One of the toughest obstacles a person new to trading faces in becoming profitable is staying objective about what the market is telling them. Staying objective means being able to change one’s mind when the market environment clearly indicates our assessment of the direction of the market is wrong. That’s only one aspect of being objective, the other, and most important part of trading with an objective mindset, is having the flexibility to act upon the new information presented.
Traders come into the markets with lots of preconceived notions and beliefs. Among these are inherent biases that can act as impediments to making the right trading decisions. Of these biases, the strongest is something psychologists refer to as a “confirmation bias.” This is a natural tendency of all human beings and can be a benefit in other areas of life, but can pose a challenge in trading.
Simply, we as humans have to protect our ego, this entails always trying our best to make the right decisions. In every day life this works most of the time, however, because speculating in the financial markets is fraught with uncertainty, and this is something we have little control over, it becomes a challenging aspect of the human condition that has a negative effect on trading.
The way the human mind works is that, after all the analysis and thinking we ultimately come to a decision. Once that decision is made and the action taken, we must vigorously defend that it was the right decision. We do that by seeking out every piece of information that will validate that, indeed we have made the right decision. In addition, (and here is where the difficulty lies) we will dismiss or ignore altogether any information that contradicts our decision. These can sometimes lead to devastating consequences, as it allows us to rationalize staying in a losing trade.
Staying objective becomes more difficult when we have a position in a particular market . For instance, talk to a trader that is long 5 E-mini S&P contracts and he will give you 100 reasons why the market will go up. When we put on trades, we obviously never put it on intending to lose, however, staying open to the possibilities that we will be wrong sometimes will free up our mind to focus on executing the strategy rather than worrying about being right all the time.
Most traders and investors tend to have a buy-side bias because they have money invested in the market for retirement or other long-term goals. Moreover, this bias is also a product of them not being educated or skilled in short selling. Thus, knowing that they buy now with the hope that they will sell higher at a later date is the preferred trade. For these traders and investors all the warning signs of a potential sell- off in the markets often tend be ignored until it becomes too late.
Staying objective means that no matter how strongly you feel about a company or market, when the market tells you differently you will heed the warning signs and react accordingly. When it comes to successful market speculation, being rigid in our thinking will lead to bad results in the long term. Alternatively, being flexible in our thinking is a key element for survival in an environment where you always have to expect the unexpected.
Until next time, I hope everyone has a great week.