Game of Psychological Warfare

Trading is an extremely personal activity, with no absolutes, and no correct way to do it.  You can't take a cookie cutter approach like you can with so many other academic subjects, like math, physics, or sports like golf.  Beyond the basic financial math of valuing a stream of cash flows from a bond or stock, it gets vague and value is in the eye of the beholder.  Those that say you have to be good with numbers to be able to trade don't really know much about trading.  It is more art than science.  A psychological game more than a numbers game.


Pattern recognition, which is the foundation for learning almost everything, is probably the most important skill.  But unlike other things, the patterns aren't constant, and change just when they become too obvious to the majority.  This is what screws with investors' heads, because the odds are constantly changing and indefinite. 

Probably the closest thing I can find that can match trading is tennis.  It's an individual sport, and you are matched up against an opponent who has certain patterns.  And you have to come up with a strategy to optimize your chance of winning, while also staying mentally tough, and not placing too much emphasis on the latest few points.  Also knowing when to go for a winner and when to just try to not make an unforced error.  Tennis, and maybe golf after that, are probably the most psychologically demanding sports out there.

It can be mentally draining trying to stay emotionally disciplined, and not fall into deep rooted instinctual tendencies that are counterproductive for trading.  Especially after a string of losses, or even just one big losing trade.  Why do we have a tendency to trade more aggressively after big losses to try to comeback quickly from the loss?

Its partly feeling the need to get revenge, detesting the feeling of being a stuck loser.  If I'm down 50%, it feels almost as bad as being down 90%.  So might as well risk all my money to get back to break even and feel much better about myself, with the downside being losing everything, which wouldn't feel much worse than my current down 50% state.  While its hard to lose everything in one trade with stocks, it is quite easy to lose everything in one trade with options, and even futures.

That's probably why a lot of traders that go from stocks to options, a lot of them don't go back to stocks.  Stocks become child's play after you start trading options.  Stocks are the gateway drug.  Options are the end game drug.  But since most retail traders are buying options, the odds are against them.  Options are usually priced too expensive, both calls and puts, because you are either buying insurance or lottery tickets, both of which have to pay a premium above intrinsic value.

I would never recommend anyone to just buy naked puts or calls.  The only way to neutralize the inherent overvaluation of options premium is by entering spread trades, which most retail traders don't do.  I am not really into options because of the lower liquidity and higher transaction costs and slippage, but if transaction costs and liquidity were the same as futures, I would just trade options spreads.  Its much easier to define risk and reward and safer in that respect.

Back to trading psychology.  From my experience, you have to be willing to take losses when your thesis no longer is valid or not working, but you can't be so willing to take losses that you don't give your trades room to breathe and time to work.  There is a fine line between being too tenacious, refusing to lose and being vulnerable to blowing up, and being too weak, taking losses too easily, and bleeding heavily from repeated paper cuts.  Trying to find the right balance is not easy, and for those that can't really do it, its probably just better to systematize everything. 

Not much action in the past few trading days, holding Nasdaq short and waiting.  Probably won't get a big move lower until after the phase 4 coronavirus deal gets passed, which is likely early August.  Everyone's bull case is still based on Fed and overflowing liquidity, but QE has been greatly reduced, still large, but definitely not an amount that guarantees higher stock prices. 

Its been 4 months since the March bottom, usually a correction is imminent after such a long up trend.  Market is ignoring the daily Covid case numbers but there is still that fear of a big jump in the fall as schools reopen.  Also looming election where Trump likely to lose and possible Democratic sweep of Congress probably keeps investors from taking on more risk over the next few months.  Just playing the odds, there is no certainty in this business.