Are You Comfortable Being Wrong?

Hands up if you like being wrong.

If your hand is up, put it back down: you are lying to me, and possibly to yourself as well. No one likes being wrong. The best you can hope for is getting comfortable with it.

In trading, you will be wrong all the time. And I am not talking about the occasional mistake, or the “aw, nuts, I missed it” kind of wrong. I am talking about the in-your-face, no-getting-away-from-it, all-the-goddamn-time kind of wrong.

The only people who are never wrong as those who:

  • Work for a large institution that has a set of assets or flow that give them material insight into market structure. Such people are not really traders, but rather optimizers exploiting their market power.
  • Are selling out-of-the-money options, accepting a regular income stream in exchange for a catastrophic wipeout that has not arrived yet (but will inevitably come).
  • Deserve to be in jail.

So why will you be wrong all the time? Consider the standard process for trade construction and execution:

  • Analysis. There are numerous opportunities to be wrong when doing market analysis. You could misunderstand the company fundamentals or the commodity supply/demand situation. You could use inaccurate and/or incomplete data. You could not consider some important variable, or overemphasize a less important variable. You could take the advice from a wide range of market participants, and under or overweight their advice, which could be right or wrong.
  • Instrument Selection. You could choose the wrong instrument to express your view. Maybe it is the price that moves. Maybe it is the price relationship to other currencies/futures contracts/stocks. Maybe it is the options market that reacts.
  • Market Reaction. You could misinterpret how the market is set up. If you correctly anticipate that the news flow will be bullish, the market can still go down if everyone else was expecting it to be even more bullish than it was.
  • Extraneous events. You could be hit by extraneous events e.g. Federal Reserve action or acts of war, that unexpectedly impact your market.
  • Randomness. All markets have a nature of randomness to their price action. You can be correct about everything, and still get taken out by random market fluctuations.
  • Position Size. Even when you are right, you will be wrong, because your position size is always too small when things are going your way. Conversely, when the market is going against you, your position size is always too big.

In trading, the opportunities to be wrong and to experience decision regret are almost unlimited. If you cannot get comfortable with being wrong, or if you get paralyzed by the “What-Ifs” of decision regret, you will hate being a trader.

I am wrong all the time. I was wrong at least eight times today. I do not like it. But I have learned to get comfortable with it. Why? Because I am not trading to validate my ego or to prove how smart I am: I have other things for that. Being wrong is an intrinsic part of being a trader, and how you handle being wrong will determine how successful you are. As discussed in the previous post, it is about deciding if you want to be right or if you want to make money.

Would You Rather Be Right Or Rich?

Ask yourself three questions:

  • Would you rather be right or wrong?
  • Would you rather be rich or poor?
  • Would you rather be rich and wrong or poor and right?

 

The first two questions are simple: most people would rather be right than wrong, and most people would rather be rich than poor.

The last question is where it gets tricky. My experience is that most people, if they are actually honest with themselves, would actually choose being right over being rich.

I think this is why: from an early age, we are taught that being successful is highly correlated with being correct. When a child gets 85% on a test, they are asked what went wrong with the other 15%. When they get asked a question, giving the correct answer is praised and rewarded. This attitude applies from Kindergarten to College and on into the workplace.

For most professions, the correlation between being successful and being correct still applies. For example, I think that my doctor is a good doctor because he gets his diagnosis correct; I think my waiter is a good waiter because he gets my order correct.

Within a trading organization, this rule still holds: I think my trade analyst is a good trade analyst because she analyses market fundamentals correctly; I think my salesman is a good salesman because he generates customer business correctly.

But trading is different. In trading, you are successful if you make money, and making money is not necessarily about being correct.

A few examples:

  • You can correctly call the fundamentals, but the market might not reward you within the time-frame of your trade.
  • You could correctly call the market direction, but apply your view using the wrong instrument.
  • You could correctly call the market direction, but be stopped out before the trend goes your way.

In trading, you can be correct in many ways and still lose money. It happens all the time, and it sucks. Even worse, the lazy idiot who sits next to you can be wrong and still make money.

