[00:00:10] Show Introduction
[02:09]Phil: I've got this vision now of the Goonies where they're asking Chunk to tell me everything.
[02:18]Sean: Yeah, very much, that would be the kind of side bar that would be a completely different episode for a completely different topic. But we're gonna talk about a lot of cognitive biases. Andrew kind of came up with this idea for a show so I'm gonna let him go through it a little bit and kind of talk to us about what cognitive biases actually are. A lot of people take it as one topic, like its one bias, but there's a lot of subtleties and elements to this. Give us kind of a 30,000 foot view of what a cognitive bias actually is.
[02:58]Andrew: Let's get a definition out there. Basically, according to the handbook of evolutionary psychology by Haselton, Nettle and Andrews, a cognitive bias is a systematic pattern of deviation from norm or rationality in judgment. Biases have a variety of forms. Cognitive biases appear as mental noise caused by heuristics. Heuristics is a Greek word that means how we make choices. These biases are motivational biases, such as when beliefs are distorted by wishful thinking or subconscious biases that we're not even aware of. Both can be present at the same time and both offer serious challengers to traders and just people in everyday decision-making. Like I said, these biases are so ingrained in our being it's hard to recognize their existence from the outset, so it's really important we make in depth evaluations of each decision we make on a daily basis. I know a lot of people don't do this because it's time consuming and we make thousands of choices every day, so a little unrealistic to think we're going to examine each choice and how we felt about it. I think in trading, it's really important since there's real money on the line and this is our job. It's definitely something we should put effort into.
[04:23]Phil: I've always advocated that when you're keeping a trading journal, you don't necessarily just document I entered here and I plan to exit there. I've always suggested that we note our frame of mind as a reference as well. Your dear diary style is the flippant way I've explained it, but that's gonna help you identify these biases we're gonna dig a little deeper on in a moment.
[04:50]Sean: Yeah. One thing I want to say is I can guarantee that every one of us here has been through each and every one of these biases and elements. We're all guilty of it because it's part of the human condition.
[05:07]Phil: You don't stop either. It's a continuing, I wouldn't say battle or struggle, but as long as you've got some type of awareness of these. The fact that you're aware of your biases, positive or negative, means you can start to do something about it.
[05:30]Sean: My lord, Phil, are you telling me you have to be aware of things around us like we say in every goddamn show?
[05:35]Phil: Surprisingly, you've got to be self-aware. Just look around you. What a strange world that would be if we all paid attention to what was going on.
[05:45]Phil: Compare it stepping out into the road like kids do these days. They've got their head down, looking at their mobile phone, step out into moving traffic and wonder why they're getting hit by the cars. We can make a conscious effort with every decision, like you were saying Andrew, which would be a little time consuming, but with important decisions. Once you get into the habit of it, the routine, then it's hard not to break that routine.
[06:27]Andrew: I agree. Definitely.
[06:30]Sean: With that being said. If we just filter it down to our trades, it allows us to add an extra layer of analysis. Okay so, let's have a look at some of the different elements. We kind of got an idea now that cognitive biases are a group of different things that affect our decisions and we have different elements that make up those biases that help us rationalize, create logic and framework for our decisions. A lot of it based on previous history, a lot of it based on what we believe to be true, our environment and understanding, our different schemers we build up in our head to analyze. Okay, this is a round object that fits in my hand and it's orange in color, what's my experience with this? Round, orange things of this size, usually is that a fruit or is it hard, squishy? Let's get into the first one here which is the ambiguity effect. This is a cognitive bias where decision-making is affected by a lack of information, or ambiguity. The effect implies that people tend to select options for which the probability of a favorable outcome is known, over an option for which the probability of a favorable outcome is unknown. We all know when we get into the word unknown, I've got to go 'my known knowns, my unknown knowns, my unknown unknowns, and I've got to go full Donald Rumsfeld here. How does this affect our trading? We're all guilty of this. We deliberately filter out stuff we don't know and discount, different elements in our trading. We try and go with what we do know. We're looking at the charts. We're looking at fundamentals, we're looking at track history. There are elements we know that we rely on, but what about the unknowns, how do you think that comes into this, where the ambiguity fits in?
[08:40]Andrew: So yeah, this is really an ingrained survival trait in cognitive thinking. People don't like unknowns because they can be dangerous and scary. Classic example - people tend to choose fixed rate mortgages over variable rate interest mortgages because they don't know what the future's going to hold. That's generally a smart decision, but sometimes it might be wiser to take the variable interest rate loan. Maybe you're not going to stay in that house that long and it's cheaper. Fixed rates are generally more expensive and the main problem with this cognitive bias is that the tendency to disregard a group of information or a data set off the start because there isn't a set outcome. Maybe you've got trades on the left, where okay, I can risk 50 and make 100 and that sounds good and you're just gonna completely disregard the trade on the right where your risk is unknown and your profit is unknown, but the setup looks good.
[09:49]Phil: So maybe an example might be where do you get out of trades? An example of the ambiguity effect might be that you've got your entry criteria selected but you've necessarily selected but you've not necessarily got the management criteria. You've not set a target if things are going right, where am I getting out? What's your expectation. Even if you have an expectation of what could happen, it creates that nervousness, the anxiety, that's the ambiguity effect in play. You're not certain of the outcome, or even have an expectation of what could happen. That's what's causing the emotional response of will it or won't it work? The nervousness, the sleepless nights. That's the physical response to this. Surprisingly, it's a simple solution. Set a target.
[11:05]Sean: For me, I look at this stuff and think okay, well, if there's unknowns and they're gonna affect my trade, I want to know what those unknowns are. Where's the ambiguity? What can I do to maximize my knowledge of what is in the trade. Where are the holes? I'm always one who likes to mitigate risk. Stuff that adds risk, if it's not part of my overall strategy, I want to try and eliminate any unknowns and ambiguity in anything I do. I want as much data as possible.
[11:38]Sean: There's a risk versus reward and I will take speculative trades. Bitcoin is a prime example of a speculation. No one knows what Bitcoin is going to do. It's such a wild and volatile cowboy-ish market.
