond. In December, when the Fed raised rates, January was not a happy month…
- BoJ: October 2012, Bank of Japan decides to debase its currency. It did impact not only Japan but the rest of the world
- ECB: has diminishing persistent impact
- Pegs: The Swiss have done a great job at fending off “evil speculators”. Brexit too. We have currency peg alerts on Google, but we stay away from pegged currencies such as HKD, HUF etc anyways
The rest, whether it is non-farm payroll, CPI, PPI, MoM retail numbers, consumer confidence survey, housing starts, inventory or tea leaves expert forecasting, all this rarely elicits anything beyond: “yeah, yeah, pass me the salt, please”. There is immediate market impact, but no trend inversion and no persistence of signal.
Useless does not mean worthless. It means those indicators will be baked in the thought process that will ultimately lead to the decision on rates. They are important components, like the windshield on your car, but what You care about is your automobile, not its parts
3) Stop Loss and news
Beginners want to stay in control. Veterans know control is an illusion. Beginners like to keep a tight leash. Veterans allow markets to breathe. Beginners’ tight stop losses get tripped all the time. Veterans love their long lunches…
Tight stop losses means bigger positions. Combine this with crushing leverage and this is a recipe for a toxic neurococktail: cortisol is a powerful chemical that numbs any pains. It is present in all traders experiencing high stress and in harmful concentration in those who blow-up. Game Over
Forex seems to have more randomness than other data series (at least those i have worked on) on identical sub 30 mn periodicity. I don’t know why and it is irrelevant, frankly. What matters is how the noise gets cancelled in the order management logic.
To that effect, i am the proud inventor of French Stop Loss. We follow a scale-out/scale-in model. Rather than anchoring all stop losses on the latest position’s stop loss, we use the one prior (+ a cute little zest “bien sur”). This gives a lot more wiggle room to positions. Cons: This reduces position size and performance acceleration, Pros: this reduces the number of stop losses, increases win rate, lowers avg loss. Bottom line, this stop loss method is fashionably late, hence French Stop Loss, of course
The point of that digression is that allowing the market to digest knee jerk reactions to news materially increases trading edge
We have three configs for our risk management: autopilot, monetary cavalry and Elvis. Autopilot is our standard config. It is on except for one week every month
Elvis does exactly what it says on the tin: rock n’ roll… Our metric is reproduction rate. Our units are Buffets and absolute. But, damn, those valleys are a seriously bullish signal for the adult diaper industry
More importantly, monetary cavalry is named after the main central banks. The week they come up with some announcement, we tighten risk. This is the only type of news where we take action to reduce risk. Sometimes we end on the profitable side of things, and sometimes we don’t. We have made a conscious decision to earn a little less than we could, because we do not want to lose a lot more than we should, and neither should You
My answer to What is the point of hedging a portfolio instead of closing losing positions?
Answer by Laurent Bernut:
It seems like You are experiencing pain right now. This is clouding your judgment. So, let&s do a step-by-step approach’ 1. Emotional relief, 2. Boundaries, 3. Recovery 4. New rules
1. Emotional and Financial capitals: forgiveness and dissociation
You can recover from financial losses over time, as long as You recover from emotional losses. So, We need to get out of your emotional pain first.
The power of forgiveness
Forgive yourself for losing money. Make peace with yourself. You made a bad a decision. It is alright. In Jungian archetypes, this is called re-parenting the orphan. You soothe yourself as if You were soothing your child who got hurt. This is no new age fell good stuff: i am a professional short seller, not a cat lady.
There is solid academic research that links forgiveness and learning ability. Bottom line, if You beat yourself up, You create trauma and are statistically more prone to relapse. The Village People masculine approach to taking losses like a man may result in storing memories in the hippocampus (trauma, pain), rather than the pre-frontal cortex learning centre.
“No problem can be solved at the level it was created“, Albert Einstein, patent clerk
This is a cool jedi trick. Put yourself in the shoes of someone You respect for her investing/trading skills. Really feel being that person. How would she react ? Would she be calm, composed ? Would she have slow or fast breathing ? Try to emulate this person both physically and mentally.
While You do that, exhale twice as long as You inhale, and widen your vision from tunnel to peripheral, look up a bit.
When You have impersonated this person, ask yourself how would this person solve the problem ? Take a pen a paper and write it down. Do not commit to memory. The chemical reconstruct we call memories are highly fickle and inaccurate.
This is a powerful exercise that frees up some mental bandwidth. Stress triggers the fight flight syndrome. This hijacks the prefrontal cortex and hijacks the thinking brain. This exercise frees up mental bandwidth. Practice often and You will be the iceman on the trading desk
2. Set boundaries
“Hope is a mistake“, Mad Max, Aussie philosopher
If You ask this question, it is probably because You thought this “soft patch” would go away and You would be back on happy street in no time. You ignored the signals and You got caught in a storm with a t-shirt, didn’t You ?
