Psyche: A Trader’s True Moat
Week 6 ends with Risk Management and Trader Psychology under Javi Medina’s mentorship. This was pretty much an interesting topic, with various experiences shared on the importance of setting cut losses, managing emotional hangups, and understanding the phases that a trader undertakes. In this session, we have also had the opportunity to meet three CTS Global Equities (formerly Citisecurities, Inc) Traders from various generations. Among the interviews done during the session, there is a statement of Tipi Oblea that caught my attention the most throughout this session:
“You see, we are all caught up in the excitement just like now… We see people flashing their portfolios… their sports car… or whatever… their successes. Here is Arthur Cutten, an underdog, just doing his work. So my point is, actual and during trading success is done in the quiet. It is not noisy. It is doing your work every day, every year – being disciplined and accumulating money slowly.”
I share the same stance as Tipi in valuing trading psychology on three points: (1) The end does not justify the means (2) Consistency matters, and (3) Emotions influence decision-making.
The end does not justify the means. Perhaps this is one of the most neglected adage not only in life, but also in the trading world. Many of the traders use rationalization as a defense mechanism to believe that “everything ended according to plan” just because they were able to get out of a trade with a positive return. This action reinforces the bad notion that “I can get into a trade well and be good afterall”. The main problem with this unmanaged behavior is that you are slowly believing that you have a plan, where in fact, you do not have one. As we have always emphasized in the healthcare parlance, what is not written is not done. When one continuously maintain illogical trading behavior and fail to objectively explain their trading plan, they are more prone to encounter psychological struggles in the long run.
Consistency matters. Many traders often opt for the jackpot trades and quick wins in this modern day world where everything is instant – from noodles to placing orders. We are often caught in a storm of euphoria when things go extremely well. But we often dismiss big losses thinking that the next trade will be a good one anyways. This mindset slowly buries you in a vicious cycle of undisciplined trading, risking big to win big. When you take into consideration your analytics (i.e. hit ratio and edge ratio), you will soon realize that you are losing more even when taking profits when you allow huge losses.
Emotions influence decision-making. Many aspiring traders often put a premium on the numbers, but often neglect following their plans – assuming they have one prior to entering the trade. Most often than not, they have a system to begin with that allows them to objectively enter, cut losses and exit a trade – ONLY if they religiously follow their system. Common trading pitfalls includes not cutting losses, oversizing and overtrading. As to why this happens, it may be important to check the influence of emotions on the decision-making process of traders. A study made by Fenton-O’Creevy, et. al. (2010) highlights key themes on the influence of emotions and their regulation to the traders’ decision making process, including: (1) Mood swings induced by prior trading outcomes are a significant (detrimental) factor in traders’ decision making; (2) Trader managers play an important role as regulators of traders’ emotions; (3) Affectively cued intuitions play an important role in traders decision-making; and (4) Experienced high performers were no more or less likely to report relying on intuition than experienced low performers. In fact, their paper concludes that:
“… emotions and their regulation play a central role in traders‘ decision-making. We find differences between high and low performing traders in how they engage with their intuitions, and that different strategies for emotion regulation have material consequences for trader behavior and performance. Traders deploying antecedent-focused emotional regulation strategies achieve a performance advantage over those employing primarily response-focused strategies. We argue that, in particular, response-focused approaches incur a performance penalty, in part because of the reduced opportunity to combine analysis with the use of affective cues in making intuitive judgments.”
Unlike any other topic we have had so far, this concept perhaps is the most tricky as many traders think they emulate what they have heard from lectures or read from the books. A trader may find it easy to understand principles and practices in dealing with emotions. However, are we really ready to sustainably practice the principles? Or are we just like those who preach what they don’t practice and are labelled as “sustainaBABBLE”?