I've recently re-read Fooled by Randomness and Black Swan by Nicholas Nassim Taleb and I think there are some valuable lessons in those books. I've written a short summary of what I think some of the best ones are. Let us know your thoughts!
Luck plays a role in trading…
We like to neglect the fact that luck is playing a role in our lifes, especially when we have worked hard for something. It is only natural that we prefer to take the credit for something we have done and say that our knowledge or experience have brought the desired result. While luck is definitely not the factor that makes the difference between a successful and an unsuccessful trader, it is a larger part of trading than many like to admit. There is nothing wrong about admitting it. After all, you have taken some action in order to be exposed to luck. Those who do nothing, will rarely get lucky (even for winning the lottery, you have to make the effort to buy a ticket).
About predictions…
The analysts that have made brilliant calls will be remembered. If an analyst would have predicted that the SNB will remove the 1.20 floor in EUR/CHF three months before it happened, he would have been remembered and people would be very interested in what he has to said in the future. What about the many analysts that wrote that there is no way that the SNB will remove the floor? Or the ones that said ECB QE will not happen? No one cares and life goes on. My point here is that predictions are useless, especially long-term ones. We can’t know where the EUR/USD will be trading at tomorrow, let alone in one year.
Trading probabilities
Traders are essentially trading probabilities. We have no idea where the EUR/USD will be trading at in 5 minutes, one hour or one day, but we are acting on ceratin patterns or certain news. There is some similiarity to poker, as we are basically trying to predict what other people will act on and how. For a support level to hold, you need decent buying interest there. However, what if the pair had difficulties to develop any significant upside momentum and is approaching the support level for a fourth time in a row? Buying interest could be weaker this time and the stops resting below that support level could accelerate the decline. As you see, we are often not only trading patterns or news, but also try to anticipate the reaction of other market participants as a whole.
Live with the uncertainty
Once you acknowledge that you can’t predict the future and are only acting on probabilities, life will become easier. There is no point in becoming emotional about a trade that went wrong, as there could have been a variety of factors behind it. If you followed your strategy and applied the proper risk management rules, you did OK. Instead of overanalyzing why the market did not behave as you wished (in hindsight, everything will make sense), analyze your behavior and emotions. You will do yourself a great favour.
Trading is a scalable business
Let’s take a barber as an example (you can take pretty much anyone else in the services industry too). He can only take a limited number of clients, given that he can only work a specific amount of hours per day and can only serve one client at a time. For him to expand his business, he needs to employ other barbers in his shop. This requires physical, mental and financial work (meeting with the potential employees, figuring out who is the right one/organizing stuff, paying employees & benefits and new equipment). When they have reached their capacity, his only way to expand is to open a new shop somewhere, which then requires even more physical, mental and financial work. You see my point. In trading, we can make fortunes or lose them without much additional work. It is the same mental process of analyzing the markets, entering a trade, managing the trade and exiting the position. Basically, trading is a scalable business because you can gain wealth rapidly without much additional effort, which is not impossible in most other businesses. However, you can lose of course everything you have gained within a short time, which is much less likely with a non-scalable business.
Winner takes it all…
Trading is a very competitive business and there tends to be a small number of highly successful traders who produce huge profits and a large number of unsuccessful traders, who have blown up or just play around until the moment comes they give up or blow their account up. It is also a business environment that can change rapidly, without warning, and rarely gets boring.
Hindsight – I should have known it!
We have all done it. We reviewed a bad trade and suddenly everything made sense. How could we have not seen it at the time and avoided that losing trade? Well, in hindsight all makes sense. Let’s look back at January. ECB QE seemed pretty likely at the beginning of the year. There would be huge pressure on the EUR/CHF as a result and it would be very costly for the SNB to keep the 1.20 floor. Short EUR/CHF made a lot of sense, especially given the risk-reward. You see, it all makes sense when we write about a past event. Very few traders were short EUR/CHF into that historic event, but many scratched their heads afterwards and asked themselves how did they not see this coming. Again, my advice here is work on analyzing your behaviour and make real-time notes if possible, instead of overanalyzing the past.