[11:54]Phil: Maybe that's because most people don't know what Bitcoin is.
[11:57]Sean: That's very true. But that was a speculative investment, and I want to say investment, not trade. It was one I placed in 2014 and held all the way to Christmas and took my money out of crypto, to be honest, since the Donald Duck prediction I made. Boom, I've just let the rest of it crash down. It was an unknown, very ambiguous whether there was going to be any return or not. I just left it and sat there.
[12:28]Phil: Interestingly, that's a good example what we're just mentioning - the lack of targets, because it's speculative investments, where you think it's gonna go, upwards in this case, but how far and how fast was certainly unknown. I remember when we were talking about it off-air. I imagine that looking back on it, it was quite an emotional period. At the time, you probably don't realize the impact of it, but looking back on it now, was there an emotional impact because it was unknown how much further it would go. Could it have reached 30,000 by Christmas from 20,000? What do you think? Was there that emotional impact because of this ambiguity of what could happen?
[13:18]Sean: Funnily enough, no. One thing I talk about a lot is the divestment of emotional engagement in money. That's something I've worked on a lot. I had to. I wanted to be a professional gambler, so I learnt to divest myself of that emotional impact. If you look at the people who were getting in at the end of last year, it's their only investment, getting in at the high not knowing because they see people like John McAfee saying, oh it's gonna get to like a million dollars or I'm gonna eat my genitalia. Stupid stuff. I bet he's a little nervous right now if he's gonna stand up to that bet. People who are getting in at the end were so emotionally invested in that because they had no idea whether it's gonna go up or crash. We talked about this, where people are mortgaging their houses to get into crypto because it only ever goes up.
[14:29]Andrew: Let's put it all in XIV and we'll be fine. The ambiguity bias really comes down to the fact that you need to do more research into this data set to figure out what the variables are before you discard it. Maybe you find out it really isn't a good trade. Good. That's just as important as planning out that the trade is going to be profitable.
[14:53]Phil: Yeah as we keep saying if you're not sure about the position you're putting on in the first place, what you're doing, when you're doing, why you're doing it. If you can't answer those questions, go and find something else. Keep researching until you do have something you've got the confidence to put on without worrying about am I gonna lose sleep over this? I think if you've got that at the back of your minds, if I put this trade on, am I gonna be losing sleep over it, then it's probably not the right one. If you can start to say through your analysis and your research, I know with my strategy, I know 65% of the time I'm gonna be right. I just don't know which 65% of the time. But I know that if the trade sets up, the trade goes on. I've had multiple setups every day, the last couple of weeks, so I'm putting multiple trades on. There's gonna be weeks where I'm struggling to find one position because there's not the multitude of setups. Again, there's no ambiguity with what I'm doing. I know what I'm doing, when I'm doing, why I'm doing it. I know why I'm entering a position, when I'm entering a position, and when I'm getting out. I know all the basic info to be able to put the trade on, and that came about, because as Andrew was suggesting, because it's well-researched what I've done. It's not an accident that these things have happened. I'm consistently applying a methodical approach to find, filter, and sort stocks and deploy a strategy. There's no ambiguity with what I'm doing.
[16:29]Sean: Well that's what we try and do with a lot of the strategies we develop here at Trade Canyon and the Rebel Trader core strategy, is to remove as much ambiguity as possible. It becomes very mechanical. But let's move on to the clustering illusion.
[17:01]Phil: I want to re-name this, just because I particularly like the way Clint Eastwood says it in Heartbreak Ridge.
[17:10]Sean: Go ahead, you're allowed.
[17:12]Phil: Clusterfuck analysis. Come on.
[17:13]Sean: So anyway, the clustering illusion is the tendency to erroneously consider the inevitable "streaks" or "clusters" arising out of a small sample set of random distributions to be non-random. Okay so, what the hell does that mean? The illusion is caused by a human tendency to under-predict the amount of variability likely to appear in a small sample of random or semi-random data. That's the technical definition.
[17:51]Andrew: Basically what this means, for traders, is... Let's say they have backtested a strategy 100 times. They have 100 data points and that's their data set. Statistically speaking, 100 data points is pretty darn small. And so maybe, they see that have a magic moving average, that really seems to work at certain points in time. Let's just say they choose a 33-day moving average, just at random, and they notice that every once in a while, there seems to be some clustering around that moving average that looks to be more than just random. There's tops and bottoms forming at the 33-day moving average. Why is that happening? There must be some technical aspect behind it. That's probably not true. That's probably just a cluster or streak of random data that appears to show a pattern, and we won't know for sure if it's a pattern or just random without more than 100 data sets.
[18:55]Phil: I was just gonna interject, this might be what we've discussed. I usually refer to this sort of thing as coincidence analysis, when there's two unrelated events just happen to be coinciding. We see this on the talking heads a lot. Price has reacted off the 200-period moving average. Alright, great. But do it again tomorrow. It's often a coincidence and sometimes a self-fulfilling prophecy because so many people are looking at this. They caused the event in the first place. Most of the time, it's not an accurate reflection of how to use that data set to interpret what's going on in front of you. It's an interesting bias. We've spoken about this at length, usually in the Bullshit sections. Just to dumb it down for the poor farm boy in the room, it's coincidence-type of analysis.
[19:52]Andrew: Yeah, and this really conforms to a lot of mental and emotional biases that we have about wanting to be right, and that's very dangerous for traders. You start to see these patterns when they're not there, or you really don't have enough evidence to put money on the line, or you shouldn't. This desire for us to be right is really strong and that's something that traders need to fight. You want to be profitable, and if being profitable means that your strategy you worked on years for is wrong and you need to do something else, you better start finding another strategy instead of keep wasting your time just because your ego can't handle it.
