Fear Vs. Uncertainty in Trading

[Tradewinds 12]

If you know with certainty that your trade will work 70% of the time and that the average loss will be <= the average win then how can there be fear?

 

The increase in confidence that I continue to build, comes from knowledge and a deeper understanding of the market I'm interested in. So my main weapon against fear is the certainty. I see this as my foundation. There is no way around facing down the fear, and doing the emotional "work", but I want to do the emotional work while I'm standing on solid ground, not quick sand.

[davidjohnhall 10]

Thank you Ingot54 for sharing your insight and the knowledge that comes from your life experience and trading experience. I enjoy your straightforward approach and your insistence on doing the work -- that work being actual trading and honest self review! Definitely appreciated.

 

David John Hall

[MightyMouse 12]

EDIT: I do have to agree with your opening statement, Rande -

 

"Trading does not come natural to the human brain. For the vast majority of traders, it has to be learned."

 

I have disagreed with Rande's statement before. Trading does come naturally. Through our social interactions, religious beliefs, and upbringing we learn to become non-traders, but we are born with the the basic characteristics needed to trade.

[davidjohnhall 10]

I have disagreed with Rande's statement before. Trading does come naturally. Through our social interactions, religious beliefs, and upbringing we learn to become non-traders, but we are born with the the basic characteristics needed to trade.

 

Hi MM -- I agree completely!

 

My girlfriend's son has started asking her to buy chocolate chip cookies for lunch -- not because he wants to eat them -- but because they make great trading chips (pun intended) at lunch and he can use them to trade up for other items.

 

I was laughing hard when I heard this the other day. I used to trade toys and Star Wars cards and all sorts of things when I was a kid. You have something I want, let's see if if I have something you want and let's make a trade.

 

In trading, I have money and you have a position. If you want to get out of your position and I like your price we have a trade. Bill Williams states that a trade happens when two people agree on price but not on value. I love that definition and say that one of the best things you can do is learn the value (through technical analysis or fundamental analysis or both) of what you are trading.

 

David John Hall

 

 

Wanna trade?

[matt.stokes1 10]

Thanks too Ingot54 for your passionate and thought provoking response.

 

 

 

I think Rande's point is that Trading does not come natural to the human brain and that it has to be learned. If a humans starts trading using his/her natural instincts, then they will likely lose money in the long run. You could certainly argue that a significant percentage of these losers may not have purchased or developed a system with a demonstrated edge and that is in fact the reason for their failure. But I believe that you could give a new trader a profitable system with the entry and exit rules spelled out in simple terms and he/she would still lose. Why is this? I think its because our natural, built in behaviour cause us to override the rules of the system. I think Richard Dennis said that he could print the rules to for his Turtle system on the back of the national newspaper and people would still not be able to follow them.

 

So the questions I would ask here are 1) Why is this? and 2) What can be done to overcome this?

 

With regards to 1), I believe this is the focus of Rande’s initial post. He suggested this is primarily because of fear. Why are we afraid? The theory is that humans cannot distinguish between uncertainty and fear. To me this makes perfect sense. Humans are a young very species and our brains are a collection of solutions to problems we faced during the brief period of our evolution. Clearly genes that led to processing uncertainty rationally and without fear did not convey any advantage to our ancestors. It turns out that our evolutionary psychology that was good for surviving African savannahs is bad for trading. I personally have a theory that it wouldn’t matter what psychology we inherited, that it would be exploited in the marketplace. Ie if 100% of humans think a certain way, then a minority will put in the hard work to “change their psychology” to exploit the majority. I think that’s what’s happened today.

 

But I agree with you, this is getting off topic. The WHY humans are poor traders naturally is not anywhere near as important as 2) What can be done about it. Rande doesn't address that specifically in his original post, but perhaps its coming or it exists on his website - I confess I haven't checked. For me knowing WHY helps me approach the HOW to overcome these natural tendencies, but perhaps it doesn’t for you and that’s fine. I just want to make one more point on this. By introducing an explanation for why trading doesn't come naturally to humans does not mean that we are not responsible for our failure - we are, and we have to put in the hard work. Forgive me if I am wrong, but that is how i interpreted your statement:

 

But I am not going to sit here and be told by some other academic that it is because of the animal in me that I am having trouble trading because it is not my fault - it is the 50 million yr old gorilla brain in me!