Most people find this hard to deal with. Most focus on being right, not on making money. Funnily enough, this is especially true for high achievers who tend to be the ones who either get recruited to be professional traders or who make enough money in another field and try their hand at trading. The classic of the genre is the doctor or dentist: after years of being indoctrinated that only 90% and above counts as success, they struggle in a trading job where making the most money might require them to be right only 60%, or 51% or 30% of the time.

If you want to be a successful trader, you need to be honest with yourself about whether you want to make money, or if you want to be right.

Trader 101

I am a professional trader. I seek exceptional risk-adjusted returns. I try to grow my money faster than the risk-free interest rate, whilst avoiding the large draw-downs associated with the traditional investment styles e.g. “buy-and-hold”, “60/40”. Specifically, in my personal accounts I aim for returns of 30% or more a year, while limiting draw-downs to less than 10%. I look to compound these returns over long periods of time.

I trade to make money. I do not trade for excitement, ego-validation or self-justification. For those things, I drive my car really fast, I jump out of airplanes and I have a loving family to tell me that I am awesome. Knowing why you do something, and being honest with yourself about it, is important. In Market Wizards Ed Seykota says, “Win or Lose, everyone gets what they want out of the market”. The market will give you what you want, so you have to know what you are really after.

You need to know who you are, and your place in the market ecosystem. Markets are made of a wide range of participants: market-makers, hedgers, institutional investors, investment funds and speculators. I am a speculator. Speculators have one chief advantage over other market participants: they can choose how and when to engage the market. Other participants, to varying degrees, have to be in the market all the time whereas speculators can refuse to participate until they see the right opportunity.

Since you have the freedom to choose when to participate, it is important to take advantage of it. This means being agnostic regarding market direction. I have no inherent bias towards any market: I can be long or I can be short. I can be long one day and then short the next. I have been known to flip my market position and opinion on a dime as the market conditions demand.

I am both incredibly fickle and incredibly loyal. If a market is kind to me and my position is making money, I can be loyal until the end of days: I will wine her, and dine her, and perhaps even sixty-nine her. If a market turns on me and treats me bad, I become incredibly impatient and move on to the next good thing.

Large, liquid, transparent public markets provide a wide range of opportunities to achieve my goals. These markets are very efficient mechanisms for transferring wealth from the many to the few. Most market participants lose money: in order to make money you have to do what other people do not do. Since most people do what they find psychologically easy, to make money you have to do things that are psychologically difficult.

Like most traders, I struggle to do what is difficult, to trade the plan, to control my emotions. Along the way, I have learned some tricks, some strategies and some road signs in the mist. The next few posts will explore some of the difficulties of being a trader, and some of the solutions I have picked up.

What Is The Zikomo Letter?

Like all of us, I play many roles. I am a father, a husband, a son, a friend, a lover, a neighbor, an employee and a citizen. For this blog, however, I am a trader. I trade professionally for a large commodities trader, and personally for my own accounts.

The focus of The Zikomo Letter (ZSL) is on trading. Once or twice a week I post on trading, investing and personal finance. These are my thoughts and convictions, argued with passion and hopefully intelligence and humor.

In real life, I am actually reasonably humble, appreciative of nuance and incredibly grateful of my good fortune. That is unlikely to come across on this blog. I encourage you to disagree and debate with my assertions: I am often wrong. I read widely and borrow liberally, and I try to acknowledge sources where appropriate.

I am not a financial adviser or a fiduciary of any sort. Nothing I write should be taken as advice regarding the suitability of any particular security or investment strategy for you. At times I may hold positions in trading instruments mentioned on the blog. I may also have positions inconsistent with the views expressed here. Anything posted here by me constitutes my own opinion, and is for informational purposes only.

Relaunch

After a few months of experimentation and trial, The Zikomo Letter (TZL) is re-launching. The focus will be shifting towards longer posts, once or twice a week, discussing various features of trading, investing and personal finance. You will see more of my own thoughts and convictions, argued with more passion and hopefully more humor.