Over the last century, millions of investors and speculators have tried to beat the financial markets. Most give up and retire from the game. If it were as easy to make money in the markets as to lose it, then surely the number of winners and losers would be equal. The truth is that:
The majority of investors or traders lose in the markets.
Clearly, there is much more to successful investing than placing a fifty-fifty bet, up or down. Why do most people lose,or not do as well as would be expected, irrespective of their background, wealth, intelligence or investment Methodology? The game is obviously more complex than it appears. Indeed, it is estimated that in some markets, 90% of participants lose – a very wide divergence from what we would expect in a game with essentially two outcomes: an increase in price or a decrease in price. Given that the majority of people lose in the markets, a rather obvious question to ask is why so many try to do so in the first place.
It looks so easy
One of the reasons that so many people try to play the financial markets is that, from the outside, it all looks so easy. All you have to do is buy, hold on until the price is higher, then sell. Vice versa for going short. In our minds, it is easy to imagine a string of investments that could have been made – all at a profit, of course – and feel that all we have to do is start using real money and the gains will accrue in the same way as before.
Making money in theory is called paper trading. In most cases, however, a shock awaits the successful paper trader – his results with real money bear no resemblance to the theoretical trades. Why is this? Have the markets suddenly changed in some way? The answer is no, of course not. The reason for the paper profits and real losses can be summed up succinctly, and is a major theme of this course:
The game changes when you try to play it. Following a few real losses, the notion of easy money quickly vanishes, and the investor begins to realise that the game is much, much harder than it looks.
Why is it so Difficult?
Experienced investors may well say that once you master the game, it isn’t difficult at all. This is true of most human pursuits. However, all successful investors will admit to making numerous errors and incurring losses, often substantial, while they were learning how to play the markets. This is a universal experience. People lose money when they first come into contact with the financial markets, and there seems to be no limit to the number of mistakes that one can make. Mastery is elusive. Even after years in the markets, people still make errors. Probably a greater percentage of people fail attempting the markets than in any other endeavor. The reason for this is simple:
Normal human thinking and behavior do not work in the markets.
The financial markets are unlike any other commercial, social, psychological, or academic activity. The decision-making processes that we depend on and are able to apply successfully throughout our lives to our experiences in the world fail when used in the markets. The rules that determine our actions on a day-to-day basis do not seem to work. Our in-built intuition and survival instincts are, in fact, a barrier to profits in the investment arena because more often than not, they cause us to behave in the opposite way to that which is required for success. The human mind is an incredible machine, but the machine was not designed for the unique environment of the markets, where rapid change, irrationality, and excess all prevail. Our external world does not display these Characteristics, but the markets do. Since all market players are human, this leads to the obvious conclusion that:
Everyone is susceptible to acting incorrectly in the markets.
In fact, when placed in the financial markets arena, the most cautious, intelligent, rational, and successful person may bear no resemblance to their personality or performance outside of it. The alien environment in which he is now trying to function distorts his perception and perspective of events.
This explains why everyone obtains better results in paper trading. Whilst one is free of the destabilising forces of the market, i.e., out of the market, clear thinking and rational decision making is easy. This is called objectivity. Enter into the market and you begin to ask your mental processes to function in a radically changed environment, with a host of emotional handicaps weighing you down – hope, fear, greed, optimism, bias, and the need to protect your ego. The constant fluctuation of the market and his fortunes within it put the investor on an emotional rollercoaster, alternating between feelings of anxiety, relief, joy, and despair. No wonder people find it difficult.
As we make progress, we shall examine the normal or common course of action taken by investors at certain decision points. We will see how, in nearly every case, the instinctive or intuitive decision is wrong, and will describe the rules, disciplines, and attitudes which would provide a greater chance of success. It should be clear that if ordinary human thinking and behavior are not appropriate for the financial markets, then: Success requires rules and attitudes contrary to our impulses.
Don’t Rely On Others
Due to the inherent difficulty of operating in the market, it is tempting to seek the advice of others. However, since all investors are subject to making mistakes in the market, there is little point. They, too, are human beings operating under the influence of the market conditions and subject to its alien characteristics. In any case, how do the knowers “know”? Since nothing is certain in the market, how can anyone know for sure?
There are only Probabilities in a market, Never Certainties. Of course, there will be a small number of investors who have mastered the art, probably after years of hard work and initial losses. They may be better placed to advise on your course of action than you are, but remember:
Those who tell, don’t know; those who know, don’t tell. So, bearing the above points in mind, make it your goal in the market to:
Think for yourself and invest for yourself.
The Buck Stops Here
Having decided to think for oneself and to invest for oneself, there is one fact which is crucial to the progress of any investor. Without acceptance of this, very little improvement in performance can be made. It is simply this:
You are not beaten by the market, you beat yourself.
The recognition of this fact is an essential and fundamental step for every investor for two important reasons.
