Iâve reviewed all the mistakes I made in my first 2 years of trading and believe Iâve pinpointed the greatest threat to traders at any level, from beginners to professionals: Strong opinion.
It can occur in various ways, but the most common scenarios are:
1) You see a strong pattern happen again and again and again. (Or you run a ton of backtesting analyses and pinpoint a particular âif X, then Y, which leads to Zâ pattern.) You are ready to hit a real home run as you see the pattern setting up! You put on a trade assuming it will âlead to Zâ like it always does. When price moves against you (and the predictable pattern is violated), you figure itâs an anomaly and you either a) add to the position to improve your cost basis, or b) just hang on to the loser because it will eventually become profitable; itâs just taking a detour this time.
2) You form an opinion about a stock (or a futures market) based on fundamentals. Price has moved ridiculously far from where it should be fundamentally based on fair valuation. You put on a trade, knowing that the market participants will soon come to their senses and price will revert back to a fair value based on the underlying fundamentals of the company or market. Price continues to move even further from what is reasonable, and you either a) add to the position to improve your price, or b) just hang on to the loser because it will eventually become profitable when the market comes to its senses and realizes the error of its ways.
The major mistake you make in these scenarios is forming a strong personal opinion about whatâs âfairâ and ârightâ and âreasonableâ, or about what will definitely happen next, and projecting it onto the myriad of market participants who have so many different reasons for buying or selling that your opinion really means nothing. The other mistake is that your opinion is so strong that you add to, or hold on to, a losing position until the loss reaches a level that you would never allow based on your risk:reward trade management rules. Finally, you throw in the towel and thatâs often very close to the point that price actually does turn around and move your way.
If price turns and moves your way after you take a heavy loss, this leads to another major threat to a traderâs survival: After you took the massive loss, you were proven right! You were right! You just werenât patient enough! If youâd just held on a bit longer, or better yet, added aggressively to the position just when you were about to throw in the towel, you wouldâve made a profit! You took a loss needlessly!
And now the stage is set for what could end up being the final nail in a traderâs coffin. The trade based on one of the scenarios above where you refuse to throw in the towel, because you will NOT get burned again and made to look like a fool the way you did you did last time.
When you see a trader knock off steady profitable weeks, week after week after week, then give most or all or more of it back on a single trade, I would say the majority of the time itâs a result of the psychological traps described above.
What can make this psychological trap especially dangerous is a long, long period of successful trading using the âif X, then Y, which leads to Zâ method. This creates a sense of complacency. It lulls you into believing youâve conquered the market. You are one of the 1% elite who has what the other 99% donât! What you actually have is the lethal cocktail of Ego + Strong Opinion.
I think this is why you read of so many success stories that began with huge losses, or more than one account blowup, finally leading to a humble respect for the market and the risks it holds. And sometimes even that isnât enough and some of the finest traders in history lose it in the end.
There are times when a trade simply goes bad very suddenly and unexpectedly and if youâre overleveraged and unhedged it could wipe out a good portion of your capital. (Trading halts, sudden news or rumors, a black swan event such as 9/11, etc.), but I really believe most blowups are the result of Ego + Strong Opinion.
If anyone has a story that fits these scenarios, tell your story here in the hopes it prevents traders at any level from making (or repeating) these same mistakes.
It can occur in various ways, but the most common scenarios are:
1) You see a strong pattern happen again and again and again. (Or you run a ton of backtesting analyses and pinpoint a particular âif X, then Y, which leads to Zâ pattern.) You are ready to hit a real home run as you see the pattern setting up! You put on a trade assuming it will âlead to Zâ like it always does. When price moves against you (and the predictable pattern is violated), you figure itâs an anomaly and you either a) add to the position to improve your cost basis, or b) just hang on to the loser because it will eventually become profitable; itâs just taking a detour this time.
2) You form an opinion about a stock (or a futures market) based on fundamentals. Price has moved ridiculously far from where it should be fundamentally based on fair valuation. You put on a trade, knowing that the market participants will soon come to their senses and price will revert back to a fair value based on the underlying fundamentals of the company or market. Price continues to move even further from what is reasonable, and you either a) add to the position to improve your price, or b) just hang on to the loser because it will eventually become profitable when the market comes to its senses and realizes the error of its ways.
The major mistake you make in these scenarios is forming a strong personal opinion about whatâs âfairâ and ârightâ and âreasonableâ, or about what will definitely happen next, and projecting it onto the myriad of market participants who have so many different reasons for buying or selling that your opinion really means nothing. The other mistake is that your opinion is so strong that you add to, or hold on to, a losing position until the loss reaches a level that you would never allow based on your risk:reward trade management rules. Finally, you throw in the towel and thatâs often very close to the point that price actually does turn around and move your way.
If price turns and moves your way after you take a heavy loss, this leads to another major threat to a traderâs survival: After you took the massive loss, you were proven right! You were right! You just werenât patient enough! If youâd just held on a bit longer, or better yet, added aggressively to the position just when you were about to throw in the towel, you wouldâve made a profit! You took a loss needlessly!
And now the stage is set for what could end up being the final nail in a traderâs coffin. The trade based on one of the scenarios above where you refuse to throw in the towel, because you will NOT get burned again and made to look like a fool the way you did you did last time.
When you see a trader knock off steady profitable weeks, week after week after week, then give most or all or more of it back on a single trade, I would say the majority of the time itâs a result of the psychological traps described above.
What can make this psychological trap especially dangerous is a long, long period of successful trading using the âif X, then Y, which leads to Zâ method. This creates a sense of complacency. It lulls you into believing youâve conquered the market. You are one of the 1% elite who has what the other 99% donât! What you actually have is the lethal cocktail of Ego + Strong Opinion.
I think this is why you read of so many success stories that began with huge losses, or more than one account blowup, finally leading to a humble respect for the market and the risks it holds. And sometimes even that isnât enough and some of the finest traders in history lose it in the end.
There are times when a trade simply goes bad very suddenly and unexpectedly and if youâre overleveraged and unhedged it could wipe out a good portion of your capital. (Trading halts, sudden news or rumors, a black swan event such as 9/11, etc.), but I really believe most blowups are the result of Ego + Strong Opinion.
If anyone has a story that fits these scenarios, tell your story here in the hopes it prevents traders at any level from making (or repeating) these same mistakes.
