The stock market is often likened to a casino, and there are parallels. In both venues, people put money to work in anticipation of rewards, while cognizant of the risks. Games of chance, however, have defined end points, when you know whether your bet was successful.
Equity trades and investments in the stock market, however, do not come with an expiration date. That circumstance increases the potential for both risk and reward and makes active traders more vulnerable if their trading psychology is flawed. So how do we avoid these costly mistakes? Stay away from Death by opinion.
One of the most common and costly psychological mistakes is getting stuck in an opinion. One trader I spoke with has been holding puts during the recent 50-point rally in the S&P 500. As the market rose, he just didn’t believe it would/could/should continue to rally while XYZ was happening in Europe.
He got stuck in an opinion. He forgot that in the market casino anything is possible. So… as active traders how can we protect ourselves from self-sabotage at the hand of our own opinions?
At casinos, wise participants expect to lose because statistically we all know that the average gambler does not have an edge and casino operators work diligently to make sure that they maintain a slight advantage. You will get ejected and banned if you are discovered using methods that circumvent these measures.
The market however, is like a casino in heaven that allows you to bet with the aid of computer assisted real-time analysis. You are permitted to analyze every card that’s been played by every player in the casino, if your computer can handle that amount of data this is called the Traders Advantage.
You can analyze trends and apply forecasting algorithms with impunity and never get banned. You can discuss your strategy with experts; people who basically live there. Moreover, you can act on your market intelligence instantaneously and do so for a very modest fee. Your fixed cost is the commission you pay and you get to keep all your profits.
This is a much more generous and user-friendly situation than any casino would ever tolerate. To take full advantage of it, learn to trade by the numbers (i.e., mathematically). You will still have opinions, but they will probably be held less tightly than before. The less invested in them you are, the better you will do.
Until Next time,
Dr. Kenneth Reid holds a Ph.D. in Clinical Psychology. He is currently a trading coach and has published articles for Forbes, SmartMoney, and SFO Magazine. He has also appeared on CNBC and writes a column on The Trading Psychology for Trader Planet. Kenneth Specialized in trading stock and futures and is working on a futures trading book.