Trading to win vs. trading to not lose
Once upon a time three people each gave $100,000 to a money manager in what
they hoped would be a highly profitable venture. The money management firm
adhered to a carefully tested trend-following methodology. It set up separate accounts for each
client and managed each of the accounts identically. Risk never exceeded
3.5% of capital on any market traded, and the average historical loss per losing
trade was under 2%.
The first client was retired and filled with wanderlust. So, he decided
to take off and travel the world. He didn’t return for 14 months. In
his stack of mail when he arrived home were 14 brokerage statements. He
sifted through them and opened the most recent one. He was pleasantly
surprised to discover that his initial investment had grown from $100,000 to
$227,000.
The second client was also hoping for above average returns on her $100,000
investment. As soon as she received her monthly brokerage statements, she
quickly opened them to see how well her account was doing. For four months
in a row, she watched her account balance grow from $100,000 to $170,000.
Needless to say, she was thrilled.
Then, however, things seemed to change. Over the next two months, she
watched her account balance fall from $170,000 to $161,500 and then to
$133,000. That $37,000 drop in two months really spooked her. She
worried that, if it were to continue, she might be back to breakeven or even
worse. She called the manager and closed her account, walking away with
$137,000.
The third client was different. He had a lot of time on his hands and
was computer literate. He loved the idea that he could check his account
online anytime, 24 hours a day. Since he was home most of the time, that’s
exactly what he did.
For the first month, he only checked his account once or twice. At the
end of the first month, he was pleased to see his account was up by over
$20,000. The next month, he decided that he wanted to take a closer look
and see how the manager achieved such fine returns. At least once a day,
he logged onto his account and tried to understand it.
As he watched his account day after day, however, he became nervous. On
some days, he’d see his balance grow by as much as $15,000, only to see it drop
$5000 the next. He wondered what in the world was going on. So,
instead of checking his account daily, he decided he’d better watch it at least
two or three times a day. Sometimes he’d see nothing at all; other days,
he’d see his balance change dramatically. Although his account was up
another $20,000 at the end of the month, he found the movement in his account to
be intolerable. He called the manager, closed the account, and walked away
with $140,000.
There was one money manager handling three identical accounts in an identical
fashion. After the first two months, each account had grown by $40,000,
but the third client had quit. After another four months, the remaining
two accounts had grown by at least $37,000, but the second client had
withdrawn. After 14 months, the first client, who had not quit, saw his
account grow from $100,000 to $227,000.
What set these clients apart from one another?
Their investment was conceptualized on one timeframe, but two of the
clients managed the investment on a shorter horizon. We see the same
dynamic among traders who get shaken out of good trade ideas when they replace
their profit targets with tick-by-tick market scrutiny. Take Friday’s
trade, for example. Shortly after the jobs report, we spiked to 1324 on
the S&P futures, pulled back, and then failed to take out that level as
interest rates soared. By the time the market opened for its regular
session and bounced back to 1322, market weakness was apparent. As I
posted to my research blog, only two of the 17 stocks I track in my basket of
representative issues were making new highs for the week despite the seeming
S&P strength. A trade back to the previous day’s midpoint of 1316 was
statistically likely, providing quite a few points of profit potential. A
couple of upward jukes of more than a point each, however, were enough to scare
many traders out of milking that trade.
Anxiety results from the perceived threat of uncertainty. Once we have
a profit in a trade, we have something to lose. Uncertainty is now
perceived as a threat. That leads us to cope by asserting (over) control,
managing the trade on a different timeframe from the one that had initially led
to the trade. At that point, we are no longer truly managing the
trade. Instead, we’re managing our own anxiety.
That is the very definition of emotional disruption of trading: when
what we do to avoid loss prevents us from winning. The ability to
tolerate uncertainty separates the trader who trades to win from the one that
trades to not lose. We can only benefit from demonstrated edges in the
market if we can allow those edges to unfold. But how can we learn such
patience? Brett’s next article will outline ways we can improve our
ability to sit in good ideas.
Adam Mann is a technical writer with Wildwood Partners, LLC,
an Arizona-based firm that researches and develops trading strategies across
multiple markets. Over the course of eight years, Wildwood Partners has
developed its own proprietary model that has demonstrated above average
performance while trading a real-time virtual account. It combines pattern
recognition with breakout and trend following concepts.
Brett N. Steenbarger, Ph.D. is
Associate Clinical Professor of Psychiatry and Behavioral Sciences at SUNY
Upstate Medical University in Syracuse, NY and author of The
Psychology of Trading (Wiley, 2003). As Director of Trader Development
for Kingstree Trading, LLC in Chicago, he has mentored numerous professional
traders and coordinated a training program for traders. An active trader of the
stock indexes, Brett utilizes statistically-based pattern recognition for
intraday trading. Brett does not offer commercial services to traders, but
maintains an archive of articles and a trading blog at www.brettsteenbarger.com
and a blog of market analytics at www.traderfeed.blogspot.com.
His book, Enhancing Trader Development, is due for publication this fall
(Wiley).