Friday, December 20, 2013

Trader Psychology: Why the Stock Market is Always Right

The need to be right, at least on occasion, is important to an individual's self-esteem.  Most of us don't feel as good about ourselves when we're wrong, so some of us have found a work-around to this problem by occasionally (or frequently!) sacrificing our grasp on reality in order to preserve our self-images.

What does this have to do with trading or investing?  We'll get there in a moment.

The funny thing about this tendency is that it's difficult to observe in ourselves, but incredibly easy to observe in other people.

Let me draw an example, and see if you haven't noticed this trait appear at least occasionally in a coworker, or a friend, or a family member... and maybe yourself.  We'll start with an innocuous example to illustrate, then we'll talk about how this can impact traders and investors on a more serious level.

Here's the example:  You're playing Trivial Pursuit with family, and the current trivia question is: "Which Dickens character said, 'Please, sir, I want more.'"  Uncle Richard answers "Tiny Tim."  Uh oh.  Here we go again... "Sorry, Uncle Richard, it was Oliver Twist."  Well!  As we all know from countless years of unfortunate experience, Uncle Richard is NEVER wrong.  So instead of simply acknowledging this fact and letting the next player take their turn, Uncle Richard forces the whole table into an impromptu debate about classic literature -- and, although he's a plumber by trade, he has suddenly become the World's Foremost Dickens Expert.

This goes on for the better part of ten minutes -- meanwhile, everyone else at the table knows Tiny Tim's famous line was "God bless us, every one!" and sees that Uncle Richard is dead wrong.  But that doesn't matter.  In Uncle Richard's reality, everyone else is wrong and he's the Hero Fighting for Truth.  The debate eventually ends, but only because we finally agreed to give Uncle Richard the pie piece, due to sheer exhaustion in the subject matter.  He never admitted defeat.  Nor will he ever: for whatever reason, his version of himself requires him to be right at all times -- even if it means he has to warp his perceptions of reality in order to accomplish that.

This is what I mean about this trait being easy to see when it manifests in others.  We all know "how Uncle Richard is" -- but do you think he notices this trait in himself?  It's unlikely that he does, because otherwise he would find a more efficient and productive way of approaching life.  Probably all he knows is that he feels threatened and defensive a lot, and that most of the rest of the world "is a bunch of idiots."

I mention this because I have seen traders and investors fall into this same trap countless times.  I myself have fallen into it on occasion.  I've talked about it before, as our tendency to create an imaginary "market morality" i.e.- "The market shouldn't have gone up yesterday!"  As if the market did something morally wrong by rallying, while we were in the right and thus hold the high ground.  Even though our positions lost money, we are thus comforted by the thought that, somewhere out there, the Equities Gods have been angered by the market's display of impudence and They will one day rain down fire and brimstone upon the exchanges.  People who took the other side of the trade are invariably thought of as "fools," and "lucky."  And maybe they were, but that isn't the point (the actions and choices of other people have absolutely nothing to do with our own paths, and simply aren't our concern).

As far as I can determine, these thoughts exist for one reason, and one reason alone: they are a self-defense mechanism for the ego.  But they are ultimately counterproductive to our trading ability (as well as to other aspects of our lives).  One of the hardest parts about choosing and entering trades is removing bias, preconceptions, and ideas about what the market "should" or "should not" do.  The need to be right precludes that ability, and can actually cause us to misread reality.

Successful traders adopt the attitude that the market is always right.  I believe we should view it as our goal to align ourselves with the market as much as possible -- not the other way around.  If we're to succeed, then we have no choice:  Either we get in sync with reality and go with the flow, or reality will drag us along kicking and screaming.  I simply don't see another option since, as individuals, we cannot "force" the market to break or rally by employing willpower, by wishing, by prayer, by bargaining, by cursing, or by any other means (note: the preceding limitations may not apply if you are a central banker).  

The ability to accept that the market is always right is an outcropping of humility; and ultimately, it's also the only way we will recognize and learn from our mistakes.  After all, if the market is "wrong" when we lose money, then in essence we're saying that we didn't make a mistake, the market did. And if we truly feel that way, then there's no impetus to even go on the quest for knowledge and learning in the first place.

Thus it is ultimately an act of humility to accept defeat and accept the lessons of the market -- and in the end, we'll be better traders for it.  Without the need to be "right" slowing us down, we can react more quickly to changing market conditions and reality in general, and we'll find that we end up on the (actual) right side of the trade more often and with greater speed.  At the end of the year, your account will thank you (and, in Uncle Richard's case, so will everyone else).

There's been no material change in the outlook, so just one chart today, in order to avoid having to reprint yesterday's article in its entirety (See:  SPX Captures Sixth Straight Target Zone -- Will Bulls Reach the 7th?).

In conclusion, there's very little to add to yesterday's outlook at the moment; so please refer to it if you missed it on the first go-round.  Trade safe.

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Reprinted by permission; Copyright 2013 Minyanville Media, Inc.

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