?

 

With regards to the second question - what can be done to overcome our trading fears? MightyMouse suggested increasing desire. Urma Blume and yourself seem to lean more towards putting the hard work in and developing a system with an edge. After all, if you KNOW that your system has a positive expectancy, what is there to be afraid of?

 

I agree with this 100%, and I think its the first step for any trader to find a system that matches your personality and backtest it extensively across multiple markets to clearly define your edge.

 

I guess my point is that, in my opinion, many traders do this and are still afraid. I really liked how DavidJohnHall broke down trading fears into two simple categories. Fear of Losing money. Fear of Being Wrong. I am thinking out loud here wondering whether putting in the hard yards knowing and defining your edge will help you with the former fear, but not the latter?

 

Traders that need to be right, in my opinion, need to focus on changing the way they think. They need to embrace the uncertainty. I think DavidJohnHall mentioned this too. After all, no amount of market analysis can predict whether a particular trade will work or not. To do that you would need to know what the thousands of market participants are thinking at any moment, which is, of course, absurd. Once you accept that you cannot know what will happen next it liberates you to think in probabilities. You don’t need to be right in order to make money (provided you have defined your edge)…. So why are you afraid of being wrong?

 

 

Great discussion everyone!!

[Tradewinds 12]

I would make the distinction between trading and discretionary risk assumed in the market. If the definition of trading is an economic exchange, then yes, trading comes naturally. But I don't think that is what Rande is talking about when he uses the word, "trading". I think he is talking about something else. I think what Rande is talking about when he uses the word "trading", is about how the typical person deals with a level of risk that is outside the typical human experience. If I trade 2 cookies for a slice of pizza, or a toy car, the risk isn't very high. If I enter a a highly leveraged order in very volatile market, that is very different. Trading cookies for pizza, and walking a tight rope over a river are two very different things. My opinion is, that what Rande is talking about when he uses the word 'trading", are situations, where the risk is a lot greater than what the average person experiences.

Edited March 6, 2011 by Tradewinds

[matt.stokes1 10]

I agree with Tradewinds:

 

The other 2 fundamental differences are:

 

1) When you trade a cookie for a slice of pizza, you are forced to define your risk (the cookie). With trading, nobody forces you to define your risk and you could lose your entire bet, plus more if you're leveraged.

 

2) When you trade a cookie for a slice of pizza, the outcome is certain - you give up the cookie, you get the pizza. With trading the outcome is completely uncertain.

[Rande Howell 10]

I have never heard such pathetic explanation of the human condition in all my decades of walking this planet!

 

I am sorry for your approach and for the beliefs you espouse, Rande. I am not sorry for my indignation, or for confronting on this. You want to reduce everything to the level of the animal - you state as facts that we have animal over-riders governing our every activity, and this is typical of the unwashed academic of today - instead of recognising man as a distinct and unique creation amongst other creatures, you drag him down to the animal. I totally reject this thinking.

 

Yes - you will have friends who nod in agreement, or nod ignorantly - but if this is what your years of study/learning has made of you, I don't think you will ever have anything to offer me. Your caveman theories actually do explain quite well some of the fright/fight or flight theories, but conveniently ignore the unique qualities of man - that of spiritual (note that this is NOT a religious situation, but a spiritual one - there is a huge difference) depth in the human being. I speak of the kind of depth that allows a man to be an over-comer of adversity, through resourcefulness and inner strength.

 

Spirituality is what gives man the transcendent ability to rise above circumstance - to be afraid but act correctly regardless, because he has a certainty within. It is my interaction with higher values that give me a reason to trade, to work, to live my life unselfishly and to contribute and to attempt to bring others up with me.

 

What animal ever does this?

 

The fact that I have been able to basically work out my own trading and my own trading success, without reverting back to my "baboon ancestry" immediately provides me with evidence that your words are simply academic crap.

 

This is nothing to do with evolution, or religion, so before people go rushing in to take this off topic, I want to state that.

 

What it is about is that we have a situation where a human being will be confronted by fear of loss. There are tools available to assuage those kinds of losses, but human beings are basically too lazy and too spoiled by affluence to get out of their own way and learn to master those tools.

