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Trading is NOT Investing

I'm writing this from the perspective of a trader. Traders encounter problems and situations quite different from those of an investor. Traders generally do not hold positions for many weeks, months, or years.

Many traders do things that aren't in their own best interests—even though common sense warns of the consequences. Why do smart people make such mistakes? And how can they reverse the pattern? What is behind self-defeating behavior—and how can we change negative patterns?

What is self-defeating behavior? It is any behavior that keeps people from reaching their goals. It ranges from holding a grudge against someone you care about, to being afraid to pursue a career change.

Each time we engage in self-defeating behavior, we suffer in major ways:

We have to put energy into repairing the outer damage -- making peace with people we hurt... and/or straightening out projects that were fouled up.

We have to deal with the inner damage that we've done to ourselves -- shame, guilt and the resulting belief that we don't deserve happiness. These mental messages can lead to even more self-defeating behavior.

Self-defeating behavior also undermines your credibility. People who engage in a lot of it may be pitied, but they are never respected.

What are the most common types of self-defeating behavior? By far, procrastination is the most common. We put off tasks that intimidate or overwhelm us—ignoring the fact that the more we put them off, the harder they become.

Procrastination isn't an issue of laziness but of loneliness. Most tasks we put off are things we're trying to accomplish in isolation. Asking someone to help you or ride hard on you can help you focus.

When there's no one handy to turn to, I've found it helpful to think about people from my past who believed in me when I didn't believe in myself.

I'm motivated by my desire to honor the people who said to me, "You're better than this. Just get it done!"

Another common self-defeating behavior is not admitting that you made a mistake. You can't learn from a mistake—or do things differently—unless you acknowledge that you made one.

Why do people get in their own way so often? Self-defeating behavior actually starts as a way of coping. When you are tense or upset, you grasp at whatever will make you feel better at that moment.

What makes self-defeating behavior so hard to change is that it works. You do feel better—in the short term. And the prospect of feeling better overrides your concern about consequences.

Example: You start to enter a trade but then freeze up before making the actual entry.

How do people get in their own way relative to the market action? One mistake is to insist on being right all the time.

Among traders, a common self-defeating behavior is failing to listen to the market. Traders feel anxious and want to regain control, so they don't pay attention to what is actually happening.

Example: You draw a trendline and then convince yourself that prices must retrace to that trend because they have done it before.

A better approach is to learn about how to think through sticky situations.

Example: "How do you make the decision that a market is dangerous? What are some things you could do next time you want to stay in a trade later than you planned?"

What's the best way to stop defeating yourself? Learn to reflect instead of react. The next time you're faced with the consequences of negative behavior, take out an index card and write down your answer to this question: If I could do this over again, what would I have done differently?" Carry the card with you, and look at it the next time you are tempted to do the same foolish thing.

Asking a friend to be your "sponsor" can also help. The two of you pick a habit that each wants to change. Check in with each other at least once a week to offer encouragement and hold each other accountable—but, never, ever trade with someone as "partners." Trading is a lonely business—accept that truth.

How can we get ourselves to stop and think instead of acting automatically? The key is awareness. Here's a simple technique called the Six-Step Pause. You can use it any time you're upset or under stress.

Physical awareness. Where do you feel the tension? Pinpoint it—a knot in your stomach? Tight shoulders? Etc. and give the sensation a name.

Emotional awareness. Attach an emotion to the physical sensation.

Example: "I feel angry... bored... afraid, etc."

Impulse awareness. Complete the sentence, "This feeling makes me want to..." Fill in the blank with your immediate emotional reaction.

Consequence awareness. Answer the question, "If I respond this way, what's likely to happen?" Think through all the possible consequences.

Solution awareness. Complete the sentence, "A better thing to do would be..."

Benefit awareness. Finish the sentence, "If I try that strategy, the benefits will be..." List as many as possible.

With practice, you'll run through the steps quickly, and be on your way to breaking self-defeating patterns.

Throughout the years I've been writing, I've often written about mind set—having, the right frame of mind for your trading so you become a winner.

I've stated that it is our job to trade the present, not history, and not the future. This is vastly different from investing where you pay attention to both the past and the future.

The future is the next bar on your chart.  You can't possibly know how it will develop, how fast prices will move, or where it will end up. Since none of us know where the very next tick will be, it's impossible to know where the tick after that will be or the tick after that, etc. All we know at any one time is what we're seeing. Interestingly, what we're seeing may not be true.

If we are day trading, we are not sure that what we're seeing is a bad tick, especially if it is not too far astray from the price action. Yet those are the kinds of errors we have to put up with in the trading business.

