Trading Regrets

There is the cliche that in order to be a good investor, you have to act without emotion, be like a machine.  It assumes that one can do that, which is very unlikely, even if you run a "system".  The development and tweaking of the system is ultimately discretionary, and, thus not pure.  So even for systematized strategies, human discretion and emotion are involved.  Even if you really wanted to take the emotion out of investing, you can't do it.  

Maybe its actually good to feel emotions when trading, to actually improve your decision making and learn from past mistakes.  There are those blind optimists who say that they live with no regrets.  But for most of us, we have regrets about the past, and its not a bad thing.  If you don't regret touching that hot stove, then you probably will be just as careless around that hot stove the next time.  I spoke with a trader in the past and asked whether he felt regret about selling his long term stock holdings after the initial bounce in April 2020, fearing that there would be more weakness.  He said no, the conditions were unprecedented and it seemed like a bear market rally at the time. 

That's completely different from how I felt after covering my short way too early for a small gain a few days after the market topped in mid August.  I felt regret almost immediately, realizing that I left a ton of money on the table, and ignored the signals from the options market, which were actually pointing to a lot of complacency in the face of the selloff.  

Losses are the best teacher, but huge missed opportunities are not far behind.  If you don't feel that disgust after exiting too early and taking a small profit when a big profit was just around the corner by holding a few more days, then you are probably going to keep exiting too early when having a small profit.  It works the other way as well, holding on too long (usually when holding a loss) and letting the trade go against you even more, changing the original exit plan to avoid taking that loss.  

Why do we do this to ourselves?  Why do we hate to take losses and love to take those small gains?  Its that reptilian brain that feeds off of dopamine hits, disregarding the long term or past history.  Gain = dopamine hit, and its not proportionate to the size of the gain, so small gains have almost as big of a dopamine hit as a large gain.  Thus encouraging suboptimal trading behavior.  

Loss aversion also feeds into this tendency, as traders book their gains quickly for fear that they will turn into losses, and avoid taking small losses, for hope that those small losses will turn into gains.  That's what a lot of these HFT algos run on, pushing the market in one direction as they know that most discretionary daytraders will be stuck on the losing side, and will eventually puke out their losers later in the day.  The video below is a classic example of loss aversion, during the January 21-22 2008 huge gap down (scarier than the March 2008 Bear Stearns liquidation). 

 Quite a few regrets about 2022, missing one of the great shorting opportunities in SPX, multiple chances at low risk entries on the short side, and missed most of them, and the one that I did catch, took profit way too early.  Not taking at least a small long position into the heart of the inflation fears in mid June, even though stocks were highly oversold and due for at least a short term bounce.  

Underlying most of these missed opportunities was a fear of getting short squeezed, and still having memories of the relentless dip buying and chasing in 2020 and 2021.  The bear market is more mature now, but there is still a lot of fat left on this pig.  Sometimes we make the game harder than it is.  Usually you have to put a big weight on positioning and some weight on what you hear repeatedly on CNBC, Bloomberg, Twitter (from a contrarian view), and that has interfered with the big picture view of a Fed that doesn't want to see financial conditions loosen (stocks and bonds going up) and is hell bent on tightening despite many signs of a slowing economy.  Worsening liquidity + overvalued stocks in a post bubble environment + Fed showing no signs of letting up on the brakes = a time to short aggressively.  Its simple logic, and a rare set of conditions which heavily favors the short sellers.  Let's not lose sight of that when making our decisions for the rest of the year.  

From Wednesday to Friday last week, I finally saw a change in options activity showing investor concern, as we no longer saw the heavy call buying and put selling on the dips, and instead saw call selling and put buying (not nearly enough to reverse the monster call buying and put selling from August 19 to August 30).  Its a sign that the steep drop is probably over, and that we're likely to see a few days of consolidation of the losses before the next downleg.  I will be looking to put on shorts during this consolidation phase, especially if there is a rally after the CPI report next Tuesday.  Expecting no significant rallies (more than 100 points) from these levels. 4000-4050 is probably about as high as it can get before its gets hammered back down by sellers.  

We have bonds giving up most of its post NFP gains overnight, and it looks like central bank fears are still quite high and should stay that way until we get to the FOMC meeting on Sep. 21.