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If You Are Losing Money, Should You Stop Believing In Your Self

By 27th May 2019 News No Comments

Most of the time, when someone has lost money, the first thing that they will be told is that they have to work on their psychology and they will often be suggested a book on the topic.

I need to say that when I walk into a library, I always skip the self-help/motivational section.

I think that those writers/motivators are just trying to over simplify what psychologists and philosophers have tried to understand for decades.

The way humans react to the environment is very complex, and when someone tries to help you by saying “you should believe in yourself more”, it is because they don’t know what they could actually do to help you, so they just use a psychological-sounding cliché.

Most of the time, especially for newbie traders, when they try to mentally recover from a loss, they are told to believe more in themselves and to be more optimistic.

The reason why they have lost their money, in my experience, is never their low confidence. It is because they have a bad trading strategy, or they have not learned enough to be a winner.

The point is: they burn their accounts because they were much too confident in their ability and they thought they were much better than they actually were. This overconfidence accelerates an inevitable process that would have, sooner or later, led to a financial loss.

When you start to do something new—according to the Dunning-Kruger paradox—you feel that you are better than you are just because you know so little about what you are doing. Essentially, you don’t even know how hard it could be.

There are evolutionary reasons for our inner optimistic nature and tendency to overestimate our abilities.

In fact, mating could have been easier in the past thanks to the overestimation of the possibility of finding a partner. (Stephen M Susher, 2009)

Sometimes, overestimating our ability is an advantage for ourselves and for everyone else. For example, most entrepreneurs overestimate the possibility of success and most start-ups fail, but the few who make it change our world.

The problem is that we only remember the few who made it, like Bill Gates who brought personal computers from industry to every home.

We forget about the other 99% who just went bust but it is thanks to them that the world goes ahead.
Nassim Taled always says that we should always be thankful to those who have tried and did not make it, because without them trying and not succeeding, we would not have capitalism and technological evolution.

There are many examples of when being overconfident is a good thing with a positive effect for everyone but trading is not one of them.

Low confidence, or being realistic, is much better in trading because, with this mindset, the risk you run is lower. This is an essential condition in order to succeed, as I have written in this article (CAN I DOUBLE MY TRADING ACCOUNT EVERY YEAR?)

 

Financial markets change all the time, and this means that even if you are super good, in just a few years, you might need to learn a new technique, or even try a different instrument. Consequently, any approach similar to “believe in yourself” is very dangerous. If you think that you have the right ability and you are already good enough, you’ll be dead when the market changes enough to make your strategies obsolete.

Overestimation of our selves brings a dangerous optimism. When everything looks like it will go in the right direction, then having a plan B just in case something goes wrong is not necessary.

A classic example is when the “safe” stock you bought is down 50% and because this event was completely outside your optimistic world where only good things happen, you now don’t know what to do because you did not have any stop loss in place.
People say that very few people succeed in trading and this is true. It is essential to do the opposite of what anyone would do. Most of the solutions that successful traders implement are therefore very counter-intuitive.

Saying that being pessimistic is the right attitude for trading sounds very strange, but this is a winning approach to the financial market.

We all have an inner tendency to underestimate the probability of a very rare event when they are bad and to overestimate them when they are good. This is why people buy lottery tickets, even if the probability of winning is extremely low. On the other hand, they think that they cannot have health problems by smoking, drinking and other bad habits, even if these events are thousands of times more likely than winning the lottery.

I usually force myself to think about what could go wrong and try to estimate the potential loss in case of rare events.

When I ask someone something like“have you thought that your broker can go bust?” Does anyone else have your trading account password, just in case you are so unwell that you cannot close a losing trade on your own? Their answer is usually, “this cannot happen, take it easy”.

The problem is that, in the long term, say over twenty years, some of the things that “cannot happen” will indeed happen for sure. And just a couple of them are enough to blow your account if you were exposed enough to that risk.
An example of this is when the Swiss bank removed the peg in 2015, and people who were over exposed on CHF are now doing another job.

I force myself, only in trading, of course, to be pessimistic, considering every possible source of risk. Thanks to this approach, when something really bad happens, I already have a plan. I am not unprepared, and the loss is limited.

 

Alberto Pallotta

Bitnami