One of the critical mental states for Scenario Planning is the ability to hold competing ideas at the same time without having to resolve the discordance. Among my mentor students, this lesson is one of the hardest to learn. I believe this is because humans are wired with two traits:
- Hindsight bias and
- The need to resolve apparent conflicts – cognitive dissonance
Hindsight bias leads us to believe that ‘we ought to have seen that coming’ (but often it’s obvious only after it has occurred) and cognitive dissonance leads us to ignore information that is inconsistent with a held view. In a recent book, ‘The Opposable Mind’, Roger Martin argues that the most successful leaders are the ones who practice integrative thinking. He defines this as ‘the ability to hold two opposing ideas at once and then reach a synthesis that contains elements of both but improves on each’.
While the synthesis aspect may not be available to a trader – if we are trading directionally, we’ll be either long or short – by holding opposing ideas and by constantly looking for clues that confirm or deny a scenario, we become better traders and risk managers.
The ability to do this allows me to deal with the issues raised in Derrick’s question: How would I deal with a close above 1416 and a fall to 1253?
If this question were posed by one of my students, I’d say there were certain assumptions she’d have to challenge:
- The first is the need for certainty. A trade we take is based on our belief that the probabilities favour a successful result. But any trade we take can move against us. Most times a student needs to deal with the unconscious belief that his model of reality is reality i.e. whatever he believes will happen must happen. The result of this belief is a block against thinking in probabilities.
- The second I raised above – the blocking of information (rather than acceptance) that is contrary to the original assessment.
Scenario Planning trading requires just the opposite. We accept the discomfort of holding two opposing ideas; we accept the probability of loss; we accept that we’ll sometimes act in a less disciplined manner (while constantly seeking to improve discipline). Doing this allows us to form a high probability view and then constantly review market information to confirm or deny the views: our original view and an opposing one.
This means that the probability of success is constantly undergoing reassessment. If at any point during a trade, we assess the probability no longer favours, we need to exit the trade or at least tighten our trailing stops. Then, we need to accept the consequences of our actions. Sometimes, we’d have been better off not exiting or tightening our trailing stops. But if we do it right, most times, we’ll be better off taking the action.
So, Derrick, a short answer to your question: I would handle that situation in the same way I handle all trades. Before entering, and during a trade, I ask:
- What do I have to see to remain in the trade?
- What do I have to see to exit the trade?
The answers to these questions would involve price points as well as structural benchmarks.