- “I’m looking for a portfolio that will make about 20% a year but I don’t want any down years.”
- “Can you give me a hedging strategy with options that will protect me from all downside without limiting my upside and at zero cost?”
- “I’m working on my trading plan and I plan to just eliminate my losing trades.”
Believe it or not, I didn’t make those quotes up–they are exact quotes from questions or conversations I’ve had with either professional managers or developing traders. They are all tied together by one thing: fear of loss.
We spend much of our lives taking reasonable precautions. We look both ways before crossing the street. We smell fish before we cook it. We buy insurance, hopefully after carefully considering the cost and risks. In trading, we find ways to limit or to define our loss and we avoid taking stupid risks. It is good that we do these things, and good that we are aware of the risks.
Healthy respect for risk is one thing, but when it becomes fear, problems arise. Fear leads to tension and conflict; we don’t see information correctly and clearly, and we will make mistakes. Cognitive biases and emotional reactions seize control of our behavior, and, in the worst cases, traders are completely unable to act and end up quitting in desperation. Attempts to counteract this, but focusing on risk control and aspects of the trading plan, can often work against us as they simply highlight the probability of losses. Too many traders get stuck in this spiral.
What’s the solution? One powerful solution is to accept vulnerability. If we know, with certainty, that losses will happen–and they will; losses are a part of every trading methodology–then we are not afraid of those losses and certainly are not surprised when they happen. For “scarier” things, like tail risk, we must first accept and emotionally open ourselves to the reality of those risks before we can turn rational analysis to understanding the tradeoffs between magnitude and probability of these risks.
Life, existence itself, is fragile. There are no guarantees in anything–by opening ourselves to this reality, we can understand our trading and interaction with financial markets as part of that web, and can better understand our place in the universe.
Something else happens here too: risk and opportunity truly do go together. In all of those cases at the top of this post, we could eliminate the risk or cost. Just get out of the market completely! But we cannot have any upside if we eliminate all the risk. There’s always going to be a cost or a chance of a cost or the chance of a loss with any valid approach. If we fully accept this, it will shape our understanding of markets and may even point out some hidden opportunities we might’ve missed if we were only focused on the possible loss.
Spend a few moments considering this. See if you can grasp the power that comes from truly accepting and opening yourself to the experience of vulnerability. See what it can do for your trading and investing.