 

Instead we are happy to sit here behind behind computer screens and read without question or comment, some academics sprouting theories that are baseless nonsense.

 

I have had my share of study and learning, and I am in my 7th decade of life - all of my life has been spent in the scientific field of chemistry, physiology, biology and medicine. I have a lot more to learn yet. But I am not going to sit here and be told by some other academic that it is because of the animal in me that I am having trouble trading because it is not my fault - it is the 50 million yr old gorilla brain in me!

 

Look - if you want to be unafraid - calm, detached, confident in trading - then you will NEVER achieve that without having an edge, and understanding that edge.

 

Do you think that some trader sitting in the middle of Bombay or Delhi is worried about his "reptilian brain" or what his "limbic system" is preparing for him, or how his "Amydala is interpreting" the move against him of 3 ticks?

 

No - he probably is more concerned about learning to master his trading - he knows that a move of three ticks is not a threat to his financial life, or indeed a physical threat. His "fight or flight" response is to get his head deeper into his technical learning, and his understanding of his trading principles.

 

If people want to listen to this academic nonsense to explain why they are unable to overcome a lack of knowledge, or a lack of mastery in a very difficult vocation, then please be my guest. The cross-infection between Zoology, Anthropology and Psychology is unwarranted and unscientific

 

But I implore all of you - to use the head that you have, that is far above the chimpanzee, to understand that there IS another explanation and approach to overcoming ignorance in how to trade. We do not need comparisons with animals or evolution to explain the laziness of an entitled group who expect to participate in financial markets long before they are technically prepared or trained.

 

Instead we get this pseudo-science fed to us - totally unprovable stuff by the way - that somehow it is not our fault - the problem is in our heads.

 

You have a brain - use it. Get over your laziness and failure to take action.

Educate yourself about the markets you are trading.

Stop making excuses for your own failure to move your butt.

 

Many come into trading thinking that the disclaimers don't apply to them - but that's what they are there for - the markets are going to educate you, unless you educate yourself. And many come into the markets thinking that in a few short weeks they will be able to buy-low-sell-high just like th glossy web-site said.

 

So it doesn't work out quite like that. The "few short weeks" get extended to "a few months" but the reality is that the process may take Y-E-A-R-S to understand all that has to be taken into account. The markets thrive on new participants. And obviously there is quite another parasitic market thriving on holding the hands of those who have not done their homework.

 

If people think that the pseudo-science of the animal kingdom is going to make one scrap of difference to the required knowledge of what to do when the market turns against you, then please - continue. I belong to a group of traders who KNOW I am much better than that - I know how to use my brain to find my own solutions, and I am succeeding at that.

 

And guess what - not a psychological idea in sight! Psychology as applied to trading, glosses over what is actually a very corrupt and dangerous financial pursuit. Those who think they can get their heads straightened out so that the fear of loss they are feeling becomes a bit numb, are deluded.

 

What they really need is a sense of appreciation - to get rid of the "easy-come-easy-go" mentality, and to begin to truly value their money; to get seriously hungry for the knowledge and ability to engage the markets on the correct (technical and strategic) terms; to stop playing in the muddy waters of psychology, which is a cop-out ... a crutch ... an excuse for failure to apply the principles of learning and engagement in difficult financial markets.

 

I get quite angry and feel like abusing those who are lying to traders about what is really necessary to move them from their folly. I find it quite extraordinary that a "professional" person can come onto a forum and peddle such nonsense.

 

It doesn't matter if 100,000 people all believe something that is wrong - it is S-T-I-L-L wrong ... the number who believe it does not make it right. Guess what - the problems will not go away until YOU decide you have had enough. The markets do not exist to give YOU money.

 

What is true in trading is not going to be found in dealing with your so-called limbic system. It sounds nice. It sounds plausible. It creates an artificial void begging to be filled, and lo! here is someone who can fill it for you. In fact there is an ENTIRE industry feeding off such theories today - creating-then-solving mythical problems. The industry has reached critical mass - it is even respectable now, and has its guru's and shining lights.

 

Sorry - I think I am a little above this approach.

 

EDIT: I do have to agree with your opening statement, Rande -

 

"Trading does not come natural to the human brain. For the vast majority of traders, it has to be learned."

 

From there you had a golden opportunity to truly get traders onto the correct path of education.

