Thursday, March 10, 2011

It's the Law: Markets Must Deliver Maximum Pain

Like gravity, it's the law: All markets must be difficult to trade. Most investors, traders and money managers do not match market returns. Trading and investing is one of the most difficult proving grounds an individual can test themselves. And it makes perfect sense.

Imagine that market
s were easy to trade. They never tested our emotional maturity or triggered any one of sixty emotional biases, myths, mind traps and false beliefs that MarketPsych has identified. When the market made a pattern shift, we could all see it coming. We were able to find a statistical edge and create a trading system that worked reliably through all market conditions. As we made money, we increased the size of our trades and we were able to make even more money. Even though we were making more and more money, our ego remained humble, avoiding the destruction of hubris and pride.

If markets were easy to trade, what would happen?

If it were that easy for us, it would be that easy for most other traders. More and more people would be trading for a living. They would all be making more and more money. Soon everyone in the whole world would be wealthy beyond their wildest dreams.

Of course this
is silly and we know it cannot happen. So what drives this unrealistic belief? It is attached to our most important dreams.

We chase
this dream with new systems. We shift the asset classes we trade. We change gurus. We change indicators. We subscribe to a new newsletter. And still, the illusive dream of consistent profits eludes us.

This is the way is has to be. Because, if we take it to the extreme as we just did, the markets would not work. In fact, the markets are designed to make trading as difficult as possible.

Here is why the markets must challenge us

Depending on the market you trade, there are thousands or millions of participants. The market you trade is connected economically like a complex web to thousands of other markets and market players. There are speculators, investors, day traders, arbitragers, investment banks, hedge funds, mutual funds, brokerage firms, and international interests all jockeying for position, each with their own behavioral constraints, myths and judgments.

This is not to mention the pressure of global economic fundamentals, cost of capital, avail
ability of capital, risk temperament, interest rates, currency fluctuations etc. that all have an influence on people's decisions in the market you are trading. Add to that incredible computerized sophistication that the big boys have to find and eliminate any obvious market anomaly in milliseconds.

Everyone is trying to take money out of the markets. There is no one whose goal it is to contrib
ute their capital to you the trader, money manager or investor. Whew!

All trading systems work. All trading systems fail

It is difficult to find a trading system that DOES NOT work in some market some where some time. It is also difficult to find a system that DOES make consistent returns in all market conditions.

Here is the really good news

Investors and traders have the luxury of picking and choosing their trades. They don't have to trade all of the time. This is their edge. They can wait until the market patterns are working for them.

It is in the evolution and transition of trading patterns that a lot of money can be made. Because trading patterns are driven by humans who trade repeatedly with the same behavioral responses (this doesn't change!) the destruction and emergence of new patterns create profit opportunities.

It's like one
of those Zen puzzles: any belief you are attached to, the market will destroy. As a trader, it is your ability to see new trading patterns emerge that has the most profit potential. To do this, the mind needs to see the markets as they are without the prejudicial filters we all carry around. If our ego is attached to a trading system and its success, the ability to see new patterns emerging is difficult.

In my work coaching money managers, we build a series of Mind Muscles that address specific trading issues. In this case, the Mind Muscle we work on is Pattern Sniffer. The Pattern Sniffer loves reality more than stories we create to protect our beliefs. Here is one of the exercises that will help you access pattern shifts.

Pattern Sniffer Mind Muscletm

  1. Define several market patterns that cover the range of normal market behavior for your asset class
  2. Create several scenarios for a "Black Swan." (That is an event that feels unlikely and the results could be catastrophic)
  3. Note what indicators would be likely to precede a shift for each pattern or swan.
  4. Once a day, pick a pattern/swan on a rotating basis and look for its leading indicators.
We cannot see what we cannot imagine. History is full of stories and the market has plenty of examples of people who could not see the inevitable because the results were too much to bear.

By envisioning these new shifts every day, we build our "Pattern Sniffer Mind Muscletm." We build our ability to see changes in the market. Every day, exercise that new Mind Muscletm

Richard Friesen
Training & Development
[email protected]

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