Firstly, it is you, the investor, who must take responsibility for your results and mistakes in the markets. Presumably, you will give yourself credit for a profitable investment t. Similarly, you must take the blame for any loss.
Take responsibility for your results.
Your losses are not the fault of the markets, bad luck, or other people. The markets in themselves are neither good nor bad, they are simply an environment with which you are interacting.
Secondly, it is by accepting responsibility for the outcome that progress can be made through a careful examination of your mistakes. You must:
Recognize, Admit, and Learn from your Mistakes.
If you do not accept responsibility for your losses, i.e., you attribute them to factors outside your control, then you will not analyse your behaviour and will continue to repeat your mistakes. The investor who recognizes that he is responsible for making or losing money in the markets is taking the first step on the path to more successful trading. Be sure to:
Get value from your mistakes, but don’t repeat them.
What Motivates People To Invest in the Markets? Before we can examine in detail the reasons why people make psychological and attitudinal mistakes in the markets, it is necessary to have an understanding of the motivation or the need to invest in the first place.
The reason for this is that all the driving forces behind an investor are potential traps for him when it comes to making such decisions either at the time of entry or later during the lifetime of the investment.
Below is a list of possible motivating factors influencing a decision to participate in the financial Markets – Most people will admit to the first, some of the other reasons may be present sub-consciously but would not normally be disclosed?
- The desire to make
- The desire to make it easy
- To prove we are right/smarter than
- The excitement, entertainment, and action of the
- To gain a sense of independence and
- The thrill of winning
- As a means of gambling
- Everyone else
- Hobby, Interest, or New
How the Motivators Cause Problems
Let us now outline the key potential problems associated with each of the motivational factors.
1. THE DESIRE TO MAKE MONEY
The first, and probably most obvious, of the two primary motivators. It can cause major problems because the desire to make money from the markets means that investors have tremendous difficulty in accepting and taking losses due to the conflict with the motivator. How to deal with losses in both psychological and practical terms is so important that we shall devote a whole section to it.
2. THE DESIRE TO MAKE EASY MONEY
This is a basic error made by newcomers to the field. From the outside, it all looks pretty easy. Surely there are only two choices, thinks the novice; up or down. Get this right more often than not, and we can give up the day job. As has already been described, this line of thinking severely underestimates the difficulty of the game. Easy money is a rare commodity. Gains from the markets are paid for one way or another, usually through years of hard work and initial losses. Trying to get something for nothing frequently produces nothing for something.
3. TO PROVE WE ARE RIGHT/SMARTER THAN OTHERS
The second primary motivator. The need to be right is the reason why people can’t take small losses when they have the chance. They see a loss, no matter how small, as an admission that they got it wrong, thereby conflicting with the motivator. This, coupled with the desire to make money, can be a lethal combination as we shall see later in the course.
4. THE EXCITEMENT, ENTERTAINMENT, AND ACTION OF THE MARKETS
Anyone who enters the markets for these reasons is almost certain to fail. Since the markets are essentially a game with no ending, for them to provide this kind of stimulus would also mean a high level of stress due to constant participation and activity. If you seek excitement, entertainment and action from your money, a trip to Disney World would be less stressful and ultimately a lot cheaper.
5. TO GAIN A SENSE OF INDEPENDENCE AND CONTROL
Most people, unless they run their own business, have their finances determined and controlled by someone else. In most cases this is their employer. For many people, this financial strait jacket is a source of frustration. To be able to control one’s own income is a very attractive idea and the markets would appear to offer this opportunity. However, money cannot be extracted from the market just like that. One has to accept a degree of risk and potential for loss, thereby negating a key benefit of a regulated income.
6. THE THRILL OF WINNING
This is not the same as the desire to make money. The thrill of winning is a psychological benefit rather than a material benefit. It is interesting that the excitement of the occasional win is enough to keep most people playing a losing game, whether it be in the financial markets or elsewhere.
7. AS A MEANS OF GAMBLING
A gambler who uses the markets as simply another vehicle for his habit is going to be very disappointed. Simply taking into account the costs of dealing and the tendency for markets to behave irrationally and illogically at times, there are surely better bets available elsewhere for the true gambler.
(It is a common misconception that because there is an element of risk in financial markets, this equates to gambling. This is not necessarily so. In any true gamble, there is nothing the gambler can do to improve the odds of winning, i.e., the result is pure chance. This is precisely the opposite of games of skill and strategy, where varying degrees of control are exercisable.
8. EVERYONE ELSE IS
Some of the greatest crashes in history have occurred because people invested for this reason. You cannot make money doing what everyone else is doing – not in the long run anyway, indeed, if everyone else is invested, you are usually better off disinvesting as we shall see later.
This list could be taken to mean that there are no good reasons for investing in financial markets. For some people, this will be true. They are simply unsuitable for one reason or another.
For the rest, suitability depends on their ability to adapt to a totally new and different environment, and to apply rules, disciplines, and attitudes contrary to our natural impulses.
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