[20:32]Sean: This is something Phil says a lot too, which is always be prepared to change your mind. It's basically, you have to be ruthless with what is in front of you. It's literally a disconnection, almost a cyborg approach. I'm working with a guy in the personal development space, and we talk about the emotional attachment to inanimate things that are important in our lives, even like our trades or things we're passionate about, like my guitar. I'm emotionally attached to a particular guitar, because that is something I play when I want to relax or have fun, and there's a lot of emotional attachment to this inanimate object because of the emotion it can drive in me, which is the ability to tune out the rest of the world. I can jam. I am smiling as I'm rocking out Metallica or Iron Maiden riffs, so I have an emotional attachment because of the joy that that guitar brings. It's an inanimate object. That frickin guitar doesn't give a damn about me. It doesn't have any emotions - the same with our trades. The markets, the trades we place, have no emotional reactions to us, but we end up with a lot of emotional attachments to our trades. We have to be right. If we develop a strategy. Oh, it's the holy grail. Angels and choirs going off. And then it turns out the environment where that was optimal, a great strategy, has changed. It no longer is, but we still flog that dead horse a lot, because hey, that's worked in the past.
[22:13]Phil: I suppose this begs the question of how do you get past that clustering bias, because you've got such a small sample set. Let's just say it's 100 occurrences you're looking at. It's big enough for most people to say hey, this could start to be interesting amount of data, but small enough to have a lot of this clustering you were talking about. How do we get past that?
[22:32]Sean: Add more data. Add more variance.
[22:35]Andrew: Add more data.
[22:37]Phil: I think 100-300 occurrences of something is enough to see if there's viability in investigating further.
[22:47]Sean: Yeah, that's a good point. It's not a measure of, let's put all the chips in the table and let's start playing with this strategy because it looks good. I think when you've got that 100-300 occurrences and you start to see a pattern. Is it just a temporary phenomenon or is there more to it? That would for me be the point where, if we've got 100 occurrences or 100-300, that's the point where I'm saying I'm going to investigate this further, not I'm going to start trading this strategy. If you're researching 4 or 5 ideas, they've all got 100 data points and one of them has an interesting enough... on average it makes money in that small data set, that would be the one I would then investigate further. I'm not gonna waste my time with the ones that have literally a random occurrence, a random set of results that aren't really showing any positive returns. That's how I would evaluate that system, or that tweak or adjustments to then investigate further.
[24:21]Andrew: Yeah, and the keyword is work. Trading is not something you're going to master overnight. The trading strategy we put together at Trade Canyon, that took years and years of research, and a lot of trial and error. This is not our first trading strategy. Most of us have been doing this for over 10 years, and so there have been a lot of failures on the way to success. That's something that people need to remember. This is not something you're going to pick up and then a week later, you're going to be guaranteed profitable. You need to put real time and effort into figuring out your trading style and figuring out whether the approach you've selected is actually going to work.
[25:05]Phil: Not just work generally, but work for you. It might be that trading style doesn't suit your personality. All we mean by that is does it make money? That's the one I want to use. But what if you don't like doing it? I've blown the dust off a lot of old strategies I've traded over the years. I've gone back to a little day trading, a little scalping of stocks, and I've reminded myself why I don't do that. While I can do it and at the time, it was the right thing for me to do, it's not what I want to do now. What we mean by personality is just a list of things that you like doing. I don't want to be glued in front of the computer all day - ergo, day trading is off the table. Having just revisited that, yes it was profitable, but my god, it was stressful. It's hard work. I don't know how I did it for all those years. But then, my personality, the things I want to do in trading, have very much changed. I think that's important to help you determine what strategies you should investigate further.
[26:27]Sean: Absolutely. I think that's very, very good. Let's go onto the next one, which is the hot-hand fallacy. This one is very much a professional gambler fallacy. Certainly, in the trading sphere, that is very apparent as well. It's fallacious belief a person who experiences success with a random event has a greater probability of further success in additional attempts. Just to throw this into the Vegas area, say you're having a winning streak in blackjack. You're winning, winning, winning. You believe you're on a roll that you're going to continuously win, because you're on that hot hands streak. Again, the cards don't care about you. You're not magically reorganizing themselves to be in your favor because you're on the winning streak. Again, the randomness of events, of what is the base line of whatever you're doing, is going to continue to be unaffected by your joyous exuberance. But again, it can be a trap for a lot of people. So what do you think about that guys? Let's start with Andrew.
[28:22]Andrew: Real world examples? Right away - bubbles of any kind. NASDAQ bubble back in the early 2000s. Bitcoin, just recently. We can't lose. It's gonna keep going up. Even the volatility trades of late. Continued subdued volatility. People are just making tons of money on the other side. Doesn't look like it's gonna end.
[28:55]Sean: Until it is. Until it does. Until the fund is shut down right around ya.
[29:01]Phil: My favorite example of this is kind of like - you see it in the real world all the time - to cyclical type of bubbles, where at Christmas the price of Christmas toys goes up, and then there's people that will try to get hold of all the excess stock around Christmas, thinking that the high prices are gonna maintain. Come new year, they've got pallets of these toys that they bought at the over-inflated price, and they can't even get rid of them at retail. There are many nightmare stories outside of, because they've anchored the pricing to the really high price they see on the run up on the auction sites like eBay. They've anchored that high price thinking if they can just get a pallet of these popular toys, in January they'll be able to make big money. The reality is, they're left holding the bag with excess stock. This is a bias that everyone falls into. This is the one I'm constantly trying to put in check for myself. Have I done all of my analysis? Have I done all of my research? If I've just closed a position, do you think the next trade you've placed is going to be profitable or unsuccessful depending on what the previous result was? There are so many biases because of previous events. It will influence the outcome of the next one. We see it on winning streaks. You disregard the rules. We've seen this on Bitcoin, double mortgaging the house, getting loans, selling the farm, and living in a mobile home (nothing against that) thinking that Bitcoin only goes up. We know that is not true. Maybe there's a little bit of a reality check for some people. This is the one people are gonna experience the most. People with beginner's luck don't really know what they're doing but they're following a very simplistic but mechanical rule set that maybe has been passed down to them. They have a few early wins and successes, but they don't realize it's because they're following a mechanical approach. But then they fall into this fallacy of thinking that hey I can just put any trade on and it will make me money. I did that the first few trades. I had some very good early successes, and then the next 4, 5, 6 trades were just flat as a pancake because I was just so high on my early successes that I thought the next trade... I thought I had the Midas touch.
