This bias might be at the root of all the other biases that very active traders “enjoy”.
Yet, being right has very little to do with making money!
The evidence is overwhelming that the more we trade, the worse we would do. That’s because most trades are just expressions of our delusions, biases, and emotions getting the better of us.
Most of us who actively trade stocks are like weekend warriors who try to compete with professional athletes: Not only would we definitely lose, we could also get seriously hurt in the process.
Any human trader bold enough to compete against the algorithms of high-frequency and low-latency traders should be mindful of how far the odds are stacked against him or her.
For me, the first lesson is to be aware of who I am competing with and to realistically assess my chances against them.
And my assessment is that our single most competitive edge is time—it’s our greatest investment ally—because we don’t have to account our returns quarterly to our bosses and shareholders (ok, occasionally to our spouse).
And the longer our money stays invested in the stock market, the lower the risk. That’s a statistical fact.
Most of us weekend warriors should purchase stocks and simply hold them, selling them only when there is an absolute need; nevertheless, it’s difficult for many of us to adhere to this. We trade more than we should for the same reasons we overeat, overdrink, and gamble.
Ok, I hear some of you grumbling: “But I am better than the professionals, because I have beaten them here, here, and here!”
Could it be that you suffer from another bias: the Self-enhancing Transmission Bias, where you recall and share your successes more than your failures? Do note that this bias leads to a false perception of reality and an inability to accurately assess situations. Might you have you forgotten about that trade where you lost 90% of your money? Just check your account statement. What is the name of that pitiful stock still sitting there in the corner hidden by the shadow of your biases?
Being right is the enemy of staying right—partly because it might make one overconfident but more importantly, it might lead one to forget the way the world works.
So, how does one overcome such a bias?
I personally attempt to make better decisions by always weighing how right I think I am against how sorry I would be if I happen to be wrong.
Because whether I should take a risk depends not only on the probability that I am right, but also on the consequences if I am wrong.
In other words, the Risk/Reward Ratio has to be favorable (in my case, at least 3 to 1 before I commit to a trade).
If I am wrong —because the market moved in the opposite direction—I would be stopped out (since I never trade without a predetermined Stop Loss) and I take note of it. Thereafter, I move on to the next trade in preferably another counter, so as to avoid the emotional reminder of a previous loss with that counter.
What are your trade secrets to succeed in the emotional stock investing business?
Ok, I understand, when you’d share your secrets here, they would no longer be secrets.
Then what about your tricks, systems, algorithms and knacks?
After all, we are all in this together and gathered here on the Internet to learn.
“Successful trading isn’t about “being right” or “being in control” of the market!” — Dr. van K. Tharp
“As many advisors have told us, your portfolio is like a bar of soap. The more you handle it, the smaller it gets” — William Smead