 

Why didn't you?

 

What is your motivation for persisting with this red-herring of evolution and the Baboon mentality supposedly inherent in traders?

 

 

As I was saying. Talking heads taking on different positions. Please note that my spirituality is of the Christian tradition, I teach Aramaic Christian thought and Christian meditation at my church, and used to be a therapist for Lutheran Familty Services. So it's not like I divorce spirituality from what people see in the mirror when they trade. In fact, I see trading a great place to look into a person's soul. At least his mind. And to truly get to knowt he self.

 

I also have respect for any one who organizes their practices and produces success. I simply have a particular way of viewing improving performance.

 

Rande Howell

[SIUYA 11]

trading pizzas for cookies, is not speculation - and that is what most of us are doing.

Humans are poor risk managers. We would rather take short term gains over long terms gains, we have trouble taking losses, we think we can control what happens in the market (when in fact we can only control what we do in response to the market), when you introduce money into the equation - it changes how we think, we underestimate good and bad luck, remember the times we thought we knew what we were doing and forget the times we completely f...d up.....the list is endless.

humans might be naturally inclined to trade, but they are definitely not wired for speculation.

[MightyMouse 12]

I agree with Tradewinds:

 

The other 2 fundamental differences are:

 

1) When you trade a cookie for a slice of pizza, you are forced to define your risk (the cookie). With trading, nobody forces you to define your risk and you could lose your entire bet, plus more if you're leveraged.

 

2) When you trade a cookie for a slice of pizza, the outcome is certain - you give up the cookie, you get the pizza. With trading the outcome is completely uncertain.

 

Matt,

 

It may not be as obvious as the exchange of a cookie for a slice of pizza, but an exchange is being made with a certain outcome or you will not enter into the trade.

 

Some traders know how to trade. Call them accomplished. They will trade only when they are reasonably certain that they can take money from the market. They put up their money with an expectation of getting back money plus gain. So he wins.

 

A new trader will take a trade knowing that there is a tuition to be paid to learn and he is willing to pay that tuition because he wants to become an accomplished trader. He gets back money minus tuition plus the utility from the lesson learned, but the value of the utility for which he paid tuition, is far greater than the actual loss, so he wins. If the value he gains from the utility gets smaller and smaller and his loss does not get smaller and smaller, then he will stop trading or become a seasoned loser.

 

A seasoned loser who has no chance of becoming an accomplished trader will continue to trade and lose. He is getting some sort of pleasure out of it (like gambling) or he would not continue trading. He is getting back money minus loss plus utility gained from trading. So he wins.

 

Oddly enough the accomplished trader can enter a long with 10 contracts and win money from the new trader and the seasoned loser and all three can win even though 2 of them lost.

 

Yes, I am missing quite a few reasons to trade to make this a complete analysis, such as hedging, portfolio rebalancing, and etc., but i am not going to do that in 200 words or less.

 

You can also gather from this that the accomplished trader can only profit to the extent that the new trader and the seasoned loser continue to gain a high enough utility from trading in spite of their losses. Casinos parade hot waitresses around to keep the gamblers interested in coming to the casino. Maybe traders need hot brokers to spice up the markets and keep them here.

 

MM

[davidjohnhall 10]

I would have to say that trading cookies for pizza is certainly speculation. Don't think with your adult brain - think like a 10 year old about the matter.

 

You are taking your cash (not easy to come by when you're 10) and buying cookies with the sole intent of trading them. What if the demand for cookies drops off? What if the cost of cookies for pizza doubles? What if another student decided to trade twice as many cookies for the same pizza?

 

Trust me - these kids are making complex transactions. LOL I think even Buffet once gave credit to selling bubble gum as a 5 year old for his introduction into business and that he rarely uses abilities outside what he learned during that endeavor.

 

When it comes to your risk - you had better make sure you are defining it. And if you are not defining it just assume you are risking it all. Rarely do I ever feel any more pressure trading dollars for stocks than Eric feels trading cookies for...whatever he trades them for (I don't think I ever mentioned pizza in my first post).

 

In his recent book - You Already Know How To Be Great - Alan Fine discusses how we sometimes let complicated concepts get in the way of execution. He was teaching a tennis student how to hit the ball and her performance was horrible. No matter how many concepts he fed her and how much tennis theory he shoved down her throat he was getting nowhere.

