Traders employing a discretionary or subjective bias to their decision making can suffer enormous swings in their emotions – from euphoria when they get a winning trade, to dread and horror when they lose. Anyone hoping to achieve longevity and long term success in the markets can not trade in this way. It is simply not sustainable over the long term, because there is no plan in which to trust.
The dictionary defines trust as “reliance on the integrity, strength, ability, surety, etc., of a person or thing; confidence”. Many actions we trust inherently because the results are well within the emotional bounds between life and death. Take every day driving of a motor car. Every time that we drive a car there is a chance that we could get killed in an accident. There is nearly one motor car fatality every day, on average, in each state in Australia. However we don’t get behind the steering wheel and fear our impending journey. Why not? Two reasons. Firstly, we trust our driving skill and, secondly, we inherently know and trust that the probability of a fatality is extremely low. That is, we trust in the probabilities of getting to our destination alive. The roads are a probabilistic environment.
Other actions, including execution in the market, require that trust is earned, both in our own skill and in the probabilities that exist in executing in the market. The market is a probabilistic environment.
Much of the trust for executing in the market will come from having a well developed and researched process that you know produces a positive outcome over the long term across a wide range of market conditions. The research and development is your preparation as discussed in last week’s blog. The output is a trading system that is part of a trading plan that defines the process. The trading system must have an edge. The edge is defined in terms of probabilities and it is these very probabilities in which you trust. There is no certainty in any trade yet there is certainty over a large sample of trades because the probabilities of the edge will be met.
To find a trading system that has an edge you must make a decision; you either spend considerable time gaining the knowledge and conducting the research to build an edge, or seek out an existing and proven edge to buy. Build or buy?
Most people who choose to build never complete their edge, or at least to the point that they trust it, and hence never get to the point of executing with a predefined edge in the market. Building is only suitable for a very small percentage of investors who have the necessary skills, time and mindset. It is tough work building an edge but for those who do, it is very rewarding.
Buying an edge involves a leap of faith. To take that leap of faith there is some fundamental information that should be sort. You need to assess the builder’s qualifications, experience and ethics, and ensure their researched edge is transparent and works. The ultimate proof is the equity curve over the long term through multiple market ups and downs. It is not the result of each trade that matters, or even a few months trading – it is the overall result of the edge over multiple market conditions over a large sample of trades, including brokerage and slippage. This level of proof goes well beyond the much maligned black box systems that are regularly sold to the unwary. Trust is “reliance on the integrity and qualities / attributes” of the edge.
By choosing to buy an edge, your time can now be spent developing other areas that build trust and allow you to execute with confidence. This includes developing your trading plan, learning the processes of your trading system, improving execution and developing your trading mindset. By sticking to the rules of the trading plan, you are able to execute the trades as and when they come along with no emotional attachment to the outcome of each trade. That’s trust!
Trading is an endurance activity not a sprint. In order to survive over the long term we must have a process and set of rules we can trust. It is the probabilities of the system over the long term that we need to understand and trust.
My friend the bike rider who featured in last week’s blog, trusts his bike 100%. He prepared first and trust followed. He chose to employ, buy, a mechanic with the desired qualifications and proven experience to build a bike he can trust. As a result, my friend is able to focus on the planning and execution, pushing himself to the limits of endurance because he has the confidence to do so. This trust gives him an edge over other riders who may not have developed the same level of trust with their bike, and even with their own mind and body. Those that lack this level of trust and thus confidence, are not able to perform as well under pressure or after more than 20 hours of gruelling physical and mental endurance.
Trading the markets is the same. We need to have trust – in the edge of our system, the development and workings of the system, and most importantly, ourselves. There is no other high probability way of doing it. Preparation will develop trust which will develop confidence which will overcome the emotional turmoil of fear, uncertainty, doubt and trepidation that the markets would otherwise deliver.
I have learnt that you cannot trust and fear (or worry) at the same time. So which of the two will it be for you when it comes to the market?