[32:09]Sean: Very much so. We've all been guilty of this, but one thing I wanted to highlight, which I think is the primary danger of this particular one, is that it really does make you slacken off the rules of your strategy that are the framework for your success. If you start slackening off because you think you've got the Midas touch, like Phil was just saying, we've all been there.
[32:47]Phil: It's the one we can experience on the most regular basis.
[32:52]Sean: Very much so.
[32:53]Phil: This is the most dangerous one in my mind. How do we overcome it though, boys?
[32:56]Sean: It's discipline.
[33:04]Phil: My knee jerk reaction is trade more frequently.
[33:05]Sean: For me, it's discipline. It doesn't matter if you're on a winning streak or not, do not disregard the framework, the strategies, the rules, the checkboxes that must be checked for each and every trade. Like you say, trade more frequently. For me it's trade and walk away. Walk away. If you can put your trade on and you're not obsessed with it, then you're not thinking about it.
[33:41]Phil: Having a portfolio allows you to do that. Whereas, if you're just doing the one or two trades at a time approach, you've got that emotional reaction. You're more inclined to babysit them, whereas with a portfolio, you're more worried about the average. You've got more of that business world experience. If you've got a real business, you're not going to stand over the checkout person and make sure they're putting all the right numbers in. The same can be applied here.
[34:31]Sean: Very cool. Andrew, any final thoughts? I think this is one of the most that's the most dangerous. I want to get each and everyone's opinions. This is going to resonate with a lot of the traders that are listening to this podcast right now.
[34:47]Andrew: Well I think it really comes down to discipline. Sticking to your trading plan, and then when something crazy does happen, like Bitcoin going up and everyone has this fear of missing out, or FOMO, what is your rationale of breaking your rules and jumping into that play? Oh, because everyone else is doing it, I don't want to miss out. That's an issue right there.
[35:19]Sean: That's lemming trading.
[35:22]Andrew: You've got to have a plan, and you need to stick to it. I think, reigning in your emotions. Money is such an interesting idea and concept. We put all these complex human emotions into one physical object. Especially with trading, you are expected to keep all those emotions in check.
[35:44]Phil: It's not easy.
[35:44]Andrew: It's not easy. I think that requires serious introspection. Meditate. Do whatever you gotta do to get those emotions under control so when things don't go according to plan, or when things do go according to plan just in a really high degree, you're not thinking oh my gosh, this is it. You've got maintain a level head in any environment.
[36:07]Phil: You raise an interesting point, Andrew. It's not just the losing trades that we're worrying about here. You can have these emotional reactions because of a winning trade. I've got to admit, some of the worst trades I've had emotionally have been some of the best trades from a profit point of view. I have struggled and continue to keep the emotions in check. This is how and why I've developed my strategies, because I don't want these emotional experiences. It's stressful. I want the stress-free life. I want the feet up, pipe-smoking, slipper-wearing experience. I think most newer traders don't expect when they've got the profitable trade. It's like, I've got to ride it very bend in the end, and it's not always worth it. You're gonna pick that top, so I'm not gonna even try. If I can just get a chunk out of the middle, you've got to be happy with that. I think most people aren't prepared to think like that because the textbooks say ride the trend, squeeze everything you can out of it. Well, how about you just take you expect out of it, instead of trying to get more than what you thought?
[37:30]Andrew: Definitely. One of the worst feelings is having a great trade, and then you over trade it and end up giving back a lot of those profits. That's a bad feeling.
[37:47]Phil: That's a nail in the coffin right there, particularly when it's a big winner and you just say I'll see what happens.
[37:57]Sean: If you ever say that to yourself, take a step back.
[38:07]Andrew: Put your profit targets in place and let it run.
[38:14]Phil: When it does what you expect it to do, get out. That's it. That's how I deal with it. Set a target.
[38:18]Sean: Okay, so that leads on to the next one very nicely. We've got two more we've got to do here. This one is another one I think a lot of people are guilty of is anchoring or focalism. From the business side, funnily enough, from business, sales and marketing, this is actually a bias in all people that you will find marketers use on a daily basis to create a deception.
[38:48]Phil: You see this on an everyday occurrence. This is ingrained into society as well.
[38:56]Sean: It's a cognitive bias that describes the common human tendency to rely too heavily on first piece of information offered, which is called the anchor, when we make decisions. During this decision-making process, the anchoring occurs as we use that as our cornerstone. It is the anchor that we then make subsequent judgments on. I'll give you an example. If I told you that there was a new computer company called Peach. It was a direct rival to Apple and it's worth $100 per share. Now that you've got that in your head, there's two pieces of information in there that I've just anchored. Even if you've never heard of this company, Peach, I've anchored it against a company called Apple, which we're all familiar with. And it's a rival, so you have the impression immediately that they have similar product lines. You might even think, oh well, what's the thing if you think about Peach as opposed to Apple. You may be thinking the little apple symbol on the back of the computers or laptops is now a peach. You already start to create these decision-making connotations to fill in the blanks, based on the anchor of a company that's worth $100 per share. What makes it $100 a share? Probably just because I've just said, definitively, it's worth $100 per share. I didn't say it may be or it could be. That opens up a question that maybe you would go do some further research to see if it really is worth $100. But if I say it very definitively and anchor that information, you already have that information. I've said it and I'm an authority figure because you're listening to this podcast, and if I say it's worth $100, you'll take that as gospel. But again, it's that check and verify.
[40:45]Phil: I see this with sector analysis. If you use this same Apple example, it might be that Apple's going up like a freight train, and you might think you've missed the apple move. You start looking to the sector and because you've got the fact that Apple's moving like a freight train, you might assume that Samsung is gonna do the same thing.
[41:10]Phil: Because they're kind of related, and it's not necessarily always the case. It might be. There might be a little bit of rising tides syndrome but just because one similar company is doing something, doesn't mean something in the same sector when you're doing your analysis is going to do the same thing.There is a provision. Unless your research does dictate that that's what you expect to happen. Again, your methodical process to find, filter and sort stocks, if that's a way that you identify an opportunity by that type of analysis, then yeah, it can be valid, but it's not always the situation.
