Yesterday I wrote that investment success requires consistent execution of our risk management and trading plans. In ‘Taking It Seriously’ (April 3 edition of ‘Psych Cap Tips & Tricks‘), Denise Shull suggests that it is not possible to execute a plan without an element of discretion - unless you are running a mechanical system that executes using a robot or computer.
This is a point traders often overlook and it brings together 3 strands I have written about:
- The fact that our hand-wiring leans us toward being systematic or impulsive. Both modes have advantages and disadvantages.
- The trader’s preference for intra-day trading or end of day trading.
- The trader’s preference for mechanical or discretionary.
I wrote about items (1) and (2) in Day Trade?
Let’s tie the three factors together. The shorter the time frame, the more discretionary the trading method, and the more we lean towards the impulsive decision-making mode, the greater the element of our discretion in our decision-making. Knowing this, will allow us to identify the style that best suits us.
It’s important to do so because humans suffer from hindsight bias: once we know the result, we tend to think: ‘we always shoulda, and coulda known it’. As a result we tend to beat up ourselves with the consequent adverse effects on our trading.
Yesterday I was speaking with one of my mentor students. He was an ex-pit trader who periodically blew up and has the potential for doing so. The problem is not his decision-making style (his profile fits the description above) but the refusal to pre-define his risk. The fact that he does not blow up more often is a testimony to his natural talent.
To ’solve his problem’ he has resorted to trading within a given set of rules. As a result, when the inevitable large loss occurs, he points to the fact that he ‘broke his rules’ by not following his check-list.
But he is missing the wood for the trees. The only rule he needs to observe is to define his risk as soon as he has entered the trade - recall I said in Day Trade? that for the Impulse mode, the natural process is to act first, evaluate after. For this mode, the ’sin’ is not to evaluate.
The point I am seeking to get across is that our optimum decision-making is a product of our DNA and personality. It’s to our advantage to recognise what it is and work with it.
Refer this blog post to a friend or colleague…
