Friday, January 25, 2008

A Cardinal Virtue of Trading

The novelist/philosopher Ayn Rand considered the willingness to face and deal with reality to be among the cardinal human virtues. While other animals can survive through their ability to forage or hunt prey, the human animal can survive only through reason and the use of the mind. To blank out reality--or fake it--is to betray what makes us unique; it is a moral failing and not just a psychological one.

I've interviewed and worked with some very experienced and successful traders at investment banks, hedge funds, and proprietary trading firms. One common ingredient in their success is their willingness to acknowledge when they're wrong. If a trade goes against them and hits their stop point, they get out. They don't fudge reality, they don't turn the trade into a longer-term position, and they certainly don't add to the loser in hopes of making the money back.

These very successful traders are often quite confident, but they accept losing. They can face drawdowns, cut their risk, and keep themselves from blowing up. There's no head in the sand, no excuses, no revenge trading. For them, losing is a normal event, not a threat.

In a recent interview for a Reuters story, I emphasized that the SocGen trader who nearly brought his firm down with $7 billion in losses merely enacted on a larger (and illegal) scale what we see among traders during volatile times. The failure to acknowledge a loss leads to efforts to make up for the loss and eventually to a blow up. How often do we see the same kinds of blowups when people fail to face other kinds of problems, with their health, their marriages, or their careers?

It all boils down to acknowledgment of reality vs. denial.

There aren't many occupations that require participants to face loss every single day. That requires a kind of steadfast integrity: a rare ability to see consistently see things as they are, rather than as we'd like them to be. It sounds paradoxical, but normalizing failure and accepting loss are the prerequisites for achieving success and gain in the markets.


The Dual Road to Trading Success