[41:45]Andrew: Yeah and I think when you're implementing tradings strategies, that first trade that you take and you're looking at somebody's program and that first trade's a winner and you're like oh my god, yeah this is awesome. Or, you've done your own research and you've put all this work into it and your first trade's a loser and you're like crap, that was a waste of time. That's not enough data. Don't let that first trade dictate how you feel about something or some strategy until you've put more trades on. The easiest way to do that is to paper trade it for a little while and really see what's going on. I think that's a common trap a lot of people fall into.
[42:22]Sean: Again, increasing the data set. Okay, so let's go onto the last one here -hyperbolic discounting. Discounting is the tendency for people to have a stronger preference for more immediate payoffs relative to later payoffs. Now, hyperbolic discounting leads to choices that are inconsistent over time and people make choices today that their future selves would prefer not to have made just by using the same reasoning. Now, in psychological terms, this is also what we call delayed gratification. It's a skill that most people really need to develop. It's the ability to wait for that payoff rather than, oh I'll spend $100 right now to make $10, rather than spending $100 now, waiting two weeks for a $50 return because there might be factors that could affect or risk that return. Kind of going back to that first one we talked about, which is the ambiguity, is the unknowns. There could be risk factors in there. Phil, talk about the day trading real quick, because this is something I wanted to bring up, versus swing traders or investors who could be waiting days, weeks, months or even years into the future for a return, versus, I've got to make sure all of my positions are closed by the end of the day.
[44:03]Phil: Yeah, I mean, there are lots of reasons why you might day trade, but for most people, most new traders think that they can place the trade and by the end of the day, they're making some money. If you're trading 1,000 shares, which is pretty common for day trading, you're in and out, scalping 20 cents here, 50 cents there, maybe you get a few dollar or two runs. I think it's the speed of information, of the feedback, that you get that lures you into a false sense of belief as to, I can make a lot of money really, really quickly, but at the same time, there's a very high emotional attachment for most people. You get lulled into this false sense of security because of the speed of information. I'm trying to think how it was phrased to me years ago. How fast you get the feedback, you're either gonna make some money or lose some money, and you can find out in 20, 30 minutes whether that's gonna happen. To use the gambling analogy, when you're at the spin of the wheel, when the wheel stops spinning, you will find out whether you've made money or you've lost money. That's typically how I compare day trading - just the feedback of the trade, the choices you've made, can be quite quickly. And that again, if you have a few early wins, you get lulled into that false sense of security that you can do that on a regular and consistent basis. And most people can't.
[45:38]Sean: That's very true. One of the things that we hammer is patience, discipline, and the time to be right in what we do, because it's built into our strategy, which kind of forces you into a patience with that delayed gratification because, again, it's part of those checkbox rule sets that we put in there. Andrew, what are your thoughts specifically in regards to trading.
[46:09]Andrew: I think really, it comes down to getting more data points. People really like to jump in early with trading strategies that aren't fully developed, maybe. We see this all the time with procrastination. It's just so much more satisfying to put your work off tomorrow and play today, even though a year from now or two years from now, you continually do that and your future self is gonna hate you for it. I guess an investing example would be, I've got $100. I can go out to the bars tonight, or I could put that away in my savings account. Your future self is gonna thank you a lot more, not counting the hangover, of saving that money. I think that putting time into your trading strategy and developing your craft as opposed to assuming that okay, I've been trading for a couple months now, I know everything. I'm good to go. That's a dangerous mentality to get into, thinking that you know everything and you know what is going to happen. I try to never think that way. I always try to learn something else or take some kind of new perspective even though it requires more time and work, I think in the end, it's worth it in the long run.
[47:26]Phil: I'm reminded of my favorite trading book, which is Reminiscences of a Stock Operator. That's gonna be the best $15 you'll ever spend. It was written in 1933 I think as a book, but it was published in the late 20's as a series. There's a section in there. They're talking about this very thing, where they've kind of the short term day traders, the scalpers, the in and out. They're literally running around - this is the 1900s, 1905, that time - they're in the brokerage office. There's a room there where all the traders hang out. There's younger people running around like headless chickens because there's a little bit of a market correction or a little bit of a sell-off and they're running around saying you best get out now if you know what's good for you! Take profits! The old timers have seen this a thousand times before and the advice that's in this book is "the money's made in the waiting". The reactions from some of the old timers telling the less experienced traders, hey don't worry about this. It's a bull market. They're looking for one trade with the biggest swing of the move rather than worrying about every ebb and flow, every up and down tick in the markets. With the day trading mentality, the speed of feedback that you can get these days on your decisions is exceptionally fast, whereas the money's made in the waiting. That's the hard part. It's for the most part, the majority of what we do is just to sit back and wait for the trade to do whatever it's gonna do. It was just waiting for it to happen.
[49:17]Sean: One thing I want to jump in there with is this is really a rationalization of fear. It's the risk, the lizard brain element, the fight, flight or freeze. It's rationalization of fear to make a more immediate decision that we can control, rather than the risk of waiting in case something we cannot control influences our decision. Again, having that discipline, having the ability to be patient, the money is in the waiting, I'll certainly testify to that. Take that step back. Don't over-analyze or be fearful for that immediate return for the greater return in the long run. Would you agree and say that's a good way to look at it - a rationalization of fear?
[50:02]Phil: I think it's a hell yes from me.
[50:03]Andrew: Yeah, definitely. Giving into your instincts and wanting to be happy now, as well, on the other side of the fear is take the easy win and let's be happy now, who cares about the future profits that we're giving up, kind of thing as well.
[50:24]Phil: Surprisingly, my suggestion to actually avoid this is trade small and trade more frequently.
[50:32]Sean: Absolutely. It's very true. Divestment.
[50:38]Phil: You're not worried about that one trade. It's such counter-intuitive advice, is to trade with less per trade risk and to then trade more frequently. We've proven it time and time again and that's how you make good money long-term because you start to benefit from the law of large numbers while we're kind of throwing interesting phrases around. You've got a large data set you can play with, and you can that feedback and again it's that average profit you're looking for. Just benefit from that portfolio of strategies or trades or markets and just have a finger in many pies.
