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The Trading Virus

This article is best read after a substantial rise has occurred in the market following a period of sustained bearishness.  Why?  Because it is precisely the time when many will have seen the direction of the virtual portfolios turn.  Some may even have caught the bottom in stocks like Bank of America, up 50% in less than 10 days!  When wealth is attained so rapidly, a tendency towards confidence or more particularly over-confidence is natural.  Short-term results vindicate decision-making at the bottom to ‘bet heavily’ or ‘go all in’.  And they solidify a belief that the next bottom can be called successfully also.  This may indeed occur.  But a danger exists, which I call the Trading Virus.
 
The Trading Virus affects almost every trader.  The victim is affected soon after a successful outcome in the stock market.  The virus manifests as excessive confidence and belief in one’s ability to time the market.  For most the virus is a lifelong condition.  Bulls and bears are equally affected.  As stock markets rise, bulls are infected and ride the glorious waves higher and higher until the inevitable crash cycles around again.  And bears rarely hold out long enough in sustained bull markets to enjoy those crashing sounds. 
 
For both bulls and bears, the virus implants a disease called ‘Results-Focus’.  Each is a keen market observer driven to action or inaction by the latest direction of streaming quotes, media hype, account value or some other short-term mechanism.  And a dependency is soon created; a dependency that demands information in the short-term that produces adrenalin rushes that lead to action that further lead to hopeful and expected results.  This is not to say that, in the short-term, talented traders cannot profit. Of course, they can.  But for most, the disease is a lifelong incurable condition because something very important is overlooked – the process of wealth accumulation.
 
Those successful shorter-term traders succeed not because they are results-oriented but because they are process-oriented.  And those victims who cure themselves do so precisely because they transition from the trap of attempting to time the market perfectly all the time to creating a process that succeeds at all times.  You will quickly see at PhilStockWorld that Phil and Optrader are both highly successful traders.  Both use options to take advantage, albeit in slightly different manners.  And that’s the key.  Each has his own approach and process.  They do not focus so much on trying to make 15% or 25% or 50% or any other percentage as much as they focus on measuring the risks and rewards in the context of their process to ensure that no single position can detrimentally impact the entire virtual portfolio so substantially that a crash leads to elimination from the game.  While both will suffer losses on occasion, I would confidently expect that by remaining true to their respective trading styles, neither can suffer the ‘wipe-outs’ experienced by some other traders (who may be considered more esteemed in the financial community by the nature of the size of their house or the parties to which they are invited!).
 
Manage risk and you can create a vaccine for the disease.  Manage risk well and a profitable, long-term trading career awaits.  Of course, this means that insurance must be purchased at times - which will end up costing money.  In the stock market, this should be accepted as part of the cost of trading successfully.  Most complain that insurance is wasted when it is not needed.  But such an argument is akin to stating that buying insurance on a home was a waste because no fire burned down the home!  Just because you have insurance against a fire doesn’t mean you want a fire to appear!  But if a fire does appear you definitely want insurance.  Be careful of falling victim to logical fallacies that are governed by emotion as opposed to reason.

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  1. Nicely put, this virus.

    I like to think that I have learned my lessons, at least partially. I’m still pretty new to options trading (less than a year) and trading in general (a bit more than a year), so I console myself, that I had to pay some tuition to the market for my losses :)

    The me from 6 months ago would have jumped in with both feet, regardless of other conditions. But not this time… I admit I’m bit sorry that right now I don’t have more time for trading (week of meeting followed by business trip week, which is followed by another week of meetings (this one), followed by vacation week, followed by another business trip week is far from ideal for following the market), but I’m resisting the temptation. If the really turns up, there will be months to trade it (it seems obvious, but before I made my losses I was in constant "fear" of losing opportunities).

    I guess, that was yet another confirmation (for me) that no amount of reading and simulated trading can replace the real experience…


  2. tlsvet, there’s a good story I saw Seth Klarman of Baupost quote recently about the best way to ride a horse is get up and there and practice rather than read a book about how to do it.  It does take time for us all but it’s definitely worth when you stick with it.  Persistence is the key!