How to deal with market uncertainty?

I received a good question from a reader, Jeremy, this morning:

In you latest podcast (#26 – Taming the bear) you made the comment:”…. participating in the market means fully accepting that uncertainty and risk. If there is one thing that could change the average investor to an exceptional investor would be understanding and embracing that uncertainty. It is hard to do. Its easy to say. It’s very, very hard to do.”

From a practical standpoint:
How does one deal with market uncertainty?
Why is accepting uncertainty so hard for most traders, especially newer traders and/or those who are not consistently profitable?

More specifically:
How does a discretionary intraday swing trader deal with market uncertainty?
Are there any practical strategies/techniques you recommend?

First of all, allow me a shameless plug for that podcast: go listen to it!

question1Now, Jeremy’s question is good because I think this principle drives straight to the heart of the trader’s struggle. I also don’t think there’s an easy solution. There’s nothing I can tell you here that’s going to magically make you able to fully embrace uncertainty because part of it is truly a growth process. I’ve written before on the Trader’s Journey, and I think a big part of that journey is coming to accept uncertainty.

If you think about it, this runs so against our experience and skills in much of the rest of our lives: imagine having a passionate argument with someone, about a subject that have strong conviction and beliefs, and then, when the other person makes a small point, you simply say, “Oh. Yes. Ok. You’re right and I was wrong.” Very few of us argue like that! But, in trading, that’s exactly what we must do: you look at the evidence, come to a conclusion, and then (often quickly) have to do something that involves a significant amount of risk to take a stand on that conviction. However, we also have to be prepared to step away from that conviction when one small piece of evidence contradicts it. That’s not natural, and it’s certainly not easy to do.

Maybe this is why there are so many effective examples and parallels between trading and combat; we make high risk decisions, made under pressure, always without having all information, and almost always on insufficient information. We have to act quickly on those decisions, and the right decisions, without the right action, can lead to ruin, as can the slightest hesitation. Those decisions must be open to change and revision as the situation develops, and sometimes we simply have to admit defeat and move on.

I can tell you my personal journey with this, and it had two parts. First, I think simply trading for a while and getting kicked in the teeth a lot helps. You begin to realize that you’re not as good as you think you are when you’re hot, but you’re also not as bad as it feels like you are cold. You start to think about what you can control, and realize that it’s only your own actions. Once you accept that reality–and it is reality, so you can either accept it or fail in this business–then you start to think about how uncertain the market is, and here lies the path to wisdom. (Well, perhaps wisdom is optimistic. It’s at least the path away from the foolishness of being a new trader completely at the mercy of his emotions.)

The second part was more cerebral, but I think this might not be the answer for everyone. I became kind of engrossed in math and probability, and you do begin to develop some intuition that carries through to the market. Running simulations, and seeing what could happen within probability distributions was enlightening–just looking at how far off the mean even decent size samples can be will really open your eyes and then you start to tie it in to trading–perhaps I have four losing trades in a row not because I’m stupid, but just because that’s how the chips fell? Play with numbers and simulations. See a lot of data and events, and you will build understanding that goes beyond the classroom.

Once you have that realization, then you develop strategies to deal with it, and “strategies”, in this sense, is all-encompassing: your trading strategies will accept it, your risk management strategies will certainly respect it, and, emotionally, you start to calm. You also start to develop a healthy respect for “black swan” events, and the possibility that literally anything could happen. Could I get up tomorrow and find world stocks down 50%? Yes, that is within the realm of things I have considered. You separate what you can control from what you cannot, and you go on living life.

The bad news is that I think this is an experiential thing: I can’t give you these skills. Your realization will be different than mine, because it must work with who you are and how you think. Perhaps, at best, you can be guided toward this realization, shown hints of it. Many authors have written about this, and I think one of the clearest explanations is in Mark Douglas’s Trading in the Zone (which is a book I’d highly recommend you read.) Stay in the game long enough (trade small), think in the right directions, and you’ll work toward your own wisdom.


Adam Grimes has over two decades of experience in the industry as a trader, analyst and system developer. The author of a best-selling trading book, he has traded for his own account, for a top prop firm, and spent several years at the New York Mercantile Exchange. He focuses on the intersection of quantitative analysis and discretionary trading, and has a talent for teaching and helping traders find their own way in the market.

This Post Has 3 Comments

  1. Markus Fernandez-Kennedy

    I like the “passionate argument” metaphor you use here. It really resonates with me. We take an (argumentative) position in the market and often have to accept that the market was right and we were wrong. Knowing that the market is mostly random it is easier to accept these errors which in turn leads to market related catharsis. Thanks Adam.

  2. irdoj75

    Honestly I do not have a major problem to accept uncertainty in the markets when I have either a winning position or no position at all… I also have no problem to accept it on a rational level by having seen plenty in either charts, live trading or backtest.

    The problem really arises when you have to face the downside of uncertainty, i.e. getting hit in the face, losing real money, even not winning the money you believe you were “probably” going to make – when you had a vision of progressing over a certain time frame and you get a hit and it is not in your hands to define the speed of your recovery. There is simply a huge impact by things you cannot control. It may be like sailing or rock climbing or surfing, all activities heavily dependent on ambient conditions you have to accept – no way around it.

    I would separate the uncertainty you may experience during drawdowns into uncertainty whether:

    1) you do not have an edge at all
    2) you deviated from your plan
    3) market conditions have changed and your approach may be breaking down losing its edge in the short/mid-term or even forever
    4) it is a short losing streak

    I was thinking about the following solutions:

    Ad 1)
    Backtesting, backtesting, backtesting both quantitative as well as manual.

    Ad 2)
    The better defined and documented your plan, your decision making process and your execution (journal), the easier it is to resolve your uncertainty

    Ad 3)
    – Simplification of your approach. Simple concepts are the once that have worked over the years,
    you can hear this over and over again, not only in this blog, but by basically any serious trader
    – Diversification of your approach.
    a) 2 concepts: trend and mean reversion
    b) trading volatility
    c) trading spreads
    d) trading different instruments/markets, FX, commodities, stocks, international stocks etc.

    Ad 4)
    Patience 🙂
    Also I would recommend to build a table based on your expected win/loss ratio and trading frequency to see how often per week/month/year you’d expect to see a losing streak of x trades or a drawdown of y%

    I furthermore believe there is a profound disconnect one has to bridge, jump or close between the zen-like advice to focus on your process on one hand and the extreme competitiveness of trading and the focus on measurable numerical results on the other hand.

    I find it very hard not to look frequently at the numbers, actually I believe it is extremely important to look at the numbers as you have to review your trades, audit your brokerage statement, check whether you are on track in terms of expected drawdown or something potentially broke up, re-adjust your position size as a fraction of PF value etc.

    So ignoring is most likely not an option. A couple of days ago I read a post about sucking at something on “zenhabits” and how to deal with it. Maybe this one will help me to accept uncertainty in losing streaks, maybe it will help me in other areas of life, maybe it just entertained me on my rage – ehm, pardon me – journey to become a professional profitable trader… Meanwhile I keep chopping wood and carrying water…

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