First, we all need to realize that it is in fact oftentimes reasonable to fear losing money. One would be nuts not to. We might be told we are supposed to get over it—have full confidence in fake precise probabilities. But what if we really did? What if we had no fear about losing or not accumulating money? We basically all need or want more money. How is it then that we are supposed to not be afraid of failure? It is simply ridiculous to ask traders to feel something else. In fact, given what neuroscience can show about the backdrop, sequence, and “automaticity” of emotion, the dictates about emotion ironically becomes irrational!
Figure 13.1. Copyright Warren Photographic (www.warrenphotographic.co.uk).
More importantly, as we were saying in yesterday’s workshop, this fear (or anxiety and doubt), once you learn to use it properly, can be one of your greatest risk management tools. For example, it can be a very early signal of the need to exit—after you have learned to work with its amorphous, multifaceted, and ephemeral characteristics.
We will get to more of the “impulse versus intuition” question, but first we must re-characterize fear and its derivatives, anxiety and doubt. Embracing it as data (and even learning to assign it a relative value) can both be done and provides a significant trading edge, like psychological leverage. Once we learn to understand the relatively conscious fear of losing money, we can move to the more insidious levels where the fear of being wrong or even stupid resides. Those levels, which I call fractal-emotional contexts or F-eC, offer exorbitant amounts of psychological leverage in that acquiring an awareness of them can interrupt what seem like intractable acting-out scenarios that traders and risk-takers everywhere find so baffling.
In between the extremes, you will be living with at least some modicum of anxiety and doubt just about all of the time. This is the curse of having an ongoing relationship to something as uncertain as the markets. If nothing else we all have some of the well-documented aversion to ambiguity. We want to make it certain because the fact that we don’t know and we might lose or be wrong is indeed (and of course) nerve wracking. In order not to waste valuable mental and physical energy on averting the uncertainty of dealing with something that can’t be certain, it pays to go through an exercise where you consciously embrace uncertainty, or really where you consciously embrace what you feel about it.
I conducted a workshop in 2010 where my students spent a weekend creatively working on feeling their anxiety about uncertainty. One trader, Ted, submitted what is now up on the screen. Take a look. I think you will enjoy his words.
I woke up this morning, still thinking about ambiguity and my natural aversion to … well, mornings.
After a cup of Joe and a slice of shingle with a shimmy and a shake, I set myself down to ponder:
Ambiguity Coveted by politicians and poets … Disdained by science and law.
“political science” or “poetic justice”?
Artist, freed from the needs to record unambiguous reality.
Kodak moment or timeless Monet?
Sirens of synchronous and synchronized sounds.
Add feeling, and you have music.
And of the movement of minds and markets?
Rarely a consensus, always a conversation.
But with whom? I am not sure.
But for this ex-engineer to ponder its meaning, I can only say
The mind is a very strange place to be.
By the way, have you met my friends, Russell the rabbit, and his friend Elias the cat
Ted summed up our dilemma. He got a good laugh, that laugh of recognition. And, in fact, everyone who completed the assigned exercise found that they enjoyed reveling in their hatred for the ambiguity of markets. Most were surprised to find out how they really did detest dealing with constantly conflicting information. They intellectually thought that because they were market professionals, that they were “over it” or even in fact loved it. The exercise allowed them to put these unconscious feeling contexts into words and, in doing so, be much more conscious, and then more comfortable, with the anxiety the ambiguity produces.
By the way, a whole series of poems and stories can be found on the Psychological Capital blog and I encourage you to take a look. Many times, knowing what someone else feels helps us to know what we feel, or to get comfortable with it in cases where we don’t like feeling that way.
Conventional wisdom about markets almost always refers to “fear and greed.” Pundits and politicians alike think they know something when they reference these supposedly intractable emotions of the markets. Greed in particular gets inordinate amounts of play when it comes to assigning the blame for any kind of market, monetary, or behavioral fireworks.
Guess what, though? Greed might be considered one of the seven deadly sins, but in reality, the concept matters surprisingly little to what I am advocating as a more accurate and effective theory of the psychology of uncertainty.
Oh yes, it sounds good. It sort of satisfies everyone by feeling familiar and by making people feel superior as they channel their frustrations toward the faceless “evil” bankers of the big city.