 

Finally he told her that when the ball hits the ground say "bounce" in your head, and then when you are to hit the ball say "hit" in your head. This player's performance immediately increased 10x. I think our performance in a lot of areas would improve if we sliced and diced them with Occam's Razor. LOL

 

David John Hall

 

 

Bounce...hit...bounce...hit...

 

Cookies...pizza...cookies...pizza...

 

Money....stocks....money....stocks...

[Tradewinds 12]

After reading that article and studying it, I realized that I'm trying to be perfect all the time, and that I don't need to be perfect. And my perfectionism comes from a fear of what other people might think of me. But the market doesn't even know that I exist. The market won't praise me if I win, or insult me if I loose. It is neutral to me personally.

[MightyMouse 12]

After reading that article and studying it, I realized that I'm trying to be perfect all the time, and that I don't need to be perfect. And my perfectionism comes from a fear of what other people might think of me. But the market doesn't even know that I exist. The market won't praise me if I win, or insult me if I loose. It is neutral to me personally.

 

The market wants you to think you are wrong when you are right and it wants you to think you are right when you are wrong. In sum, it wants you to make mistakes.

 

If you get those feelings when you are in a trade, you are doing exactly what the market wants you to do which means it is in control of you when you enter a trade and you will make mistakes.

 

Profits will come to you when you are in control of yourself.

 

 

MM

[SIUYA 11]

Its a good point DavidJohnHall that its best to keep it simple....but I would wager that your girlfriends son is the exception. most 10 year olds would eat the cookie.....and thats the point. There are few Warren Buffets in the world. (you Tennis story has many similar rings to golf - number one, keep your eye on the ball and swing through it.....forget the rest)

Most of the recent studies have found that introducing monetary issues into many trading/bargaining/social scenarios screws up peoples decision making, changing what was seemingly rational behavior. I dont think there are many instances that show we are naturally inclined to speculate, most show the opposite.

Now that does not mean its hard to learn......but it usually means un-wiring parts of the brain.

 

plus the cookie market is so illiquid and can crumble at any moment, and the pizza market is likely to sag

[davidjohnhall 10]

plus the cookie market is so illiquid and can crumble at any moment, and the pizza market is likely to sag

 

LOL So true, Siuya!

[Rande Howell 10]

The increase in confidence that I continue to build, comes from knowledge and a deeper understanding of the market I'm interested in. So my main weapon against fear is the certainty. I see this as my foundation. There is no way around facing down the fear, and doing the emotional "work", but I want to do the emotional work while I'm standing on solid ground, not quick sand.

 

This is interesting. No matter where your psychology is, you brain is not wired to separate uncertainty from fear in the same why that the brain is wired to trigger to avoidance of snakes and spiders. You can "know" all the logic of a successful probability in a trade, but fear still needs to be de-coupled from uncertainty. This is emotional work until it is a new learned part of the perceptual map of the trader.

 

In this case the trader appears to have de-coupled the neural circuitry of this association. And he has re-interpreted it. And it appears that he has the sense to know that he has to practice this new way of understanding "standing on solid ground" so that it becomes even more highly enriched as a state of mind to bring to the trading room. Every trader can learn from this.

 

Rande Howell

[clmacdougall 11]

I agree with Tradewinds:

 

The other 2 fundamental differences are:

 

1) When you trade a cookie for a slice of pizza, you are forced to define your risk (the cookie). With trading, nobody forces you to define your risk and you could lose your entire bet, plus more if you're leveraged.

 

2) When you trade a cookie for a slice of pizza, the outcome is certain - you give up the cookie, you get the pizza. With trading the outcome is completely uncertain.

 

The real question is "what can you trade the pizza for?" If giving up money gets you a position someone else is willing to let go of, why were they so willing to let it go and why were you so willing to take it.

[TheNegotiator 13]

Hmm. The idea of keeping things simple I think is interesting. Imo and I know this may sound like semantics to some, it is more important to not over-complicate things. The cookie and pizza auction have limited variables and like in the pit, you can see when a new player comes in to get involved. The movement of complex electronically traded derivatives is much harder to judge. I think that distilling you trading methodology is a good idea and in system builder's terminology, will make it more robust. However, failing to take into account important market drivers, can and usually will cost you money.

