I occasionally hear comments about trading as a form of legalized gambling. I
believe there is a big difference between gambling and proper trading, and that
difference is in the positive expectation you can expect from any well-tested and
properly executed trading method. If you can expect to capture a positive edge in
your trading or investing, then it is not gambling to systematically implement trades
to capture that advantage. My methods to find bigger trends seek to do just that
over enough trades to let probabilities take hold. In stark contrast are the popular
forms of gambling like the games in Las Vegas or betting the ponies at the racetrack.
In these venues you are dealing with a negative expectation, where the longer you
play, the more sure you are to lose. How else could they build those billion-dollar
casinos in Vegas? Only by exploiting the house edge over a large number of bets. Of
course, if you implement a trading method with no testing or react emotionally like
the majority of traders, you are putting yourself at risk of moving from positive to
negative expectation and losing the edge that is so critical to successful trading.
These emotional behaviors are usually the downfall of most traders. On that note, I
ran across a story last week in the Tucson Citizen regarding problem gambling, and I
was struck by the parallels with mistakes I have seen many traders make.
Here?s the list of the National Council on Problem Gambling's 10 questions about
gambling behavior:
1. Have you often gambled longer than you had planned?
2. Have you often gambled until your last dollar was gone?
3. Have thoughts of gambling caused you to lose sleep?
4. Have you used your income or savings to gamble while letting bills go unpaid?
5. Have you made repeated, unsuccessful attempts to stop gambling?
6. Have you broken the law or considered breaking the law to finance gambling?
7. Have you borrowed money to finance gambling?
8. Have you felt depressed or suicidal because of gambling losses?
9. Have you been remorseful after gambling?
10. Have you gambled to get money to meet financial obligations?
If you answer "yes" to any of these questions, the council suggests you seek help.
I think every trader owes it to himself to set up an "Internal Council on Problem
Trading" to seek to not make trading mistakes similar to that of the gambling addict.
Here?s a few tips paralleling the above list for traders to consider:
1. Have you traded too long (e.g., for revenge, trading quickly just to try to make
up a recent loss)? I have noticed that even the best trading systems have good and
bad streaks, so you should have a method to downsize your capital commitment in a bad
streak while going back to full strength in a good trend.
2. Have you traded until your last dollar was virtually gone? Per #1, I track the
equity curve of each of my systems and turn off new downtrending equity lines while
taking new trades as the equity curve turns back up. That won?t stop drawdowns
completely, but it will minimize drawdowns to keep you in the game, both financially
and psychologically.
3. Have thoughts of losing positions caused you any sleepless nights? You need to get
you risk down below your ?sleeping point.? If you can?t sleep due to trades gone
awry, you need to scale back until you feel more comfortable, both at night and
during the day. Most traders overcommit their capital to each trade, which increases
the odds of a normal drawdown turning into a larger problem.
4. Have you taken on debt to fund a trading account, or traded with money you needed
for basic financial needs? This assures you will ?trade scared?, which means you?ll
pull the plug on positions too fast without giving them a chance to fulfill their
total potential.
5. Have you felt depressed about trading losses? Any element of feeling or emotion
shows you are too emotionally vested in being proven right more than in making money.
Keep yourself detached and focused on execution over time as opposed to the success
or failure of any small stretch of trades.
6. Have you traded in desperation to pay your bills? Again, the emotion of
desperation will lead you to make dumb moves, like buying very cheap options that
have little chance of paying you back.
I?m sure you can add to this list with other behaviors that have cost you money in
the form of taking too big a loss or missing out on bigger profit opportunities.
Make sure you have a plan to handle your emotions, and give your chosen trading
method time to play out over enough trades (ideally over 100 trades or more) to let
the probabilities work to your advantage.
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