The following Open Letter was sent to me by Mike Cullen as a comment to last week’s blog. It contains an interesting way of viewing trading, which I obviously agree with. I felt it deserved it’s own limelight as a posting all on its own.
The context is Mike visiting a friend, Bill, who has been successful in many other areas of his life but was battling with trading…..
When I first came to see you in Surfers in 2008, and we started to do some work on the stockmarket, you told me that you would be good at it because you were a star chess and backgammon and poker player. I remarked at the time that it might not be as easy as you think, but you couldn’t believe it.
I am sure you would like to have a consistent and large income from playing games, and I outline for you below where the differences lie between the games you are good at (chess and backgammon and poker) and other “games” such as in the casino, betting on the horse races, and stock market trading or investing, where maybe your success is not as great as you would like.
In backgammon, chess, and poker:
- You are playing against other players, not against yourself.
- All players must play the game according to absolutely indisputable, clear, well defined, unbendable rules.
- Each game has a clearly defined beginning and end.
In the casino:
- You play against other players and the croupier (“the house”) in most games, but not in all games.
- There are strict rules that must be adhered to in every game.
- Every game has a well defined start and a finish.
So, on the outside it looks about the same as the games you are good at. But that is only superficial. In horse racing:
- You are playing against yourself.
- There are no rules laid down which players must strictly adhere to. You have to make the rules up for yourself.
- There is an absolutely clearly defined start and finish.
There are clear differences here to the games you are good at. In the stock market:
- You play against yourself.
- There are no rules whatsoever.
- There is no start and no finish.
There are monumental differences here from the games you are good at. The clear difference between the games you are good at, and the “others” is that the rules that you must play by in the “others” are not in existence until you determine what they will be, and there are no other players directly playing against you.
To be a consistent winner year in and year out at the horse races or the stock market, you have to see yourself as the casino, as “the house”. You have to:
- Accept that the expected outcome of any race or trade is random, and completely uncertain.
- You must develop strict and unbendable rules that ensure that you thereby create a constant sustainable mathematical edge, that when the rules are applied over a larger number of races/trades, the outcome is anything but uncertain and random.
- In the stock market, your rules must clearly define the start and end of every trade or investment.
The rules must be non-discretionary, the same as in backgammon, chess, and poker. If you break the rules you should be out of the game, except that you are not out of the game until you’ve made so many mistakes that you are broke.
The results of the casino’s rules are a constant sustainable mathematical edge, and they know exactly what their percentage (edge) is from every game in the house, over a certain number of games. It is small, like between 1 and 2 percent, but the turnover is huge. As long as they can maintain the turnover, they are assured of their profit.
If you want to win consistently at the casinos, you need rules that give you a better edge than the casino’s rules. Your failure to realize the intrinsic differences between backgammon, chess, poker, and horse racing, the casino, and stock market trading is why you have been unsuccessful in the stock market. But you can change your approach any time you want.
To summarize, you approached it as a player, trying to win at every game, trying to predict where the market would go next, and placing your bets accordingly. This allows the development of competitive habits which are fatal in the stock market or the races, or the casino. Having to be right is catastrophic in trading. You can only win constantly and consistently if you operate as the “house”, and not as the “player”, applying your rules consistently, over a large number of trades, with no expectation of win or loss on any one trade.
But I know you won’t believe a word of what I say, even though untold fortunes are at your fingertips if you weren’t so prejudiced. And I know you won’t thank me for telling you any of this. But the fact is it was not me who thought all this up, it was the likes of Mark Douglas, and Dr Van K Tharp, and other well known trading psychologists. I just thought it was time to let you know where to change your thinking if you want to make money the way you like to do it, but consistently.
My closing comments. To be successful with trading requires, amongst other things, paradoxical thinking. That is, what you think you have to do to be a successful active investor, as your general experiences in life might lead you, is typically the exact opposite of what you actually need to do.
“If you think you have discovered a great truth and it is not a paradox, I suspect you may be deceiving yourself.” Scott M Peck, author of The Road Less Travelled.