[51:32]Sean: Absolutely. So, with that being said, let's move onto Rebel Traders Tip of the Week.
[00:51:36] Rebel Trader Tip of the Week
[51:54]Sean: Okay so, as you can tell, we talked about a lot of biases in the last section, and a lot of different things going on, all different things that have affected us, that we've learned to overcome, but here's the tip. Every mistake is a blessing. It may be expensive. It may be time-consuming. It may be a royal pain the ass. But I do love making mistakes because each one of them is a lesson of what not to do or do again, which could lead to greater losses, greater time strains, or even bigger pains in butt. You see, if you learn from your mistakes, and this is the same as in life as in trading, you've got to learn from those because they are the ones that are gonna guide you to greater success in the future. Everyone makes these mistakes. You can learn from other people's' mistakes, that's great, but the best teacher is if you do them yourself. If you don't learn from them, or are not aware of what could be done differently, or not aware of the mistake you made, and you just keep on making those mistakes, that's on you. Use them as lessons. They really are the most valuable lessons you could have.
[53:14]Phil: Here's how I applied that tip. It wasn't necessarily a case of if I had a successful trade, a profitable trade, it wasn't usually a situation of how can I do that again. That's what your strategy is for. It was when I had an experience, either profitable or not, that I didn't like. How do I not experience that again? Then I said, well if I do this, I'll not experience that again. So, that was how I did it. It wasn't a case of how can I do more of something? It was okay, how can I learn from those mistakes, by how can I exclude that experience from my trading routine. For the most part, that's how I evolved as a trader by excluding things I didn't like. Just by default, you're gonna include the things that you do like.
[54:06]Sean: That's an interesting perspective. Andrew, what are your thoughts on this?
[54:09]Andrew: Oh, I really like that and I think a trading journal, taking time for introspection and looking at how you felt when trades go right or wrong and maybe things weren't going well and you got out of your strategy early because you were scared. It's important to note that and correct your mistake. Why did you do that? What exactly were you feeling? What exactly was the market doing that caused you to break your trading plan. Again, like you said, learning from mistakes is the key. We're definitely all going to make mistakes and the only way to find the silver lining is to learn from them. I think you hit the nail on the head there.
[54:53]Phil: Good life advice as well.
[54:57]Sean: Absolutely. One thing Phil mentioned that I want to step back into is looking at the losing trades. For me, one thing I do is I will evaluate the outcome of every trade, especially ones where I've got a losing position and it didn't work out. I will reevaluate my reasons for entry, talking about trade journals as well. Look at your trading log and say okay, was my rationale correct? Now I have to then check my biases as well, which is one of the processes that lead to this show. I'll look back and ask, did I execute this trade correctly? Why did it lose? Okay, was there something else I didn't account for that I should? If the answer to that is yes, is that that something I should now add to my strategy? Have I seen this before many times? Is there a fundamental element I should have seen in advance that may lead me to refine my strategy, which makes it more profitable? But again, I have to have the suitable amount of occurrences and data sets and again, leading data that I should have seen that I didn't before. If that starts checking off it's something that warrants research, but again, evaluating every losing trade allows me to be more reflective of getting into the trade. The danger with that is, is it gonna take you away from a strategy? Does your strategy have a positive expectancy overall because not every trade is gonna win, but I do like to look at my losing trades to see why and could it have been avoided? Did I miss something? And that allows you to be a little more vigilant going into trades and a little more refined for those entry conditions.
[56:44]Phil: Just to tack on one last thing, the question that started it for every trade, not necessarily just a monetary loss. A losing trade for me, let's define it. A losing trade is a trade that I didn't follow my trade plan. That could include a profitable trade. So, if I ask the question, did I do everything I said I was going to do before the trade, after the trade? Before, during and after. If I've done everything I said was gonna do, that's a winning trade. It might have produced a monetary loss. This is gonna help with the psychology, which is the primary focus of what we're doing, and also helps you reframe your viewpoint of a losing trade. A losing trade can still make you money, but if you've had a horrible experience because you didn't follow your strategy to get to that profit, I don't wanna do that trade again.
[57:34]Sean: That's a very interesting perspective. Very cool. With that being said, let's move on.
[00:57:47] Quickfire Round
[57:58]Sean: Rummaging in the mailbag here, I've got the first one here for Mr. Phil Newton. As you guys are primarily options traders, when would you not do an options trade on a position? What would be the criteria or conditions?
[58:18]It's an interesting question. I think these days, given the simple variety of stocks, ETFs, you can trade any instrument. You can trade bonds, Forex, futures, individual stocks, you can trade a representation of a country without leaving the US stock markets. You'd have to be thinking of something quite exotic to not use options to do it. Although, you can probably construct some type of synthetic strategy that gets the end result. I'm struggling to answer this. You can probably construct the right strategy with the right combination of stocks or ETFs to get your desired result should you choose to. I don't really see a need not to trade options these days because they're just so damn cost effective. When the capital requirement for options changed, it just meant that hey, this is probably the best use of your capital and resources, whether you've got a large account or small account. It opened up the door for, especially smaller traders and small trade accounts to have this portfolio experience that we keep banging the drum about, without having a large capital outlay. So again, for the things I want to do, you can probably express any position you want with options these days. Ten, fifteen years ago, you would probably dip into other markets because you wanted to trade currencies and perhaps the best ways of doing it was directly with a currency trade, or a bond trade or a futures trade or a commodity trade. Now you can do all that with an ETF if you want.
[1:00:03]Sean: Perfect. Good answer. Okay, what else is in there?
[1:00:11]Andrew: I'm thinking about it to and I can only really think about one situation where options trading would be preferable to trading the underlying, and that's margin requirements, specifically for futures contracts. And that's only for certain options. It's a very small field, but let's take volatility for example. Options for the volatility market traded at roughly, like if you put on a synthetic short which is where you simulate owning the underlying through options. It's basically one to ten ratio, so you would need ten options to simulate the exact move of one volatility futures contract. The margin requirements for those ten contracts are higher than just owning the futures contract, so it's not as efficient and you pay more commission, but that's really the only time I can think of one.
