Despite what the late night infomercials might tell you trading is a difficult profession. The rules that describe successful trading are very simple and can be distilled into three basic ideas.
- If its trending up – buy it
- If its trending down – sell it
- Dont bet the farm.
There is nothing in these rules that could be remotely construed as being rocket science material yet the execution of these rules for the majority of people is extraordinarily difficult. In part we seek to ease this difficulty by the application of a trading plan. That is a set of instructions we use to engage the market – we are attempting to impose some form of external on an environment where there is none. There are no native rules that govern how you trade – outside of the basic rules of conduct exchanges have no interest in how you go about your business. The mechanisms you use to trade are your own business, nobody really cares. So the rules you generate are in most circumstances unique.
However, even with the application of rules most traders seem to manage to find a way to devastate their accounts. It is quite possible that the rules that are being used to engage the market are wrong and this is quite possible. As I am prone to harp on about the rules used by most fund managers to engage the market are completely wrong and are a drag on performance. However, my observation has been that most people simply fail to follow their own rules. Getting people to follow rules, particularly when they run contrary to their life experience is very difficult. As an example I was sitting in a cafe having lunch a few weeks ago and this particular cafe had a problem with their front door. For some reason the mechanism was playing up and the door could only be opened by lifting the handle up – this runs contrary to everyone’s expectation. However, to compensate for this problem whilst awaiting the door to be fixed the owners had put instructions on how to open the door in clear view of everyone. Despite this everyone who went to leave looked at the instructions, read them carefully and then did exactly the opposite of what they had been instructed to do. They even continued to do the opposite of what was needed when someone stood beside them and told them what to do.
Watching this entertaining little fiasco got me thinking about the notion of following instructions and for some reason my thoughts turned to compliance with medication. So I did a bit of digging and found the average compliance rates for various conditions.
I have seen these numbers in various forms over the years because they use to be of academic interest to me but what always surprises me is how poor compliance rates are for various life threatening conditions. Various factors are cited for these poor rates and they range from simple problems such as errors in communication, cognitive/cultural issues and in some cases simple bloody mindedness.
If people cannot follow the instructions on how to properly take medication that may potentially save their lives then the chances of them following instructions on how to open a door or follow a trading plan are fairly slim. This naturally raises the question of why following a trading plan is so difficult for people. My lay observation is that it is hard in part because trading requires an internal narrative that runs contrary to what we use in everyday life. For example if head down tot he local store and a litre of milk is $2.50 I may have some sense that this is fair value – if I come back tomorrow and the price has risen to $3.00 my immediate reaction is that I am being ripped off. Put this into the context of share trading, if I buy a share at $2.50 where I believed it might have been fair value and the next day it has risen to $3.00 I now have an internal voice telling me that it is overvalued and I will most likely succumb to this inner voice and sell it. I certainly wouldn’t consider buying it again at $3.00 because my internal sense of value says that this is too high. My internal narrative that has been honed through years of real world experience is at odds with what is required for successful trading. Often the skills we bring to trading from our previous lives are completely irrelevant and in some cases harmful to us.
If we return to our example of buying a stock at $2.50 and then seeing it go to $3.00 required us not to sell it but rather to buy more as our plan dictated then we can see how internal conflict can arise. In such situations the winner is generally the decision that makes us feel more comfortable and so we justify our decision to sell with homilies such as you can never go broke taking a profit. Just as we are poor at sticking to a plan we good at rationalising our own failings. No one will lie to more than you lie to yourself. The most persuasive lies we encounter are the ones we tell ourselves.