In my post a couple of weeks back, "Anatomy of a Spiraling Trader (Part 1) – Trader's Narcosis," we talked about how a trader who puts himself in a downward spiral gets a type of narcosis similar do that of wreck divers. In that narcosis, he makes more and more risky decisions and exhibits less and less logical behavior, weakens his stance in the market as time goes by. We said this is because a trader has gotten to this point because he has linked his ego to his trading, and therefore, he now subconsciously associates being successful at trading with survival, the primary business of successful wreck diving.
Steps 3-4 of the trader's narcosis are really the lynchpin of the downward spiral as you, the trader in a spiral, repeat the same negative behavior at an always accelerating pace. I wanted to go more into depth about what is really happening here. What, specifically, drives these ever sloppier choices that the trader is making? As I looked back into my past, what resonated clearly was the analogy of my rebound relationships, so I went out to Yahoo! and searched "rebound relationships." I hit the jackpot on the first selected link (http://www.romanceforeveryone.com/article/rebound-relationships.html ). This is the thought process in the mirror.
You – Making the Pain Go Away
Now prerequisite to anything I say here is the first choice you have made, which is to change your trading style. You wouldn't be in a spiral if you didn't. We can always make tweaks here and there, and in a future post, I will talk about healthy ways to do that. After all, the point of trading is to stay fairly consistent, but to put on concrete boots and be completely immobile as a result is not healthy. We want to leave some leeway to make healthy choices. The decision you have come to do something—anything—to make the pain go away is the result of a battered ego or self-esteem. Your ego is hurting, and you need to feel better about yourself.
Get a load of this, quoting from the website on rebound relationships:
"A rebound relationship is often a distraction from the pain of their sorrow and a quick fix for their damaged self-esteem."
"Their mind is often filled with questions of why their relationship failed and what they could have done to stop the breakup. They may also feel that precious time was wasted on the failed relationship and feel the need to quickly move on with their life."
So here you are. Let's just say that many of us have no idea how much emphasis we are putting on our trading success as a mechanism for validation. Your self-worth becomes increasingly based on one thing only—your success as a trader. So when you have a very bad experience as a trader, you look for that "quick fix," especially because you feel that "precious time [and money] was wasted" and wonder "what [you] could have done to stop" this great loss. So what do you do?
Little do you know that you will look for the thing that is absolutely working right now at the expense of all well-thought-out long-term logic. You are "angry at your ex" (the market) for "breaking [your] heart" (bruising your sense of self-worth), and you are going to teach it a lesson. The difference here is that the market can't reject you. You can go right back to that same market at any moment, and it will receive you with open arms. So in a way, it's worse than the perilous rebound relationship!
So you start looking for trades that "have a nice smile," or in other words, that are in a nice trend, look like a sure thing, and will erase all the pain, suffering, and losses you just experienced. You start dating the rebound stocks or options, or whatever seems to have the nicest smile. This new trade is "initially . . . very satisfying," since trends aren't just going to immediately reverse because you entered a trade. However, you are on the rebound and are "not in a healthy state of mind." You are not in a "place to make healthy . . . decisions." "[You] are thinking about the moment, not the long term," which causes you to make a "poor choice" for a rebound trade.
You know, I'm actually getting sick of quoting this thing. I mean I'm realizing that if I cut and pasted the article and did a search/replace on a few words, I'd have a better post than I probably have here. So let's shift gears about the choices you actually are prone to make here.
You – The Mean Reverter
Nature is all about equilibrium. We know this. The laws of nature always go to the norm. We have global warming and ice ages, but the average temperature over time stays the same. Species die out every day and others are created. Water evaporates, and then it rains. I could go on and on.
You, the trader and fellow human, are also are a creature of equilibrium, as are the markets, since they were created by beings of nature. Let's take you first. Above, we said that you when you are in extreme pain, you are going to reach for something of extreme comfort—that is, the trade that is working right now. However, the markets revert to the mean over time as well. This means two things:
- If you were experiencing so much pain that you had to change a hard-and-fast trading philosophy to make yourself feel better, then there is probably a not-so-small probability the trade you left was soon going to shift from a position of extreme pain to at least a position of less pain.
- The trade you switch to has probably been working for a while and is soon going to reverse trend to start causing acute pain.
So you are moving from a spot that likely would improve to one that is prone to start deteriorating! And what could be worse than that? You will repeat this over and over. Leaving the trade that is causing you pain and could soon reverse to one that has been making people feel better and will soon reverse.
In the end, the interworking between the market's mean reversion and your own, while timed about the same, are directionally opposed, and are creating a situation where you make choices that are exactly diametrically opposite to what would make you successful over time. And so what do you do? Well, going back to the diving analogy, you can't stand to be down in these threatening depths anymore. You fill your wings and blast to the surface, withdrawing completely from the market to heal, vulnerable for your next rebound move.
So what's the remedy? Well, half of the cure is recognizing the pattern. So hopefully if you are in a real bad spot right now or occasionally get into them and get into these spiral-spiral-exit patterns frequently, you will be able to begin recognizing this and thwart entry into the spiral process. I will present a structured way to recover from this and ensure that it never happens again in future posts.
Thank you so much for reading. I very much hope this helps.
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