[1:01:03]Sean: Yeah, that's true. That's a very good point. That happens with a couple of other commodities here and there, but that's not something really to worry about.
[1:01:11]Phil: It's not gonna be a day to day thought that crosses your mind. It's like, oh, I want to put this trade on. I'm gonna have to think of the best trade because options aren't a choice from a margin requirement viewpoint.
[1:01:23]Andrew: Yeah exactly. So, I trade a lot of volatility so that specific scenario is something I consider every once and a while, but really, besides that, I haven't come across that issue any other market.
[1:01:37]Phil: So I've got one for you, Sean. What's the one mistake that all traders make? Nice simple one for us.
[1:01:50]Sean: All of them. Traders make all the mistakes. I've got a serious answer, but pretty much every mistake you can make as a trader, you will make it. It's gonna be the lessons you will learn from that. Outside of the flippant answer, because I was taking a Phil approach there for a change, at the end of the day, I think the one mistake all traders make is not trading to a strategy and trading too large. I think people stress out so much and find trading so stressful is because they're trading too large of positions. I think that is a huge mistake.
[1:02:30]Phil: I think position size, I've got to agree with you there.
[1:02:34]Sean: Trading small. We always say about half a percent when you first starting of your overall available capitol to about one.
[1:02:43]Phil: Small as possible. Think about it like this. Most new traders are probably focused on how much money they can make, that swinging for the fence. Fear of missing out, like Andrew was saying. If you approach this like a business, and are far more focused on how little can I lose? And how much can I make compared to that risk? Then you're always gonna be in business tomorrow and that's more important than swinging for the fence.
[1:03:17]Sean: Agreed 100%. That's something we talk about a lot. It is the business approach. It is definitely the biggest mistake a lot of traders make, although you will make lots of mistakes. We've all been there, we've all done it. They're all lessons that you will learn and again, as you make those mistakes, you'll improve as a trader, but the one mistake would be position size. So, okay, I've got a question for Andrew. What do you think is the major trend setter in futures and commodities this year so far? What do you think is the biggest thing that everyone is gonna set the, it's gonna be the thing that everyone's gonna be talking about throughout this year.
[1:04:05]Andrew: That's a real good question. I would have to say for things that have happened so far, it's really going to be the movement of the dollar, at least in US markets, and how it's continuing to move downward, and I think interest rates will also play somewhat an important role in commodities going forward. But I think that the big trend setter has yet to occur, and not just for the next year but the foreseeable future, is extreme events - extreme weather events, particularly. We saw with Hurricane Harvey in the US, 1/3 of oil refineries were shut down in Texas. That's huge. It caused some serious issues in the energy world for a couple months. I don't think these extreme events are going to go away. I think they're going to get worse. I think that harvests are going to become better and worse. I think we're going to see a serious deviation from the norm going forward across crops and energy products around the world.
[1:05:08]Phil: Is it because of this availability of information, because you can get real time crop reports from overhead satellites, which is both a good thing and also quite scary. Is it a lot of these things that maybe would have slipped past most people's notice because no one's really that interested in the real time crop reports? Whereas now because of the availability and access to cheap information, real time information, is more available, do you think that's why we might see not necessarily a deviation from the norm. I think the normals might become, there might be a new benchmark for a new interpretation.
[1:05:56]Andrew: Well I think that's definitely part of the problem. Yeah, these algos are gonna be looking at these satellite images and they're gonna be getting these updates. Right now, you can only get satellite imagery about once every 24 hours. But in another 4 or 5 years, it could be a couple hours.
[1:06:17]Phil: When we're talking about crops, that might as well be real time.
[1:06:21]Andrew: Oh, a hailstorm just came through, let's see how bad the damage was. Boom, immediate price reaction and a severe one. The algos we've seen with this most recent flash crash, they like to feed off each other. When one company starts selling all this corn, other people are gonna jump in and try and figure out why that's happening and do the same thing. And just the weather is getting harsher around the world. We're seeing-
[1:06:52]Phil: Regular extremes of the weather in unexpected places.
[1:06:56]Andrew: Exactly. I think that is going to be a serious problem going forward. We could get some really gnarly freak storms that destroy large swaths of crops or maybe we get these periods of relative calm with this incredible harvests. I think going forward, trading these products and using options to trade these products is going to be really something to pay attention to.
[1:07:22]Sean: That's a very detailed and comprehensive answer. And honestly, it's not the answer I was expecting, which is always good. It means, even I learn something here.
[1:07:37]Sean: So, that's it. With that being said, let's rock on.
[01:07:42] Bulls**t of the Week
[1:08:08]Sean: Bullshit of the Week. Honestly, I was struggling a little bit to find. With the amount of BS that's usually flying around, it was a little unusual. But, Phil came up with some bullshit reasons why people fail at stock trading, which I thought was a good inclusion here.
[1:08:32]Phil: I've had a lot of emails, which is kind of what prompted it, Sean. Lots of people finding excuses as to why they can't do something.
[1:08:36]Sean: I'm gonna let Phil take this one away because he kind of came up with it based on conversations and emails.
[1:08:42]Phil: Number one, the one that springs to mind, I remember having a vivid conversation with a guy in Australia. Just trying to help him out. We'd been on and off chatting for years. I hopped on a call with him, what are you doing, what's working, what's not working, what's your trading style, how are you doing it, how are you deploying it, what are you risking, just trying to get to the bottom of why trading wasn't working for it. He'd been on and off trying for about five years. For some reason, it didn't occur to me to ask until later on in the conversation. What does your trading strategy say? He went, I don't have one. I said, let me rephrase the question. Have you got a physically written trading plan? And he went 'no'. I said let me get this straight, you've been trading for five years without a trading strategy? Nothing as simple as when the moving average crosses up, I'm going to be a buyer? Nothing even as simple as that? He went 'no'. I said so you're shooting from the hip every day, every time, on every trade, and making it up as you go along? And he went 'yes'. And that was when I just held my head in my hands and tried not to sob, because he had no strategy. And even though I'd pointed all this out, he still didn't know why he wasn't seeing any type of consistency in his trading.