Let me ask you a question. For how long has society been blaming both market meltdowns and trader travesties on greed? Has it been 25 years? 50? 100? 1,000? Niall Ferguson, in The Ascent of Money, traces the first instances of coins to approximately 600 BC, some of the first records of lending and loans to the 6th century BC, and hatred of the idea of interest to earlier than the year 1200. If he can fill a whole book with the cycles of affection and disgust for bankers and their ostensibly hip-attached greed, does anyone think that the modern version differs?
Yet have the accusations of greed truly mitigated any risk, systemic or individual?
I submit to you that it most certainly has not! We still find ourselves subjected to widespread market meltdowns and individual but influential cases of retrospectively inane risk taking. Take the insider trading trials we have been witnessing of late. Do we really think that $70 mil motivated a billionaire like Raj Rajaratnam to risk jail? Even on the other end of the trading spectrum, is it really the extra $250 that motivates the guy sitting at home in front of his market charts to risk his whole trading day, week, or month?
Ostensible greed presents us with a case where while it may look like greed and it may walk and talk like greed, it often isn’t. Just like anger typically overlays a hurt, greed overlays what in the majority of time is the fear of missing out. Successfully navigating markets presents such a challenge that the idea of not grabbing every emerging opportunity just becomes too hard to resist. Indeed, after listening to thousands of active traders talk, I can verify that “flavors” of FOMO lie behind the largest percentage of trades or even whole asset classes gone bad. And management isn’t immune from the feeling either.
• Chuck Prince of Citigroup’s famous line regarding the subprime CDO market: “As long as the music was playing, we had to dance.”
• Less famous traders than Mr. Prince refusing to exit a position that is happily up 20–30–40% (“By god, it is going to the moon!”) in a short period because they were looking for 45%, only to see the name deflate faster than a punctured balloon!
• The last people in a rally. Back in 1999, your parents’ neighbor refused to buy an Internet stock because it was clearly nuts that all those companies were trading for hundreds of dollars when all they had was a vague plan, a catchy name, and warehouse office space in San Francisco or New York. But then, come sometime around the New Year in 2000, probably after a party where even the bartender was talking about the killing they were making in the markets, they thought, “What the hell, this thing just keeps going up, I must be wrong,” and finally bought.
• The ever-present bane of the human high-frequency set—moving a stop-loss order to break even and getting taken out of a good trade moments before it races back in the desired direction. (“But I didn’t want to give any back.”)
This last iteration of FOMO probably derails more traders and their accounts than any other. It certainly plays into the frustration that debits psych cap and often turns into a spectacular incident of acting out a tantrum by making five or ten times the trades one normally would.
It works like this. A trader put together a respectable “social markets” entry. They “read” the current and likely future perception quite well. They have an idea of how far the trade could go. Because they have watched the market for many years, the idea ultimately turns out to be quite good. (Don’t underestimate the power of unconscious pattern recognition.) In the meantime, the asset’s price does what prices do—they make a move and retreat a bit, then they either reverse or keep going. It is in this moment of “rest,” “catching its breath” that the trader gets hit with FOMO. In this case, it relates directly to giving back money they had. Believing they are being prudent and managing their risk, they move their stop-loss order to the point where they entered the trade. (Never mind that the social mind of the market doesn’t know or care about that number.) And you know the rest.
Or take another common FOMO scenario. In fact, Deborah Tannen (the author famous for the 1990 book, You Just Don’t Understand, about communication between men and women) observed that men truly detest feeling as if someone is getting the better of them. According to the book, they will go to what may seem like awkward or even absurd lengths to avoid being in what they perceive as the less powerful position. Little boys, in fact, will make outrageous statements (like on upping how far they can hit a baseball), even when everyone in the group knows that little Johnnie didn’t hit it from New York to California!
Whatever the source of this feeling—chromosomes or hormones or training—I hear it all the time. Guys don’t like other guys to get a trade they know about and didn’t fully exploit. This is exactly what Chuck Prince meant when he said the music was still playing. Citigroup couldn’t let Bear or Lehman or Goldman keep profiting from the creation and sales of CDOs and step back.
We’ll come back to this specific feeling in a moment but first let’s take a step back and discuss the overarching strategy for incorporating fCs or feeling contexts into your decision making.
