The unique world of trading futures is one that encourages traders to reject objectivity
and logic in favour of the basic human emotions of greed, fear, hope and pride, with
disastrous consequences. Let’s take a closer look at the markets and the psychological
problems they create.
Operating in an unstructured environment. Trading requires you to operate in an
environment with few rules and little structure. Most people need order and rules for
guidance, it is the way their lives have been structured since childhood. Man is brought
up in a society that is held together by rules and laws that are imposed by an external
authority.
Society is structured, and it is its definitive structure that makes people feel comfortable.
Laws and rules are perceived as protection when our security and well being are
threatened. We can, for instance, go to the police or Courts to look into and act on our
grievances.
In contrast, the trading environment has no clearly defined rules and no structure. It
would be, in society terms, total anarchy. The market moves where it wants, whenever
it wants. The society of trading has no governing body that makes or enforces rules;
there is no judicial body to appeal to should the investor feel prices are not moving in
the right direction. This anarchy can be extremely unsettling for investors if they think
prices should go up and they actually decline. There is absolutely nothing we can do
about it. The market does not care whether investors make or lose money, it has no
conscience, and it is a natural phenomenon and never has to justify its actions.
A harsh and hostile environment. Every trader tries to take money from everyone
else. Everyone is trying to make money at everyone else’s expense. It is a uniquely
harsh environment, everyone is against you and you are against everyone else. One
analyst compares it to a medieval battle - a man used to go to the battlefield and hill his
adversary while his opponent tried to do the same to him. The winner took the loser’s
weapons, his chattels and sold his wife and children into slavery. Today traders to battle
on the Exchanges instead of on the field. When you take money away from a trader, it
is not that different from drawing blood, he may los his home, his chattels, and his wife
and children may also suffer. Is this description a bit exaggerated? Perhaps; however,
there is no denying how hostile the trading environment feels when you trade in it, to
stand alone can be, and is, uncomfortable.
Confronting your inner self. Standing alone is uncomfortable because it makes people
do one thing that most feel uneasy about, which is taking responsibility for one’s
actions. Most people like to delegate responsibility, blame others and make excuses
when they don’t succeed. Most people simply cannot face the simple truth that they
are responsible totally for the consequences of their actions. A person can go for a job
interview and convince himself that he did not get the job due to a personality clash with
the interviewer. A lawyer can drink too much before an important case and convince
himself he lost because the Jury was biased, a salesman can convince himself that it was
his product that was not up to scratch and not his presentation.
The trader, however, has nowhere to hide when interacting with the market. He is really
competing against himself, and the market will judge every day how well he is doing.
This confrontation with our own personality, our strengths and weaknesses graphically
exposes, is something most people would rather avoid.
The work ethic does not apply. The normal work ethic of time, effort and reward that is
common in most job situations does not apply in the markets. For example, a factory
worker putting in overtime and working extra hours is rewarded with more money.
As a general rule, the greater the effort we put in, the greater the reward we expect.
However, no such work ethic exists with the markets. A trader can spend years creating
a trading system, only to see his equity wiped out in a matter of days. A trader, however,
may quickly develop a simple system and reap huge profits. Whether we acknowledge
it or not, we normally believe that we deserve money under certain conditions where we
have to expend a certain amount of effort to get our reward. For example, an investor
sitting on a big profit feels he does not deserve it, and therefore tries to snatch it. When
a trader loses, he feels that his input in terms of effort means he deserves a reward
and he holds his loss. His subconscious mind constantly equates time and effort with
reward, and this affects his objective judgment.
There is unlimited profit and loss potential. This is the one characteristic that brings out
the worst emotions in traders and causes them to lose. They simply cannot cope with
the unlimitedness of the markets’ movements. This “unlimitedness” and the massive
leverage available causes traders to create risk by their emotional desire to avoid it.
This may sound illogical until we examine how an investor’s emotions interact with his
perception of risk reward.
Consider the following: If making money is important to you, as it is to most people, you
will have difficulty taking a small loss. If you bear in mind a trader’s self esteem and
the fact that money is on the line, you will appreciate the psychological turmoil this can
cause. Profits, on the other hand, are just as difficult to cope with. When a large profit
occurs, he gets excited, and the bigger the profit becomes the harder it is to resist the
temptation to take it now. However, profits need to be run to cover inevitable losses. In
their efforts to avoid risk, investors actually end up creating it. Consider the following
psychological test:
A group of people are given the following choice over a number of trades:
A 75% chance to win $1,000 with a 25% chance of getting nothing, or a sure $700.
Four out of five subjects take the second choice, even after it is explained to them that
the first choice leads to a $750 gain over time.
Another test gives people the following option; a sure loss of $700 or a 75% chance of
losing 1,000 and a 25% chance of losing nothing. Three out of four took the second
choice, condemning them to lose 50 more than they have to. So, in trying to avoid risk,
investors create it.
Emotion causes most traders to act in a way that will lead to their ultimate demise. They
prefer a sure gain, however small, to a logically based speculation to seek a large profit.
On the other hand, they actually seek risk in the realms of losses. They let losses run to
avoid taking a small loss and, by doing so, they create greater risk for themselves. They
expose themselves to bigger losses when they could have had a certain small loss.
