Trading Tip #4 – Being Able to Admit When You’re Wrong
I remember the last conversation with my ex-wife just before we started the divorce. I sat her down, looked into her eyes and I said, “I’ve spoken to all the mathematicians, and it is theoretically impossible for me to be wrong every time.”
As a trader, one thing I know I am good at and have no issues with is admitting when I’m wrong and then changing direction quickly. It is a must to be successful .
Being right is over-rate. I would rather be wrong and be profitable than try to prove I am always right and be a bad trader. After managing hundreds of traders and trading for over 22 years myself, I have seen the one trait that is most important to be a good (or great) trader – and that is the ability to know you’re wrong and to take action quickly. Being wrong is, in itself, not a major issue. The swift action that is taken after is the most important thing. I will be address this in a future blog post that I’ll aptly call ‘Screwing up and how to make the most of it.’
I’ve always taught my traders, as well as my executive coaching clients, that pain and pleasure can be the key towards a successful career. The biggest issue that some traders have, and in time destroys their ability to trade profitably, is the inability to simply admit they are wrong. The fact of the matter is that, on the trading floor, 60% to 70% of our trades each day were bad trades. The key to money management while trading is simple – cut your losses and ride your winners.
There are too many people, both in business and in trading, that I’ve seen destroy what could have been a very positive and lucrative career – simply because they were either too arrogant or too insecure. They were too proud to admit when they were wrong. These were people who did whatever it took to prove to others and themselves how right they are instead of quickly changing their course of action and re-directing their thoughts and energy to a more profitable outcome.
Odd as it may sound, I made more money in trading being wrong than I did by being right. The simple reason is that when I realized I was wrong I could reverse my position or get out and cut my losses.
Let me give you an example. There were times I would be long five lots of crude oil. (5000 thousand barrels of oil, which seems impressive but is not). If I was long 5 lots of crude oil at $95.10 and sold it at $95.11, I have simply made $50 on the transaction. In this example, we will assume I am long five lots of crude oil at $95.10. The market starts drifting lower $95.09 $95.08 $95.05 $95.02, and I start feeling the pain of losing trade. I start getting the sense that I am wrong, at which point I hit a 50 lot bid at $95. I go from being long 5 lots of crude oil to being short 45 lots. (45000 barrels )The market trades at $94.99, $94.95. At $94.90 I buyback 10 lots, then at $94.88 another 10 lots. – the market bounces and I cover the remaining 25 contracts at $95.00. The 5 lots I was originally long was enough to show me that I was long and wrong, and it was time to get out and reverse and follow the trade through the other side. I lost $500 on the first 5 contracts I was long, but I ended up making $2,200 on the 45 lots I was short for a total on the trade of +$1,700
There are many times that, instead of just admitting that it’s a bad trade, the trader does what I feel is one of the worst things that can be done. The trader adds to losing position. There can be (false) justifications in the traders mind for doing this. He might say to himself “there is support” while looking at his charts. He might say “the market has to go back up“, or worse – he can say the famous last words of many traders, “I hope the market goes back up”. “ As I spoke about in Trading tips #3 – there is no hope in trading.
The real issue adding to losing positions is that, many times, it works. People use dollar cost average, and if this works 6 out of 10 times, the trader feels that it is worth it in the long run. Well, it’s not. Take, for example, Trader 2 initializing a long position in Apple at $690, just after 9/19/12 when Apple settled at $702.10 The odds are on his side. However, the 4 out of 10 times it doesn’t work can be enough to blow the trader out of his position and, at times, even out of a job.
Trader 2 buys Apple at $690. There are analysts on the financial news networks and blogs speaking how Apple is expected to go to $1000 in the near future. The market rallies over $700 and slowly starts drifting lower. Then it gaps lower to $678. The trader continues to add to his initial buys at $690 – convinced that the he is right and that this is just a minor correction in the market. He says to himself “the market always comes back.” As we all know, Apple continue to drop to $500 at which point this trader could of had the trade that ended his career –
So, the key to this trading tip is straightforward. Stay light on your toes so you are always able to get in and out of positions with out mental stress. Never stay married to a bad position and, as I spoke about it in Trading Tip #1 – Leave your ego at the door. Trade within your own size, and be able to admit when you’re wrong quickly, get flat or reverse. I have said, and will continue to say, in my trading and business blogs – being flat is often the best position. It is the one and only position that you can look at the market from both sides realistically, honestly, and without prejudice to see where the market is headed.
Remember you can always get back into a trade. No traders are prefect, so don’t try to be.
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