The Lottery Mentality
The average retail trader has a lottery mentality. They trade for a couple of years. Winning some, losing some. In the end, their P&L is negative and they have likely blown up at least one account in that time. They have likely experienced a lot of different emotions during that process. Euphoria and excitment when they had a winning streak, happy that they have finally cracked the business of trading. Anger, sadness, frustration or even depression when faced with large losses and no progress. The problem is the lottery mentality. Many dream about being a full-time trader, no boss/no clients, plenty of money. But few face the reality of what it takes to get there and the negative impacts trading could have on your life. Many overestimate themselves and do not want to acknowledge that they do not have what it takes to become a trader. Of course, if you are trading as a hobby and only risk money you can afford to lose, there is nothing wrong about that. However, if you wish to become a professional trader, but don’t take it serious, it will end bad.
Copying successful traders
We see often those lists of characteristics and habits of successful people, like „Top 10 things successful people do every morning“ or similar. I find those very annoying and would not spare a second to read one of those pieces ever again. Simply, what can work excellent for someone, could be disastrous for someone else. Further, we often link random things that successful people do with their success. Would the tech billionaire who wakes up at 4 AM, does yoga every morning and follows a certain diet be poor if he would not be doing those things? No. The same idea applies to traders. Someone elses habits shouldn’t bother you much. Some successful traders perhaps have adapted to sleeping only a few hours per night and can be in front of their monitors almost all day long without being completely exhausted, both physically and psychologically. Other, also successful traders, might require a certain part of their day off for relaxation and need a certain amount of hours sleep per night.
It’s not as much about strategy as you think…
There is a lot of hype around very successful traders and plenty of retail traders still believe that those elite traders have some kind of holy grail strategy. While it is true that elite traders have much more resources available (Bloomberg terminals, data feeds, professional charting packages etc.) and a wider network of people they can exchange ideas/consult with, it’s not as much about a certain strategy as many think. A strategy certainly plays an important role in trading, as it is the part of our business which serves as our guide and keeps us disciplined. However, if we are talking about discretionary trading alone, psychology plays the much larger part. If you take a person with the proper mindset of a trader and skills, he will most likely be able to adapt to changes in strategy or trading style. It is in his blood, so to say. The majority of retail traders fail because of psychological problems and/or poor risk management. Even if you give a large group of such traders a proven strategy with all the details, only a very small number would be able to execute it successfully in the market.
Luck plays a role in trading…
We like to neglect the fact that luck is playing a role in our lifes, especially when we have worked hard for something. It is only natural that we prefer to take the credit for something we have done and say that our knowledge or experience have brought the desired result. While luck is definitely not the factor that makes the difference between a successful and an unsuccessful trader, it is a larger part of trading than many like to admit. There is nothing wrong about admitting it. After all, you have taken some action in order to be exposed to luck. Those who do nothing, will rarely get lucky (even for winning the lottery, you have to make the effort to buy a ticket).
About predictions…
The analysts that have made brilliant calls will be remembered. If an analyst would have predicted that the SNB will remove the 1.20 floor in EUR/CHF three months before it happened, he would have been remembered and people would be very interested in what he has to said in the future. What about the many analysts that wrote that there is no way that the SNB will remove the floor? Or the ones that said ECB QE will not happen? No one cares and life goes on. My point here is that predictions are useless, especially long-term ones. We can’t know where the EUR/USD will be trading at tomorrow, let alone in one year.
Trading probabilities
Traders are essentially trading probabilities. We have no idea where the EUR/USD will be trading at in 5 minutes, one hour or one day, but we are acting on ceratin patterns or certain news. There is some similiarity to poker, as we are basically trying to predict what other people will act on and how. For a support level to hold, you need decent buying interest there. However, what if the pair had difficulties to develop any significant upside momentum and is approaching the support level for a fourth time in a row? Buying interest could be weaker this time and the stops resting below that support level could accelerate the decline. As you see, we are often not only trading patterns or news, but also try to anticipate the reaction of other market participants as a whole.
Live with the uncertainty
Once you acknowledge that you can’t predict the future and are only acting on probabilities, life will become easier. There is no point in becoming emotional about a trade that went wrong, as there could have been a variety of factors behind it. If you followed your strategy and applied the proper risk management rules, you did OK. Instead of overanalyzing why the market did not behave as you wished (in hindsight, everything will make sense), analyze your behavior and emotions. You will do yourself a great favour.