It is because of errors that there are problems with back testing. Back testing and simulated testing are based on nothing but lies. That's trading plans don't work when you actually put them to the test with real data.

In fact, there are many reasons why back testing and simulation won't work, and I may as well dump them in your lap right here.

Because you are really not sure of the data you won't know if your simulated stop was taken out or not.

If you say you have a system in which if you get three up days followed by a down day, the market will be up twelve days from now 82% of the time, then your whole statistical universe may have been based on what is not true.

When you see a complete bar or candle on a chart, you have no idea which way prices moved first. You don't know if they moved down first or up first. You don't know whether or not prices opened and then moved to the high, went down to the low, and then traded in the lower half of the price range until the close, at which time prices soared up to the high and closed there. You have no idea of the overlap. I've seen prices trade from one extreme to the other more than once at each extreme.

In any of those instances, your protective stop could have been taken out intraday.

You know nothing of the market volatility on any given day. Were prices ticking their normal, exchange minimum tick, or were they ticking two or three times the minimum every time prices ticked due to a report, a speech, or some economic incident?

Even if you purchased tick data for your simulation, showing every single tick the market made, you don't know what the volatility was. For instance, you don't know if the S&P was ticking five minimum fluctuations per tick or twenty-five minimum fluctuations per tick, and if it was doing it quickly or slowly. You don't know and you can't know, and anyone who tells you their simulated system works, based on such phony data, is a liar.

Not knowing how fast the market was means you can't really know what the slippage might have been; The faster the market, the greater the slippage. You can sit there and say that you would have gotten in at a certain price or that you would have exited at a certain price, but if you don't know the market volatility, and how fast the market was, you do not know enough to say that you would have done such and such. Not knowing how fast the market was, you have no way of knowing how much slippage there would have been on your entry or your exit. Without knowledge of slippage, you can't possibly know the risk.

That is also true of volatility. Volatility is made up of range of movement, speed, and tick size. If you don't know the extent of slippage, you will not know the extent of the risk you would have encountered.

As if that's not bad enough, you also don't know how the liquidity of the market was at the time you would have traded it. If you are position or swing trading, you can't go by the reported daily volume, because there is no way to know what the volume was at the time your price would have been hit. So here again you have no idea of what slippage you might have encountered, and once more you would not have known the risk.

If you want to spend your money on trading systems based upon the unknown, then you must assume the risk of doing so. Since this is a business of assuming risk (price insurance), you are entitled to insure prices in any market that you care to.

Insurance companies spend a lot of money to make sure that the risks they take are actuarially sound. That is the equivalent of finding good, well-formed, liquid markets to trade in. But any market can become totally chaotic. Markets can become extremely fast, and they can become quite volatile. So even if your system was back-tested in a liquid market, when that market becomes fast and/or volatile, your back-tested, simulated system will not be able to cope with it and you will lose. It's like going out to write life insurance on a battle front.

If your back-tested, simulated system does factor in some room for fast and/or volatile markets, then, when you will be trading in slow, non-volatile markets with the built in factor, you will be utilizing a system that is totally inappropriate for the slow, non-volatile market you are in. The best you can hope for is an "optimized" system. How can you possibly expect to compete with traders who are acting and reacting to the reality that is at hand at the time?

Back-testing is for historians, not traders. It is the wrong view of the markets. Your trading must be forward looking without being ridiculous about seeing into the future.

If you don't know where the next tick is, how can you possibly know where the next market turning point will be? Can you see into the future?

Maybe you like to trade astrologically. Those people are always trying to peer into the future.

In the auto business they have a saying, "There's an ass for every seat. "Likewise, there's a fool for every fortuneteller who claims he can see into the future.

You could always do as one charlatan did and run the biorhythm for each market based on the day it first started to trade. Or, you can cast the markets horoscope based on the same date. With the biorhythm, you'll know what time of day the market should be on its highs, and what time of day it will be on its lows, and if you believe that, you have no business trading.

They will tell you that you will know which day the market will be ecstatic and reach a new high, and which day it will be down in the dumps and make a new low. However, you'll find that from time to time the market will reach new lows on the day it was supposed to reach new highs. Well, that's easy enough to explain. You can tell everyone "We've had an inversion. Until the market inverts again, the lows will be the highs, and the highs will be the lows!"



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Comments 1

Mark Perreault on Friday, 23 July 2021 10:39

Great article Joe! Biggest take away for the was the perspective on procrastination. Loneliness not laziness.. I've wouldn't have seen it from that point of view.
Thank You for that little gem.

Great article Joe! Biggest take away for the was the perspective on procrastination. Loneliness not laziness.. I've wouldn't have seen it from that point of view. Thank You for that little gem.
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Tuesday, 07 December 2021

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