[MightyMouse 12]

The real question is "what can you trade the pizza for?" If giving up money gets you a position someone else is willing to let go of, why were they so willing to let it go and why were you so willing to take it.

 

If you are trading an edge then the guy who sold you the pizza is going to wish he kept it. If you do not know what you are doing, you probably got yourself a piece of soggy dough.

[clmacdougall 11]

I can't imagine what's more important than understanding why a position has been sold to you and why you've bought it, it's the rest that really is semantics.

Though you may never fully understand the reason for the release of a position into your hands by preferably less experienced or educated hands, you'll always realize why you've chosen to enter the market at that moment.

Your looking to trade in someone else' poor judgment for a profit, or your piece of pizza for something even more desirable. In essence trading is simply "trading up".

[SIUYA 11]

remember the guy who traded up from a paper clip to a house.

[clmacdougall 11]

The trouble with trading is the amount of misinformation you must wade through in order to find the truth. Most of us have never lived a life where we had to question every piece of information we were taught but were told to trust and embrace it instead.

Can you imagine the damage you'd do to yourself if you trusted in even 2% of the trading misinformation which is taught out there, it's absolute rubbish.

No one reading these threads is ever going to be a major liquidity provider so don't get bowled over by the lie that the electronic markets are too complicated for you to pull money from or that simple concepts are going to part you from your money.

Learn to develop your own concept, that is your edge!! That no one looks at the market like you do will provide you with a strategy that no one can beat. Question your market understanding non-stop, tear apart your own ideas about the market with good sound logic and have a lot of fun doing it.

This stuff is alot of fun to figure out you know, don't forget to enjoy the journey and to keep your money in your pocket until you figure things out for yourself.

[MightyMouse 12]

The trouble with trading is the amount of misinformation you must wade through in order to find the truth. Most of us have never lived a life where we had to question every piece of information we were taught but were told to trust and embrace it instead.

Can you imagine the damage you'd do to yourself if you trusted in even 2% of the trading misinformation which is taught out there, it's absolute rubbish.

No one reading these threads is ever going to be a major liquidity provider so don't get bowled over by the lie that the electronic markets are too complicated for you to pull money from or that simple concepts are going to part you from your money.

Learn to develop your own concept, that is your edge!! That no one looks at the market like you do will provide you with a strategy that no one can beat. Question your market understanding non-stop, tear apart your own ideas about the market with good sound logic and have a lot of fun doing it.

This stuff is alot of fun to figure out you know, don't forget to enjoy the journey and to keep your money in your pocket until you figure things out for yourself.

 

Have you found the truth?

[clmacdougall 11]

MM, my experience has been a little unique in the sense that I started studying the markets in August of 2006 at the same time that my job came to a grinding halt. I studied for about 13 hours a day for the first 3 years and then 8 hours a day for 4th year and now I average about 2-3 days a week of 8 hours per day study.

My family has been incredibly supportive through it all, without that it would have been impossible for me to carry on.

I've gone through over 100 books and probably thousands of articles plus some overpriced systems that were useless. I've now drawn my "own" conclusions about the market and how it works and am really enjoying myself, I think I have found the truth but am looking to learn more. If you're trading without peace don't trade at all, wait until the peace comes first then trade. Peace is a good sign that you now know enough to begin.

[MightyMouse 12]

MM, my experience has been a little unique in the sense that I started studying the markets in August of 2006 at the same time that my job came to a grinding halt. I studied for about 13 hours a day for the first 3 years and then 8 hours a day for 4th year and now I average about 2-3 days a week of 8 hours per day study.

My family has been incredibly supportive through it all, without that it would have been impossible for me to carry on.

I've gone through over 100 books and probably thousands of articles plus some overpriced systems that were useless. I've now drawn my "own" conclusions about the market and how it works and am really enjoying myself, I think I have found the truth but am looking to learn more. If you're trading without peace don't trade at all, wait until the peace comes first then trade. Peace is a good sign that you now know enough to begin.

 

Sure it takes some time to muddle through the BS and then more time to expunge the BS that you learned. Also, time to figure out how you like to trade, who you want to trade with and against, how to know if there is money to be taken, etc.