Making Money Feels Good; Losing Money Feels Worse

During my trading career, I have made money and I have lost money. And I can tell you that I much prefer making money. Making money feels good.

But here is the weird thing: losing money feels worse than making money feels good. Much, much worse. The pain and the pleasure are asymmetric.

Behavioral psychology offers some explanations why (see Daniel Kahneman’s “Thinking Fast And Slow“). Using proxies and measurements for pleasure and pain, they suggest that humans experience losing something they have roughly twice as severely as gaining something they did not have. Put another way, emotionally speaking, it takes twice as big a gain to make up for a loss.

This has direct applications to trading. It is another reason why I focus on strictly limiting my drawdowns: not only does the math work against you, but the emotions do too.

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.