How well do you handle uncertainty?
Your answer to this can have a big influence on your outcomes — in trading, and in life generally.
Many people hate ‘not knowing’. It can lead to considerable stress.
I read a fascinating piece of research recently. It was from the Institute of Neurology at the University College London. The findings were not what I was expecting.
Think for a moment. What would cause you more stress: Knowing for certain that something bad will happen, or being told you have a 50% chance of a nasty surprise?
If you’re like me, you chose the former — an unavoidable bad outcome is more stressful.
But I was wrong.
The researchers found that ‘not knowing’ is much worse. This is when we’re likely to be the most anxious. The real killer it turns out is the uncertainty — not the actual outcome.
I think this says a lot about how humans are wired. We instinctively like ‘to know’. Many of us will take a less attractive certain outcome over a better, but uncertain, one.
And this can have a big impact on how we manage risk.
People often tell me ‘you never go broke taking a profit’. They believe it’s better to lock in today’s price, in case tomorrow’s is lower.
But what if the future is better?
Being too eager to ensure a positive outcome limits our potential. Sure, removing uncertainty may make us feel better. But it also removes the possibility of future benefits.
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I want to share some comments from a member. I’m sure you’ll be able to relate to his situation:
‘I read with great interest your recent email regarding trading style and allowing winners to run. I agree with this “style” but struggle with how to live it.
‘Let me explain:
‘In search of double and triple digit gains over a medium term it is extremely difficult to hold your nerve when a particular stock may have gained say +30% and then starts to retrace.
‘Do I hold on for the ride down or take my profit?
‘How do I live the trading style if I am always protecting my profits?’
I know exactly what Peter means. Every successful trader must come to terms with this.
You might remember the trade I told you about last week. It was essentially this exact situation.
Let me show you the chart again.
[Click to enlarge]
This is one of my own trades.
Within only a few weeks, I was up 45%. A certain profit was only a click away. But I didn’t take it. I was ready to ride this trade back close to my entry point.
I’m sure you remember what happened next. This stock went on to rise by over 200%.
You see, trading — like life — involves uncertainty. Accepting this is the only way you can stride forward.
Quant Trader is a trend-following strategy. It works on the basis that the future will be better. This won’t always be the case, but the payoff can be big when it does.
The key is managing uncertainty. You need to hold your nerve as the shares zigzag higher. Staying with the trend is vital. That’s how you get the big 100%-plus trades.
But I know this is easier said than done. As Peter said: ‘How do I live the trading style if I am always protecting my profits?’
I’ve got a few suggestions if you’re struggling like Peter. These are strategies I use myself. They help me keep the pressures of uncertainty from bubbling to the surface.
Here they are…
- Trade smaller. You’ll probably worry less when the stakes are lower.
- Try not to think in money terms. It’s just numbers…take out the emotion.
- Don’t look at your portfolio every day. Set your exit point and walk away.
Let’s go through them.
Trading smaller is a relative thing. It will be different for everyone. The idea is to trade a size you can manage. There’s no point taking a bigger position if it causes too much stress.
A 19th-century Wall Street saying captures this nicely. It says: ‘Sell down to the sleeping point.’ What this means is simple. If your positions are keeping you up at night, then it’s time to trade smaller.
Quant Trader’s strategy involves many small trades — not a few big ones. This means no single position can ruin you. A stock could go to zero, but you should still have ample capital.
Sure, there’s still uncertainty — you won’t know which trades will be successful. But if you lower the individual stakes, you defuse much of the stress uncertainty causes.
The next point is about how you think.
I remember receiving some excellent advice when I was starting out. A wise older trader told me not to think of my trading stake as everyday money.
He said $1,000 could buy a holiday or a new suit. The trick is not to mentally link a trading profit to something real. It will just increase the pain of giving that money back.
Think of trading funds as the score. A rising balance shows you’re playing well.
Lastly, don’t get hung up on the day-to-day fluctuations. Take a step back. You’ll find the bumps a lot easier to handle if you don’t feel them on a daily basis.
The trade I showed you earlier is a good example. It was never at top-of-mind, so the uncertainty didn’t bother me. My trailing stop was in place. I just let the market do its thing.
I’ll finish this section with a quote from former Chicago Bulls coach, Tom Thibodeau. He says, ‘You gotta learn to be comfortable being uncomfortable.’
I don’t think trading has to be an uncomfortable experience. But Tom makes a good point.
Success often requires we step outside our comfort zone. The more freely we can do this, the better our chances of excelling.
Some people say success is all about predicting the future. But I disagree. I believe it has more to do with dealing with the uncertainties along the way.
I’ve outlined three strategies today. These can make the unknown less daunting. I hope they help you make the uncomfortable a little more comfortable.
Until next week,
Editor, Quant Trader
Publisher’s Note: Is uncertainty holding you back? Does it stop you buying and selling when you should? Don’t worry, you’re not alone. The stock market can be a tough place to navigate on your own.
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Try it. See if it makes sense to you. It could change the way you trade forever.