Eureka! I’ve found it. Just when I was tinkering with the idea, I came across a very unique trading gem in Best Losers Win. The author suggests that since 90% of traders lose in the long run, do the exact opposite of what they do. That sounds logical to me! The suggestions made from a boots on the ground vantage point come to the same conclusion that I have come to from a trading brain based perspective. Let me explain.
As a trader you create an expectation for your trades. Your brain loves certainly so we are always predicting what will come next. Predicting and forecasting involves you guessed it, the prefrontal cortex. Uncertainty is threatening to your brain. You will do nearly anything to avoid uncertainty. Our neurology defaults to constant prediction to alleviate this uncertainty.
If you have an expectation that your traded long position will go higher, and it does, you are happy. But you are also fearful that you may lose that gain if you don’t exit now. Fear stimulates your brain’s emotional control center, the limbic system, crowds your PFC with useless actors(other opinions, fed speak etc.), and inhibits your perceptions and choices. You exit with a small to moderate win and start over. Most traders do this repeatedly. I certainly did in the past.
The next day you look at the trade you exited and see the position rocket higher. It continues higher for the next two weeks. Arrgh!
What if instead of expecting your trade to move higher, you expected to be wrong on your trade? You expect the long trade will not work out and the position will go lower, against your long position. If it does go lower, you were right, the trade didn’t work, and you can exit for a small loss. No emotional turmoil, it was what you expected. Now comes the trade that 90% will not do. A position short by selling short or buying puts.
If the position does go higher, something you didn’t expect, there is no need for emotional euphoria or fear, you are profiting unexpectedly. Your limbic system remains stable. You stay in your long position and ride it to the profit land. Now for the icing. You add on to your winning trade. That is something I suggest 90% of traders don’t do.
When favorable cards turn up, add to your bets.
One Up On Wall Street —Peter Lynch
Now let’s look at the other side of what 90% of traders do when they enter a long position which they expect to go higher, and the position goes lower. Do they exit with a small loss? Hell no. Unmet expectations are threatening, crowding the stage of the PFC. Perceptions are limited and skewed in a fear response. Instead, they add on to the position. Mr. Ego steps in and has to be right. Instead of adding on to their winners, they add on to their losers. They ride the loser until they just can’t take the pain anymore and exit with a hefty loss. Combining their hefty losses with moderate to small wins leads to the inevitable statistic of 90% of traders losing money in the long run. Even if they are right and take 60% or more of trades as small winners, the hefty losers wipe them out.
You won’t improve results by pulling out the flowers( selling winners with small gains) and watering the weeds(adding to losers). But that is exactly what traders do on nearly a daily basis. Our own brains are not wired to trade. Our brains are wired to keep us alive, and it has been effective for thousands of years. But trading is a different beast. It’s not a saber-tooth you are confronting. It’s a ticker on a screen.
Rewire your brain to develop skill sets that set you apart from 90% of traders. Trading is unlike any other profession. This takes time and repetition, but it is doable. Ready to be in the top 10%?
- Set your expectations that your trade will be wrong.
- Exit your losers quickly and consider trading in the other direction.
- If your trade is an unexpected winner, add to it.
Enuf said.