Searching for the Holy Grail (and Dealing with Losses)
November 7th, 2007I posted this in my Trading Diary blog and received such a huge response, that I thought I would post it here too. After all, it is very relevant to both the Planet Wealth Strategy and the Renting Shares Strategy, and in fact, any successful stock market strategy.
It is said that Psychology is 80% of trading and I believe it.
With the choppy conditions we have going on in the market at the moment, I think it is important to understand just what emotions are behind the rises and falls in the market.
Most traders are on the lookout for ways to improve their trading, but some dedicate their lives to searching for the holy grail — the perfect indicator or trading system that will provide setups with a 100% success rate. Many of them have been trading for years, and have tried and tested a number of successful systems, but they seem to suffer from a short attention-span. They drop what they are doing at the first opportunity and head off after the latest fad.
Perfectionism and Avoidance
Perfectionists are often motivated by avoidance: the need to avoid unpleasant emotional experiences. Traders who seek the perfect system are also likely to be motivated by the need to avoid unpleasant experiences.
Avoidance
Imagine taking part in a game where participants are divided into two groups, blindfolded and asked to stick out their right hand. The first group is given ten dollars each time they extend their hand. They soon learn how to play the game and, no doubt, enjoy playing at every opportunity.The second group is also given ten dollars, randomly, about 80% of the time. The remaining 20% of the time, instead of being given a dollar, their hand is jabbed with a pin. Most participants in this group are likely to quit fairly quickly — they focus on the pain and ignore the reward.With trading losses, the only pain that you will suffer is the emotional reaction to a loss — often far worse than being jabbed with a pin. If you concentrate on avoiding losses rather than on maximizing your overall gain, you are unlikely to succeed at trading.
Personality Types
A group of traders may all incur the same loss but suffer vastly different emotional responses. A lot depends on their past experiences — not only while trading but in the broader arena of life.
A-type Personalities
The more competitive you are, the more uncomfortable you are likely to be about incurring losses. From an early age, many of us are programmed to compete: to win; to accomplish; to be top of the class; to always be right; and to succeed at whatever we set out to do. Losses are equated with losing — to be avoided at all costs.
Perfectionists
Not all perfectionists are A-type personalities. Many procrastinate, or avoid competing altogether, to avoid failure.
Beginners
Newcomers to trading often start off with a string of positive experiences. Unfamiliar with the basics of money management, they are often over-confident and prepared to bet large amounts of their capital in the expectation of further gains.
Traumatic Experiences
Past trauma affects how we view related experiences. A child who almost drowns may be prone to developing a fear of water. Similarly, when hit with the “shock and awe” of a major loss, many traders never recover. They quit trading completely or spend their entire career trying to avoid a repeat of that negative emotional experience.
Developing A Healthy Attitude Towards Losses
Avoid chasing after the perfect system that promises to eliminate losses.
Don’t equate losses with failure. In fact, complete elimination of losses should be seen as a failure — you are likely to have eliminated most of your gains as a consequence.
Distinguish between abnormal losses and the small losses normally incurred by any trading system.
Accept that small losses are an unavoidable part of trading — and that you will regularly incur them. They are as much a part of trading as are profits.
Most successful traders, enjoy success rates no greater than 50%. What they are able to do, however, is to restrict the size of their losses while realising substantial gains on their successful trades.
Focus on the collective effect (maximising your overall gain) rather than on the impact of individual transactions.
Happy trading and remember…
Mums the word
Marketmum
Stock Market Investor
Planet Wealth Blog © 2007
