Sunday, 3 May 2020

TRADING LESSON : WHY IT'S OKAY TO BE WRONG



We do not live in a society that tolerates indecision and wrongness.

Every time, the mark of a 'true' leader is to boldly stick to one thing and carry it through no matter what. A leader who changes her mind halfway is not seen as bold, even though it's arguably a much more difficult thing to do.

The phrase 'no matter what' already puts our minds in a corner. It means that come hell or high water, we have to deliver. Damn the costs. You want to suddenly decide to do something else? OK, you're fired; we'll get the guy who will follow the game plan.

We fear getting things wrong. Even worse, we fear admitting that we are wrong. There is no performance bonus for the person who says "Oops, sorry guys, I guess we fucked it up at the start". But this is precisely the corrective action that is needed.

We totally understand that in corporate culture, we have to always paint a rosy picture in our business plans or financial projections.

But when that plan totally becomes useless in the face of economic realities - like say, an impending recession - the projections become about as useful as getting a haircut to relieve high blood pressure.

In the business of trading, we have to change our minds a lot. It's a necessity, and we get things wrong every single day.

Sometimes our plans don't work. Our views can be flawed, or ill-conceived. We sometimes say and do completely dumb things.

These apply to trading, but life is like that too.

BIAS V.S. FACT

When we trade stocks, we have to formulate opinions about a lot of things. Is the stock undervalued or overvalued? What's going to happen tomorrow for crude oil? How does Trump's tweet affect the stock market? Is the index shooting up or collapsing tomorrow?

We get asked a lot about any of the above. And to be truthful, the answer is always this :

I'm not sure, and I admit that I'm not sure. But I have some ideas.
 
Obviously, we have opinions about literally everything. So what we do is to admit that they're just opinions. We do not limit ourselves to the possibility of completely being wrong and changing our minds, and quickly.

So here's a two step plan to make better trading decisions.

1) Embrace your bias

Is the market going up or down tomorrow? How we'd answer : "Our bias is for the market to....". There is no sure thing. We'd assume one thing, but we don't put too much weight on that particular assumption, because the future is fuzzy.

And if anyone has an issue with this, it's fine... it's not their money that we are putting on the line.


Snapshot from our private Telegram channel

2) Always think in probabilities

In simple statistical terms, if you're looking at how stocks will perform tomorrow, there are only three possible outcomes.

Up
Down
Flat

However, the probability is not 1/3 (33%) each. Sometimes the price is unchanged (flat), but due to the inherently volatile nature of stocks as an asset class, they are more likely to go either up or down on a daily basis. Ignore this part if you're yawning to death : the rate of change in stocks tend to follow bimodal outcomes.

Just like anyone with a remotely political opinion, we always have our biases in the financial markets. What is more interesting is if something completely different happens. We assign probabilities to multiple outcomes, because we are not anchored to a single, unbendable, thought.

OK, the stock didn't do what we expected. So how does this guide our next trading decisions? Us being right with the initial opinion has its own probability, and so does the opposing one. We just adjust accordingly.

Do we stick to being wrong and insist everyone else is an idiot? No sir.
Since we are wrong about tech sectors going up on Monday, does that mean we should sell our entire portfolio? Maybe switch to trading oil and gas counters? Or buy some Hang Seng put warrants as insurance against a falling market?

Being wrong does not have to be the end of it; its just one single point in the decision chain. We get over it very quickly, because the more important things lie ahead. We owed some of our biggest trading profits to being completely wrong at the start, changing our minds, and swiftly making decisions to reflect that.

Additionally, we are completely shameless. We do not care what people think about our wrongness, even when we screw up the next 9 out of 10 trading decisions. That one time where we get it right can make all the difference.

And you shouldn't care either. It's your own money, your own call. 

DON'T WORRY, IT'S JUST A LEARNING LESSON


Let's do a simple exercise. When was the last time your financial adviser, or stockbroker, or your immediate supervisor, admitted that they were completely wrong about something? Like, absolutely, horribly wrong?

We know it can get a bit touchy. Reputations may be on the line, and admitting fuck ups do not pay well. Aren't they supposed to be the experts? 

Maybe your stockbroker can hedge his recommendation. "It was really the right call, but we didn't expect oil prices to crash by 20 bucks!". OK, it's the universe's fault now.

Is it too much of a stretch to suggest that perhaps people who really know, are the ones who learned from not knowing before?

We are not joking when we say we get things wrong every day. It's part of our process. We do not doubt it for a second, because we get results.




There's a bit of a paradox when it comes to experts, and the whole notion of expertise.

The more we think we know, the more resistant we can be to opposing opinions. My reputation's on the line, so I have to know better. 

Even worse, we become dogmatic. Instead of seeing merits in diversity of thought, we are inclined to reject them. We get defensive, and start citing our credentials while trying to snipe at other people's credibility.

Value investors sneer at short term traders who make gigantic losses from a single bad move. Short term traders laugh at value investors who held on to their positions during a big market crash out of their devotion to value, just before they capitulate and dump stocks at the bottom of the market. 

We simply don't understand people who think like this. We find value in... well, value investing, as well as trading, as well as arbitraging, technical analysis, fundamental analysis, and a lot of things. It's all different strands of knowledge in the pursuit of the same goal.

The obsession with 'me being right and you being wrong' is why most of us 
will never improve as investors.

It's no surprise that kids tend to admit that they don't know things, and that they are wrong, compared to adults. We somehow naturally end up outgrowing a very crucial and necessary trait. Maybe it's because we live in a conformist society that does not tolerate indecision and wrongness.... you get the idea.

We fear getting things wrong. We fear being thought of as an idiot by our friends or colleagues. We fear being perceived as incompetent. 

We should not be motivated by fear, though. We should be motivated by the pursuit of knowledge, and finding optimal outcomes.

Elton John got it right when he said that 'sorry' seems to be the hardest word, but next in line are 'I was wrong' and 'I don't know'.

GET RID OF THE FEAR

In trading, the primary fear is self-doubt. Fear of getting things wrong can sap confidence, ruin emotions, and destroy egos. Sometimes there will be a losing streak that we find hard to overcome. 

But this is not a business meant for egos. When you think you're a market genius, that's when you're toast. We will keep getting things wrong even when we're all in our 70s and trading out of retirement homes with shoddy Internet connections. 

So what's the cure for being fearful of wrongness? It's simple : forgive yourself. Know that it's alright.
 
In our own investment journey, we've done everything. We've been wiped out. We've had bullish calls that turned out to be complete duds. We had bought speculative crap stocks at their peaks. We once turned a 30% paper profit into a 20% loss overnight (also a speculative crap stock). Five figure losses. Et cetera.

And worst of all : we had been in denial before. Like the clueless gambler destined to spend a life in destitute, we ignored the lessons of cluelessness. It took us a long time to realise that it's OK to be wrong. Only then did we start improving, slowly.

Getting things wrong is not a negative trait. It doesn't mean you're an idiot. It's what you do after that matters.

The next time your trading or investment ideas turn out to be completely wrong, accept it, move on, and find the next angle. That moneymaking opportunity is not going to stick around forever.

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