Here’s an irony for you. Did you ever realize that most of the time trading is going to make you feel bad? I can tell you that I have asked this question at probably a dozen seminars over the past five years and almost no one realizes it before we talked about it. Who expects to go to work, possibly lose money and, in fact, be set up to feel bad in almost all instances?
This is a direct consequence of the power and prevalence of the far right end of our fear spectrum. The fear turns to the frustration because with the rare exception of nailing the trade the outcomes fall into the following categories:
• Long (or short) and wrong
• Got out too early; left a lot on the table
• Got out too late; gave a lot back
In the end, see how traders are almost always choosing between the lesser of the evils, and then by definition feeling at least somewhat regretful becomes practically inescapable!
But we might be able to work with this if we step back and think about it, i.e., theorize. Theories are just that, theories. Logical ideas about how something may work guide research. Amazingly, a very potent one known as regret theory seems to have been overlooked in a number of ivory towers. Developed by two separate groups, the theory stated that if you add the desire to avoid future regret to a theory of subjective utility, or any one person’s own view of what will serve them best, you could build a more accurate model of the way we make decisions.
Janet Landman explained the new regret model in 1993, but seemingly no one was really listening. She pointed out the patently obvious but mostly overlooked fact that many decisions create feelings of conflict. We want one outcome and sort of don’t want another. But do we not want the second more than we don’t want a third low probability but disastrous endpoint? Internal conflict in and of itself holds enormous sway over what we do. “Anticipated regret” maps essentially exactly to a money manager’s experience of FOMO.
In verbal form, applied regret theory would sound something like this.
Choice A—get out now = take profits good; it might go further = regret
Choice B—wait for trade to move further = “let profits run”; it might reverse and I will give all my money back = regret
Choice C—put a trailing stop in = I get a chance to make more but I might regret giving it back when it reverts to my trailing stop (to the exact tick and then continues!)
In graphic form, it looks like this:
Figure 13.2
Traders get lost going round and round in this series of choices, without even knowing it.
Michael again turned to Renee and shook his head, “Yes!”
Isn’t regret truly an awful feeling? I mean, fear doesn’t feel good nor does anger, but that feeling that you made a mistake—sometimes a very serious one—and there isn’t anything you can do about it…. You can’t go back in time and get a mulligan. You are powerless to change the past and feeling powerless leads to feeling depressed. Is it no wonder that we try to avoid regret? Getting over regret seems to be harder than recovering from other feelings. It tends to nag at us…“if, only if.” We will even dream about being in the alternative situation only to wake and have to relive the entrance into a “new” reality. Again.
Day-to-day trading exits may not invoke this kind of intensity but entries, or rather missing them, scare the crackers out of us. The market represents such an on-going mental challenge for us that watching our bus come and go without getting on blasts the fear of regret-o-meter.
Understanding the inherent conflict in relentless uncertainty changes everything. Or rather, maybe I should say accepting it. Stop trying to make it certain. Stop trying to get rid of the conflict.
In fact, lean into it. Try to feel it. If you do, you won’t act on it. Believe me I know, know, know that you want to know what to do—and the answer is simply feel. And watch what happens. I think you will be amazed.
If the context of feelings—the fC—reigns supreme in our perception and the majority of trades leave a residual feeling of dissatisfaction, what context do we bring to the next perception or decision? Always knowing the answer to this with the same level of perception and vigilance you normally apply to watching the assets you have money invested in will change your entire success rate with uncertainty decisions.
Every once in a while I run across a trader who for the most part just can’t get into the market. In some cases they have traded or attempted to for very long periods of time. Yet most of the time, they watch the ticker go by and do nothing. We will get to this tomorrow in our lecture on the fractal geometry in our perceptions, but if you happen to be one of those people, you feel the opposite of FOMO. And while that fC will almost certainly always remain the most pervasive one, you yourself live on the other end of the spectrum. In your case, the fear of future regret revolves around how it will feel to have lost money or to be wrong. That is a stronger feeling for you than missing out.
It seems like an intractable problem, but in reality, it can be easy to fix. Once we get to the fractal psychology part of trading, in the next lecture, you will see. Just know for now that ultimately this default position tends to be easier to fix than an overly developed or sensitive need to “be in the game.”