[1:10:20]Sean: Okay, well I shouldn't laugh, because we've heard this.
[1:10:24]Phil: What do you say to that?
[1:10:27]Sean: Listen, dude, you need a strategy. Write it down, and here's one for you. Write it down, this is gonna be it from now on.
[1:10:39]Phil: Back of the envelope. I'm not saying you should write War and Peace. My first strategy was a simple moving average crossover, something like when the 30 period crosses the 100 period moving average, I'm gonna be a buyer and I'm gonna be buying pullbacks. That's it. That's all I did for years. And it made me a boatload of cash. It doesn't have to be complicated, but at least you've got something. That was #1 - the biggest bullshit reason why people fail at trading is not having a physically written down strategy, as simple or as complex as you want to make it. I'm obviously in favor of simple because I'm just a poor farm boy who just got it right. The second one - the other extreme. Too many conflicting strategies. They're trying to do everything all the time. We've done this ourselves, but I'm sure you've both heard stories about people trying to trade everything all the time. They're day trading, swing trading, investing a bit. You can do all that. But as a new trader, you perhaps just want to get one thing right first. Conflicting strategies. And number #3 - bringing a gun to a friendly conquer match.
[1:12:05]Sean: A lot of people in the US will have no idea what a conquer is. It's an old British pastime.
[1:12:12]Andrew: Yeah, what is that?
[1:12:12]Phil: Imagine a horse chestnuts. In the UK, we would get a horse chestnuts. We would drill a hole through it, put a shoestring on it, and then basically whack the other person's conquer. We nicknamed them conquers. We would hold them up at the end of the string, the other person would hit their conquer with your conquer and whoever's broke first...
[1:12:45]Andrew: Oh okay. I get it now.
[1:12:47]Sean: We used to do that as kids. You'd soak them in vinegar. You'd bake them. You'd fill them full of epoxy resin like I did so they were unbreakable.
[1:12:58]Phil: The idea was, you have this conquer, horse chestnut with string through it and you had to whack the other person's conquer. The problem is that some traders bring a gun to a friendly conquer match. I'm talking about position size here. But they're putting all their position size into one position and hoping for it to work, whereas what we want to do is have a nice little friendly match of conquers and just place a little position on every time, multiple times. But obviously it's a wasted analogy on our US audience.
[1:13:45]Andrew: That's funny. I looked up the conquers game online now.
[1:13:50]Sean: We were obsessed with having the best conquer because you want to be the king conquer, the undestroyable conquer.
[1:14:03]Phil: If you destroyed 47 other conquers before you, it was a 47-er.
[1:14:10]Sean: It was ridiculous. I would bake them so it would shrink inside and then I'd fill the rim with epoxy and try not to let it be destroyed. Okay, what's the next one?
[1:14:42]Phil: Number four. Flogging a dead horse. A lot of traders try to do this. Not getting out of a trade when it's reached target and hoping for me. You're on a horse and you've ridden it to its destination and you think you can take it a little bit further. And the horse dies on you. You're still trying to flog that horse to get you to an undetermined destination on the horizon. You're not getting out or following your plan. Take profits when you get to targets, you idiots. That's what you've got to do. Don't flog a dead horse. And the last one, number five. Gollum trading. One trading - one trade to rule them all. Like Gollum did in the LOTR. It was one ring, his precious. He was constantly babysitting and looking around for that one ring. It actually takes an army of little trade soldiers to win a battle and having one trade to rule them all is not gonna make you a successful trader at the war of the stock market. Trade frequently, rather than put all your eggs in your basket. Don't be like Gollum and looking for that precious trade that's gonna make you all the riches. So that's it. No strategy, too many conflicting strategies, putting all your eggs in one basket, flogging a dead horse, and Gollum trading. There are my five bullshit reasons why people fail at stock market trading or any type of trading.
[1:16:46]Sean: Perfect. I've got to agree with every single one of those. They are awesome. With that being said, ladies and gentlemen, that is the end of the show. Thank you for listening. Please remember, this show is not free. It will cost you a five star review. Just go tohttps://tradecanyon.com/rebeltraders. There you will find links to listen and review and subscribe to the show on your favorite way to listen. You'll also find some incredible resources there, some training and all sorts of other things. This will help us get this message and everything we're talking about here out to more traders just like you.
[1:17:22]Phil: It's been a fabulous show, Sean. I'd also like to say thanks, Andrew, for stopping by this week.
[1:17:28]Andrew: Thanks for having me in on the main show. I appreciate it.
[1:17:29]Phil: It's been fabulous. Also remember though, you can connect with us on Facebook and the Twitter Machine at the same link. Final thoughts, what was your favorite bit for today? I've loved all of it because I'm in it, but then I'm an arrogant git.
[1:17:50]Andrew: Definitely. I loved it. I find people's decision-making abilities really interesting. I think the way we make decisions and the reasons behind them is really fascinating to me.
[1:18:17]Phil: We keep talking about this as being the final hurdle, probably the only hurdle to overcome. You can learn strategy. This is what separates every trader individually, is the psychology so it's been a very thought-provoking show.
[1:18:31]Sean: I just want to say the one thing is the hot-hand bias. That is the one that needed to be hammered home. If you want to rewind this, go back to that one thing and drum it into your head. It's the biggest danger factor. Develop discipline, develop awareness of what your biases may be. What's influencing your major decisions? Keep these things in mind. Listen to this show multiple times. Write down each bias and the relative how it relates to you and your experiences so you can be conscious and raise your awareness of those but I think it was a fantastic show. In next week's show, we're gonna be doing virtual ETFs, using the portfolio approach but creating a virtual ETF of certain stocks you feel should be in your personal S&P 500. With that being said, rock on. Thank you very much, gentlemen. Appreciate you all being here. We'll do this again next time.
[1:19:44]Andrew: Sounds good.
[1:19:44]Phil: Bye for now.