Stock repair strategies as we use in options world never really do the job properly and they cost a lost of mental capital. Bad idea. Same applies to your situation.
You were probably optimistic and failed to think about stop loss. You probably don’t believe in them and may buy into the “buy and hope” fairy tale. Well, the best car in the world would not even sell 1 unit if it did not have good brakes.
At this stage, You will have to decide a NUMBER of the loss You can afford to sustain. Not maximum pain, just how much can You afford to lose so that You can recover within 6 months ? Repeat the exercise and stretch the time horizon, 1 year, 2 years 3 years, 5 years etc. Stop when You come to the same number at various intervals. Focus on the recovery period.
This neat jedi trick invokes the “future self” and reframing: it focuses on recovery as opposed to pain.
Write that number down and commit now to liquidating everything if your losses reach that point. No negotiation, no investment committee, just out
The way to make it more acceptable is to tell yourself being right means following a process, being profitable is an outcome, not a process thought.
3. Recovery: two certainties in life: death and short squeezes
“There are unknown unknowns”, Great War Criminal
There is no way to tell how long a bear market will last. Forget about the talking heads, They did not see the bear coming, so they probably won’t see it go either
One rule of thumb about hedging: it gets expensive during sell off, so be patient. Wait for a squeeze to hedge. They come once a month. Politicians feel compelled to flap their mouth at regular intervals during bear markets… So, don’t worry, someone is coming.
When short squeeze comes do this:
- Reduce your exposure: reduce size of positions that stress You the most. Reduce until You can sleep if You are not mathematically inclined. You have to do it, it is part of hedging
- The smart way to reduce risk is to sell call against your holdings: You collect premium and reduce exposure
- Do not trade VIX options to hedge: this is for losers, amateurs and TV talking heads
- Long put spread: skew changes marginally during squeezes. So, this is time to put on put spreads. Put spreads are volatility structures that will make money if the markets fall between a ceiling and a floor. Risk is capped and so is profit potential. It is not very risky
- Don’t waste time looking for the golden fleece of safe asset class that does well in bear markets: The only asset class that fits this profile is cash.
- Avoid short selling yourself, delegate: short selling requires a level of skills that takes time and practice to mature. You should delegate this to a professional short selling manager.
- Be careful with selling index futures: Shorting S&P futures while being Long small caps it not a hedge. You are implicitly Long small caps and short large caps. Large caps fare better in bear markets, small caps get crushed. So, this feeling of being hedged is illusory at best
4. New rules
“The best time to repair the rof is when the sun is shining“, JFK, Great XXth mystery
Hedging is like swimming lessons, It is a bad idea to think about taking swimming lessons when You are drowning.
The market is a joint venture between Murphy and Marcelus Wallace. Murphy makes sure that if something goes wrong it will. Then, Marcellus gets medieval on your a@#.
Bottom line: be prepared. Decide your hedging strategy before you put on a trade.
The best advice about position sizing I can ever give is: size your position not thinking how much you could make, but expecting them to fail and how much You can afford to lose.
What is better in the end, earning a little less than You could, or losing a lot more than You should ?
Good luck, and practice the first two mental exercises. May the force be with You
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My answer to Do simpler trading strategies make the psychological aspects of trading more manageable thus making th…
Answer by Laurent Bernut:
Excellent question. Complexity is a form of laziness. 1) The privilege of simplicity is that it imposes itself, even to those who do not understand its sophistication 2) Simplicity is the exact opposite of easy.
Complexity is fragile
I have met many people trading complex strategies. I have had the privilege of meeting many people with long track record. I have yet to meet trading complex strategies with a long track record.
Complexity gives an illusion of control. It is also highly specialised. So, it tends to fall out of sync. then, traders start drifting and tweaking and add one more widget instead of subtracting.
As the Great Chinese philosopher Bruce Lee used to say: ultimately, perfection runs into simplification.
Complexity is a form of laziness:
People who settle for complex solutions have not worked hard enough to simplify them. It is easy to throw another oscillator in the mix. It is simplistic to optimise for a moving average. Below is my screen, no indicator, no oscillator, nothing, just the purity of the price:
In fact, the opposite of simple is not complex. The opposite of simple is easy.
The privilege of simplicity is that it imposes itself, even to those who do not understand its sophistication. We can understand it. It intuitively imposes itself.
Simple is not rigid, it is fluid
You will know that You are on the right track when You start subtracting instead of adding to your strategy.
