Anatomy of a Disaster
By Randy Reis III
SMB Capital Forward
Randy Reis sent us this article for the benefit of our desk. As way of background, Randy is a former successful trader. Because of his past success he took some time off and raised his daughter by himself. Also, Randy is an accomplished athlete and a really big guy. Those facts may make the below more interesting to some. We thank him for his efforts.
Randy's comments offer new and experienced traders excellent insights on the psychology of trading. There is a lot to learn from his comments. First, when you are in a position do not care about whether it trades in your favor or not. Just execute on your trading plan. Do not care. You will make many losing trades and many winning trades. One trade is not significant. So do not care. Also, you must execute your plan for every trade. We ask that you develop an exit plan for every trade. If your stock trades against you and to your exit price on the down side, then just hit the stock. Just hit the stock. Who cares about one loss? Hit the stock, gather information and reevaluate. Live to play another day. Finally, Steve has developed a breathing program for us. This will help with your discipline and patience. You cannot be a disciplined and patient trader if you have not developed the skills to be patient and disciplined. Breathing helps. And look if a 250lb, former successful trader, and former jock preaches breathing and yoga and meditation, I think you ought to listen.
Randy says it so well. So let's get to his thoughts.
“I have found that most times I have changed my rules on the fly, disaster results”. Who wrote that? I did. And yet, just days after I wrote it, I changed. Maybe a better word is ignored, my rules, and sure enough disaster did strike. I was going to recreate my trades here, along with charts and why I bought and sold, or really didn’t sell. But as I took a few days to think about this I recognized that that wasn’t the best way to for me understand why I did that and also to provide some value to others. If anyone has heard of Van Tharp, I did a lot of work with him years ago. For those who haven’t, he was one of the original “Market Wizards”, profiled by Jack Schwager, in 2 books written back in the 1980’s. So much of what I am going to write comes from him. The numbers below are fictional, but they do represent what I did this last Friday. So here goes a little soul clearing.
It’s been written that trading is 20% methodology and 80% psychology. When I first read that, I thought it was bull. But after many years (30 on the Street), I’ve come to recognize that it’s probably more like 95% psychology. Just think. Flip a coin. Is the stock going up or is going to go down? You’ll be right 50 percent of the time. Many say if you’re right 50 percent of the time in this business you can make a lot of money. Can is highlighted because the real key is in the exits we take and that is where psychology comes into play-that and position sizing.
I would bet that if you could take a look at significant bottoms or tops on just about any time frame, whether from 5 minute bars to weekly, that the extremes of the moves have been caused by people whose position size is greater than it should have been, greater usually than they initially wanted it to be. These extremes actually caused by people who have increased their size because the price was better than when they initiated their position. Look at any instance where you yourself have averaged down and bought more. It is natural to think that if we were right about an upcoming move and bought 100 at 85.10, then it's really cheap at 84.89? So… and because our ego at this point still believes we are right since it hasn’t hit our stop at say, 84.74, we should buy 200 at 84.89. And of course at 84.76, it shows some support and bounces. Then begins to drift down and at 84.79 it's a real bargain since support showed up just below earlier. And your risk is minimal since we’re going to be out at 84.74, only .05 away so…. Let’s buy 300 more. Now what started out as 100 at 85.1 is 600 average price 84.88 and it’s trading at 84.79. And I’ve been WRONG twice on this trade already.
But .11 up and I’m in the plus column. So then it trades 84.74 and I immediately try to sell using a .69 limit to be sure I get out. But other traders with faster systems or fingers or thoughts had the same idea, and its 84.35 in moments. And I just stare at the screen looking for something, anything that will tell me that that was the bottom. I am hoping that somebody puked out their position and now we can rise. As if my fingers aren’t bloody enough from trying to catch this falling knife since 85.10. Ahhh… there it is, a few days ago as it bottomed at 84.20 so that’s .15 away. And my average price is over.50 `away. And there’s a trendline connecting lows from a week ago. Alright this is it, I’ll buy` 400 at 84.29, reducing my average to 84.64 on 1000, my max position, and if it rallies I’ll get out ½ of it even. Then I will raise my stop and let the rest ride. Of course it breaks, and as it breaks I notice my P& L has dropped below my daily threshold. And since I’m not having a good week, I don’t want my Friday to end on a big loser. There’s always `support at the full (84.00), just give me a little bounce. If I sell it here, I’m done for the day. I don’t want that. Of course it drops further and further, and I puke it out finally` much lower, a few pennies above what becomes a significant low.
Ever done this? I’m sure most of you have. Ever done it more than once? Again, I’m sure that most of you have. Why? This is where psychology comes in. Why do we humans consistently do something that has not worked in the past? Why have some been able to stop doing whatever it is and some just repeat their past poor behavior? (There are a number of answers to that. I will suggest one later.) Let's take a look at some things.
