Trading Psyche – Exuberance

Over the past several weeks I've been posting short articles that relate the psychological aspects of trading. Each post has focused on a particular emotion that we may encounter as traders, and that ultimately we need to deal with in a productive way. Today that emotion is Exuberance. In the words of Alan Greenspan, we might also call it Irrational Exuberance.

I hesitate to call this a rookie emotion, although I do feel that some amount of experience gradually helps us conquer the irrational aspects of this oh-so-good feeling. Conversely, any amount of experience doesn't remove it completely. The specific concern here is that traders might be overly optimistic about their chances for success.

Trading is a tough game. It's hard to be profitable. It's hard to compete with some of the most talented, smartest, and resourceful money managers in the world and do better; yet, that's what we try and do. I'm not trying to be negative, only to be realistic about the fact that trading is a business, and it's a tough one that requires a lot of determination and effort.
I'm not completely sure why this is the case, especially with new traders, but I've often thought that the financial education industry breeds it.

Do you remember the first (or last, or any) really good trading book you read? Do you remember closing the cover thinking, "I can do this!" Do you remember the seminar that you went to, coming away feeling confident that the method you just learned would work for sure? The financial education industry has to sell it that way, otherwise who would attend the seminars and buy the books? Have you ever seen anyone sell a seminar by saying, "This is really tough and we'll try to show you how, but most people will fail... sorry." That's not the way they sell them.

I'm not saying you shouldn't seek out and invest in financial education... you should. But we need to be realistic about what it is. Nobody walks away from a university with an MBA with the kind of optimism that comes out of a two-day seminar. I find that interesting. Bottom line: This is a business, and should be treated as a business. Yes - get an education and learn the business as you would any other. Practice and get experience, as you would in any other business. Here are a handful of things to put this idea in perspective:

• Start slow... Again, using the perspective of trading as a business, it's not typical for businesses to start out making money hand over fist. It does happen, but rarely. Plan to take some time. Learn and practice the craft of trading before you try to become a professional.
• Guard your cash... In any business, cash-flow is critical. When things aren't going well in a business, companies guard their cash. They cut expenses and reduce risk. It's not different in trading. Cash is part of your trading inventory and must be protected to stay in business.
• Have reasonable expectations... I've been in business for a long time and I have a pretty good idea when I look at a business plan whether or not it's reasonable. In most business growth comes slower than expected. We need contingency plans. Trading is no different. Have reasonable expectations about how long it will take to be profitable consistently, and about how much profit there will be. Can you make 15% in a month. Sure... on a single trade. I do it all the time. But to produce large returns on a portfolio over long periods of time is very difficult.
• Develop a business plan... Most good businesses have a business plan. Virtually all start-ups that want funding require it. Trading is the same... you need a plan. It should contain your beliefs about the market, your personal approach, specific strategies, money management, personal trading policies, and anything else that guides your trading. I have a well developed plan, but it remains a work in progress, and always will. Just like in any business, we are always learning, trying new things, and adapting to new market conditions.
• Review it frequently... Not only does my business have a good business plan, but we review it regularly and make significant updates. Likewise with trading... having a plan is crucial, but it's worthless if you don't use it. A trading plan is a map that will not guide you to your destination unless referenced. I personally review my plan in total monthly, right after each options expiration, and I refer to parts of it more frequently.
• Keep good records... Can you imagine a serious business that didn't keep good records? Actually, I can. I've seen them and it's not pretty. Poor record keeping and documentation is an indicator of a poorly managed company and ultimately failure. In trading, I log every single trade. I refer back, particularly to my losers, and evaluate the trade after the fact when I can see all the facts. This is invaluable in learning and improving.
• Strive to improve efficiency... Just like in business, trading gets better and more enjoyable as we become more efficient. For me, as a working stiff, it's also a requirement. Over a long time, I have been able to streamline many aspects of my trading exercises, but I am always looking to make it better. I want to spend as little time for as much profit as possible... not unlike any business.

I'm sure there are many more parallels to trading and business that we could learn from, but the main message here is, let's not get deluded into thinking that we can just follow some strategy we read in a book, put on a few trades and our pockets will be overflowing with money. That's Irrational Exuberance.

Good Trading...