BarroMetrics Views: The Difference?
What is the difference that makes the difference? Why is it that some, the few, become successful traders, while others, the majority, failed to make the grade?
I was having this discussion with a long time friend and trader, let’s call him Tom. Tom is the best trader I know. I met him in the middle 70s when he was working for an Australian bank. He then migrated to the United States where he was hired by a hedge fund. He subsequently formed a hedge fund of his own.
Anyway, back to the discussion I was having with him.
Tom’s view: the difference lies in the response to large unexpected losses. I should mention that we predicated our sample size to be persons of equal technical knowledge and skill.
My view: the difference is the ability to be comfortable with the discomfort caused by uncertainty. In a sense, there is no difference between the two views. Let’s have a look at what I mean.
Tom believes that the unsuccessful trader, when encountering an unexpectedly large loss, will do one of two things:
- He will start chasing his losses – by increasing size and/or the frequency of his trades; or
- He will stop trading.
The successful trader, on the other hand, will hunker down: he’ll reduce size, or he may take a rest, or he may select only those setups with the highest probability of success etc. In other words, he will circle the wagons and focus on regaining his equilibrium.
If you think about it, this behaviour stems from the unsuccessful trader’s inability to handle the uncertain result of his next trades: if the unsuccessful trader knew that his next few trades would be successful, then he would just continue to implement his plan. It is the uncertainty of the results that causes him to chases losses.
It’s not that successful traders don’t make mistakes, they do; it’s not that successful traders don’t have an out-of-size loss, they do; it’s not that successful traders don’t encounter bad luck, they do. But, what they don’t do is lose their equilibrium.
Their strategy, as I outlined above, is to:
- Take a short break
- Decrease rather than increase size
- Do whatever is needed to maintain a successful state of mind
The unsuccessful trader losses it – either blows the account or retires from trading.