1) Increasing a position that is negative is the beginning of entering a zone, and not the good kind. The only way to really evaluate the potential of a trade being` profitable is not to care. That’s right, not to care. The moment you care you have allowed your emotions to enter the room. And your emotions are the 600lb gorilla in the corner.` Right now he’s invisible, you can’t see him. He’ll make himself visible later, but then` your ego will convince you he’s not so tough. Your ego will convince you that you can handle him. But that 600lb gorilla, your own emotions, most times will force you to puke your position right at the bottom. And if it isn’t the bottom, then usually it wasn’t your emotions that made you sell, it was your discipline. If your position is bigger than 50 percent of your max, then you probably care too much. You don’t want the loss. So you don’t take it. Not yet anyway. A downtrend line gets broken, you think, “now we are going up”. Except it doesn’t. Here’s a classic dog that doesn’t bark! But I don’t see it that way because I’m in a zone, an emotional zone, because my position is too big and I’m losing on the trade. I care too much! All that I can see are the things on the chart, or the bids on the screen that support my position. I care too much!
2) A buy of 100 at 85.10, that’s ok, but it trades down to 84.89. Most traders have the conditioned response that says, “Buy more” (I want to be right). Hell, I am right. I’m good. I make money. In short, we all have egos or we’d be working for the city government with a secure job, nice benefits, a pension, and mediocrity. But suppose a shift in my perception was taken. Suppose we looked at this and said immediately A) I was WRONG! Yes my stop was 84.74, but the truth is I never thought it would go to 84.89. If I did I wouldn’t have bought anything at 85.10. I would have waited, or shorted. Well we’d have to subjugate that ego a bit, but would it be worthwhile? Profitable?
3) Suppose I looked at this and said, “Thank You” to the trading Gods for having the grace to let me know my direction was wrong so quickly on such a small position. I would have lost .21 on 100 shares and gotten a valuable clue as to the true direction of the stock. And just as importantly, I don’t care if I’m wrong on 100. I have no problem taking that loss. Hell, I can take 5 in a row and still be out only $110. And if I’m right on ONE GOOD TRADE, I can make that back quickly. That means I only have to be 16 percent profitable. Imagine if I can get to 50 percent?
So what’s the way out of this mess? Discipline….Discipline…discipline? Yeah, except that discipline fails so many in all areas of life. Look at dieters. They know what to eat, what not to eat, and how much to eat. Why can’t they keep their weight off? The answer is because most humans are conditioned. I see pizza, my mouth waters, so I order. I don’t even think about ordering, I just order. We need to slow down the response time between cause and effect. If I see pizza, I stop, I think: I had pizza yesterday, I’d be quicker on the basketball court, my pant’s would fit better, wouldn’t I be better off with the grilled chicken? Now go ahead and order the pizza if I want, but I have considered the ramifications. And it’s now a conscious decision not a conditioned response. Most, after thinking of all these things, I have reduced the odds of eating the pizza. Why? Because I shut down my conditioned response and made a choice. I looked at other possibilities.
Here is a suggestion….20 minutes of meditation in the morning is a very effective way of turning off the conditioned response mechanism. I know psycho mumbo jumbo! "Ommmmmm", the Buddha, and all that yogi stuff. Well it’s not the only way and it’s not easy. But it does work. Try this. Close your eyes, and try to think of nothing but your breath entering and exiting your body. Usually very quickly, thoughts will stream into your head. That’s ok, try again. And they're back. So you’re really trying to do something, but your mind insists on popping thoughts into your head. They’re really streaming in, and fast. Even though you’re determined. Who’s in control? That’s why we all sometimes do things that we know aren’t in our best interests. Whether it’s adding to a loser, or eating that extra slice of pizza, or losing it with our daughter after she’s lost her glasses for the 3rd time this year. Things that we look back on and say to ourselves “What was I thinking? Why did I do that?” Meditation can slow down the time between an event and our response. With practice, one can look at their own thoughts and recognize that sometimes our thoughts get in the way.
Picture a sign on the wall at Daytona Speedway and imagine a constant flow of cars going by at 200 miles an hour. And there are so many cars passing that you can’t even read the sign. It’s just a blur, like the market when you're in that emotional zone. You think you see everything but you don’t see all that you are missing. Well, your thoughts (especially about your position) are like the cars. They are keeping you from seeing the signs. And the sign is saying something like the stock or the market is “going up” or “going down” “or stay flat”, and quite often very clearly. Slow down the cars. Slow down your thoughts and you allow time for a different viewpoint to be seen, for a different choice. ………. A choice of following your rules!
I need to go meditate right now!
*First, it wasn’t a major disaster, thankfully. I’m cognizant enough of human nature and trading to know that the best way to make a lot of money is to trade as small as possible at first. Only after certain profit objectives have been met (win %, expectancy, etc) should position size be increased. With that in mind, I put a small amount of money into my trading account.
Once upon a time I was known to have had more than a couple of barroom brawls back when Brooklyn was a different kind of place. So naturally, when I started on Wall St., and heard about the Wall St. charity bouts, I was intrigued. So I entered and boxed for a few years in that. But my claim to fame was getting knocked out cold in Madison Square Garden, well the Felt Forum anyway, by the former NY State Champ Tom (the Bomb) Gimbel. Knocked out so good, or bad, that 1 1/2 hours later after a shower and in the taxi on the way to the post fight party, I still had no idea that I had been knocked out. I actually asked my friend, sincerely, if they had rang the bell for the third round early. The third round seemed to go so quick. He looked at me incredulously and asked, "Are you kidding me? You got knocked out!" Aahh never felt a thing anyway. Maybe that's why I ended up chanting, “Oommmm”. So, the yoga, meditation thing REALLY is a major about face!
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