Trading is a scalable business
Let’s take a barber as an example (you can take pretty much anyone else in the services industry too). He can only take a limited number of clients, given that he can only work a specific amount of hours per day and can only serve one client at a time. For him to expand his business, he needs to employ other barbers in his shop. This requires physical, mental and financial work (meeting with the potential employees, figuring out who is the right one/organizing stuff, paying employees & benefits and new equipment). When they have reached their capacity, his only way to expand is to open a new shop somewhere, which then requires even more physical, mental and financial work. You see my point. In trading, we can make fortunes or lose them without much additional work. It is the same mental process of analyzing the markets, entering a trade, managing the trade and exiting the position. Basically, trading is a scalable business because you can gain wealth rapidly without much additional effort, which is not impossible in most other businesses. However, you can lose of course everything you have gained within a short time, which is much less likely with a non-scalable business.
Winner takes it all…
Trading is a very competitive business and there tends to be a small number of highly successful traders who produce huge profits and a large number of unsuccessful traders, who have blown up or just play around until the moment comes they give up or blow their account up. It is also a business environment that can change rapidly, without warning, and rarely gets boring.
Hindsight – I should have known it!
We have all done it. We reviewed a bad trade and suddenly everything made sense. How could we have not seen it at the time and avoided that losing trade? Well, in hindsight all makes sense. Let’s look back at January. ECB QE seemed pretty likely at the beginning of the year. There would be huge pressure on the EUR/CHF as a result and it would be very costly for the SNB to keep the 1.20 floor. Short EUR/CHF made a lot of sense, especially given the risk-reward. You see, it all makes sense when we write about a past event. Very few traders were short EUR/CHF into that historic event, but many scratched their heads afterwards and asked themselves how did they not see this coming. Again, my advice here is work on analyzing your behaviour and make real-time notes if possible, instead of overanalyzing the past.
The Lottery Mentality
The average retail trader has a lottery mentality. They trade for a couple of years. Winning some, losing some. In the end, their P&L is negative and they have likely blown up at least one account in that time. They have likely experienced a lot of different emotions during that process. Euphoria and excitment when they had a winning streak, happy that they have finally cracked the business of trading. Anger, sadness, frustration or even depression when faced with large losses and no progress. The problem is the lottery mentality. Many dream about being a full-time trader, no boss/no clients, plenty of money. But few face the reality of what it takes to get there and the negative impacts trading could have on your life. Many overestimate themselves and do not want to acknowledge that they do not have what it takes to become a trader. Of course, if you are trading as a hobby and only risk money you can afford to lose, there is nothing wrong about that. However, if you wish to become a professional trader, but don’t take it serious, it will end bad.
Copying successful traders
We see often those lists of characteristics and habits of successful people, like „Top 10 things successful people do every morning“ or similar. I find those very annoying and would not spare a second to read one of those pieces ever again. Simply, what can work excellent for someone, could be disastrous for someone else. Further, we often link random things that successful people do with their success. Would the tech billionaire who wakes up at 4 AM, does yoga every morning and follows a certain diet be poor if he would not be doing those things? No. The same idea applies to traders. Someone elses habits shouldn’t bother you much. Some successful traders perhaps have adapted to sleeping only a few hours per night and can be in front of their monitors almost all day long without being completely exhausted, both physically and psychologically. Other, also successful traders, might require a certain part of their day off for relaxation and need a certain amount of hours sleep per night.
It’s not as much about strategy as you think…
There is a lot of hype around very successful traders and plenty of retail traders still believe that those elite traders have some kind of holy grail strategy. While it is true that elite traders have much more resources available (Bloomberg terminals, data feeds, professional charting packages etc.) and a wider network of people they can exchange ideas/consult with, it’s not as much about a certain strategy as many think. A strategy certainly plays an important role in trading, as it is the part of our business which serves as our guide and keeps us disciplined. However, if we are talking about discretionary trading alone, psychology plays the much larger part. If you take a person with the proper mindset of a trader and skills, he will most likely be able to adapt to changes in strategy or trading style. It is in his blood, so to say. The majority of retail traders fail because of psychological problems and/or poor risk management. Even if you give a large group of such traders a proven strategy with all the details, only a very small number would be able to execute it successfully in the market.