I started off with 9 exit conditions. Now, I have 2: trend reversal and stop loss.
I started off with 3 distinct strategies. Now, i have 1 unified strategy. It knows when to suspend trading, reduce risk. Hint: the answer is not in the Buy/Sell signal but in position sizing and rejection of small orders…
But behind this simplicity there is immense relentless kaizen. It took me years to see what was in front of me. We do not see things as they are. We see them as we are.
Simple is a way of life.
The false comfort of complexity
People are intimidated by complexity. If it is simple, they believe that anyone could do it, therefore it cannot work. Picasso once drew a picture on a napkin to a restaurant owner and then asked for an astronomic sum. He then told it took him 30 years to draw those simple lines.
People often mistake simplistic and simple. I often ear that what i do is superficial. Perfect, “let’s step into the math then” and 5 minutes down the road, they have an angelic blank stare and conclude it is too complicated.
- Stop Loss: 2nd most important variable
- Position sizing: money is made in the money management
- Exits: You have to get off the bus at some point
- Entries: vastly overrated
- Above all: clarity of purpose, of formalisation. Be specific, very specific
Part 1: Making money on the markets goes against nature
Why we cut our winners
Part 2 How to re-write the story of stop loss
1. Accountability: take responsibility
2. Reframing stop losses
3. Identity association
- It becomes quantifiable and measurable: one trade is random. 100 trades are a data sample.
- It removes the incentive to cheat: being right is no longer an individual trade decision. You can lose money and be right. In fact, this association is stronger than the outcome orientation. It involves the neo-cortex in relationship to the dorso-lateral cortex (siege of identity). It literally rewrite the neural pathways to your identity
4. Clarity: Stop loss is a price, not a fundamental story, not a valuation exercise
- Stories: prior to becoming a superstar with Emotional Intelligence, Daniel Goleman wrote an even more interesting book about the lies we tell ourselves. He argued that self deception is a built-in feature that covers its own tracks. We rationalise our bad choices. We will change our beliefs in order to match our actions. If You find excuses to avoid the gym, then You will fabricate excuses to allow losers in your portfolio.
- Valuations: Earnings estimates are notoriously inaccurate and jumpy. Forecast accuracy for analysts earnings estimates 1 year out within +/-10% range peaks at 25%, half a coin toss !
- Stop losses are necessary to calculate position sizes. If You do not set a limit on how much You can afford to lose, You may fail to appreciate what the market has in store for You
- Emotional interference: Once we enter a position, emotions kick in. Think of it as a prenuptial agreement. Commit to a price in writing, write it close to entry cost and price. Do not trust your brain with some abstract stop loss price. Your brain will renegotiate and it will trick You into a suboptimal decision (marketing buzzword for stupid mistake).
6. Pre-mortem: enter each as if You expect them to fail
- Conservative position size: if you enter a trade expecting it to be a stopped out, You will naturally take smaller bets. You will stay out of illiquid issues
- Pre-packaged grief: we normally expect trades to work. When they don’t, we grieve our way to stop loss (Kubler-Ross). We negotiate with the inevitable. Now, if we expect every trade to fail, those which work will be good surprises. That do not perform as expected. It removes the emotional toll.
7. Execute the stop loss: re-parenting
My answer to How do I overcome an addiction to forex trading?
Answer by Laurent Bernut:
Addiction to Forex trading has all the symptoms of alcohol or drug addiction. It is deceivingly easy. It is accessible. It does not require large amount of capital. It can be done anywhere on a smart phone. It gives immediate feedback.
welcome to addictive personnalities. The best thing You can do is attend Alcoholic anonymous and substitute everything that mentions alcohol with Forex
In fact, I cannot recommend their program highly enough to overcome over-trading.
A. How the brain works:
The reason You want to stop is most likely because You are not about to buy that private jet You saw on the advertisement.
Here is the interesting distinction between gambling addicts and recreational players.
1. Illusion of success
Forex brokers do an exceptional job at giving the illusion of success. Anyone can open an account with almost no capital and start commanding vast amounts of money. It is so easy, yet it is anything but simple.
This is a form of video games, except this time You can make money. The worst thing that can happen is that You make money initially. The best outcome is You lose and wisely conclude it is not for You.
So, You probably made a bit of money, got hooked and then started losing
1, The curse of near miss
The brain does not process information the same way. Three outcomes:
- Win: addicts and civilians process wins the same way, that is they attribute it to their skills (believe it or not, we attribute wins to our skills even in roulette)
- Clear loss: addicts and civilians process clear losses the exact same way
- Near miss: civilians process near misses as losses, the same way a clear loss is processed. Addicts process near-misses as if they were wins: it activates the dopamine reward circuit (Nucleus Accumbens NaC)
2. The dopamine reward circuit and “your brain on porn”
The meso-limbic circuitry is also referred to as the dopamine reward circuit. At its core, the reward circuit is a primitive guide that will psuh You away from pain and toward pleasure. It had a vital role for our ancestors: eat the wrong berry and You will be someone else’s dinner. Fats forward tot he modern world, this is how addicitons are formed: NaC gets activated, releases dopamine and memories are formed.
The best explanation of this cycle is in this medical video. I understand people would be put off, but everyone should watch this video, especially if You are a parent: Your brain on porn
3. Beginner’s luck neurosciences and statistics
From the above paragraph, it is easy to understand how people can be driven to play again and again. If they win, they will continue. If they lose a little bit, they will play again to make it back and if they lose, they will attribute to bad luck. There is no losing combination. You are bound to play until You throw the towel
Now, if You are a recreational trader, near-misses will be magnified losses and You are likely to trade more conservatively as a result. In the end, You will make money and everyone will call t beginner’s luck.
No, your brain responded to objective (loss) and subjective (fear of loss) stimuli by adequately reducing risk, which increased your trading edge (gain expectancy)
On the other hand, if You are a junkie, You will overtrade, lose and revenge trade to make it back, which will invariably dig the hole a bit further.
The subtle statistical difference is in the treatment of the near miss. For example, imagine payoff equals loss. If the objective win rate is 48% but You think You win half the time, what do You think happens in the end ?
You are not as good as You think You are, You are just as good as your trading edge and here is the formula:
Trading edge = Win% *Avg Win% – Loss% * Avg Loss%
B. How to cure addiction
They have an impressive track record. Their method works.
The habit loop
Once an alcoholic, always an alcoholic. Neural pathways of addictions are almost permanent.The brain loves habits. More than 45% of daily activities (a bit more if You work for CNBC) are spent in automatic unconscious mode
Mechanism is simple:
The habit loop is unlikely to change. Whenever the stimulus is triggered, the urge will itch, and the loop will be activated. Rings a (Pavlovian) bell ?
The brain craves its reward and, despite all your best efforts, it will get it. How many people who You know who can’t quit smoking ?
So, the trick is to reverse engineer the habit loop. Substitute the bad routine with a good one, and gradually habits will form. The key here is to identify the cue that triggers the routine.
Whenever the cue happens, don’t fight it, use it. Example, I used to smoke 1 cigarette around 10 am and 1 around 3:15 pm after market close. I changed my routine to inserting two 5 mn Calm.com meditations on my iPhone.
Cold turkey and study
Personally, I would not hire someone who has a tendency to over-trade. This is usually symptomatic of deeper issues: perfectionism, dissonant self-esteem, poor discipline, addictive personality etc.
It does not mean that compulsive traders don’t make it. It means they have a few more demons than regular people.
There is one silver ling about being compulsive. Those traders are more attune to risk. It is easier to teach them stuff like gain expectancy. BTW, go to my website and download your free copy of trading edge visualiser (http://alphasecurecapita
). The intellectual part comes naturally, that’s the mental part that they need to keep in tight check.
It is hard to fight an addiction, but those who are admirable
Use this tool, it is 100% free and it will help You visualise, analyse and then overcome your trading addiction
Andrew Swanscott has one of the best podcasts on trading out there. He has brilliantly interviewed world trading champions, legends such as Van Tharp, Larry Williams, Jerry Parker, Perry Kaufman etc. In each episode, there is a nugget of wisdom. One word of caution though: Better System Trader is more addictive than chocolate.
It was an honour to be interviewed on episode 32.
With the recent “soft patch” in global markets, Andrew decided it was time to catch up and go deeper into topics such as psychology. Markets are stressful on the long side already. On the short side, pressure is something else entirely.
Thank You very much for all the questions and comments on the website. If You have questions You would like to ask on the podcast, please go to the link below:
Topics covered this time will probably be:
- How to improve your trading edge ? (This is a question from a reader, thank You). A post will follow shortly
- Sherlock Vs the Red Queen: why people fail at short selling ? You will understand the trappings in which people coming from the Long side fall. This topic has never been approached from a statistical perspective.
- The psychology of Stop Loss: did You notice that your desk is cleaner when You can’t close a bad trade ? We all know that cutting losses and riding winners is the key to success. We will go through evolutionary psychology, affective neurosciences. We will teach You how to reframe stop loss and trade like a psychopath
- Jedi trading: if You want to be the iceman on the trading floor and if You want to switch from fight, freeze or flight syndrome to flow state in less than 2 minutes, then practice this technique
- if we have time: why You should not be afraid of this bear market, Einstein and monkeys and the importance of Chuck Norris