Strip­ping the trad­ing floor off its cliches

The Pak Banker - - OPINION - Dr. Daniel Dupuis

WE'VE all heard the clichés: 'Buy the ru­mour, sell the news'; ' Sell in May and go away'; ' You sell when peo­ple are greedy and buy when peo­ple are fear­ful'. And my per­sonal favourite, stat­ing the ob­vi­ous as if it was an epiphany, 'Buy low, sell high'. If you ever had the joy of work­ing as a trader, then you have def­i­nitely heard those phrases at least once in your life­time. And I've def­i­nitely heard them and many more as a pre­vi­ous de­riv­a­tives floor trader in Chicago and Toronto. If it's that easy, then why isn't ev­ery­one sleep­ing on a mat­tress full of cash?

So what it is like to be a trader you're won­der­ing? Well, there is a lot of shout­ing, a lot of headaches and a lot of risk. One minute, you can buy a new car; the next, your house is gone. But if you get it right, it's all worth it in the end. As with any­thing else, there is a for­mula to fol­low if you wish to be a suc­cess­ful trader. Us­ing an op­ti­mised, back-tested com­bi­na­tion of tech­ni­cal and fun­da­men­tal anal­y­sis, you should be able to reach a 60-70 per cent suc­cess rate on trades. So why is it that 98 per cent of day-traders un­dergo sig­nif­i­cant, some­times life-shattering, losses?

The com­mon per­cep­tion is that the mar­ket is the en­emy. Ac­tu­ally, the real en­emy is sit­ting on our shoul­ders - it's your own head: fear, ego, over­con­fi­dence, greed ...

The big­gest risk faced by traders comes from their own emo­tional thought pro­cesses; the psy­chol­ogy of fear! Fear of miss­ing out on an op­por­tu­nity, fear of suf­fer­ing a loss, of re­vers­ing a profit through paral­y­sis or greed (and I still do that af­ter 20 years) and the re­luc­tance to be plain wrong. Nat­u­rally, a real trader must jug­gle with all of th­ese is­sues in mi­crosec­onds. Let me il­lus­trate my point. You en­ter into a long po­si­tion (that is, you pur- chase shares). Af­ter a few days, you are mak­ing a 5 per cent profit - your trad­ing sys­tem worked. Time to get out?

De­ci­sions, de­ci­sions … and don't for­get Mur­phy's Law. If you get out, you will watch the stock dou­ble the next day. If you don't, it will cer­tainly move into a los­ing po­si­tion. The prob­lem here is that of selec­tive mem­ory. Ac­cord­ing to Collinsdic­, selec­tive mem­ory is "an abil­ity to re­mem­ber some facts while ap­par­ently for­get­ting oth­ers, es­pe­cially when they are in­con­ve­nient". As nor­mal hu­mans (yes, traders fall into that cat­e­gory too), we tend to re­mem­ber what hurts us the most. So we fo­cus on the losses, and prom­ise our­selves: "The next time, I will close my po­si­tion ear­lier/let my win­nings run". Of course, for the next trade, our dear head - which is very use­ful for re­mem­ber­ing phone num­bers but some­times sub­ject to hys­ter­i­cal out­bursts - leads us through the same process and we re­peat the mis­take.

The most ef­fec­tive way to com­bat this fear is three­fold: dis­ci­pline, data and a writ­ten plan. Yes, each trade needs to be put into writ­ing be­fore it is ex­e­cuted; tech­nique, en­try point, or­der de­tails, emer­gency exit if you are wrong, prof­itable exit strat­egy (for in­stance, trail­ing stop-loss or­der), etc.Sounds like work? You bet it is. Solid data is also a must. Daniel Kah­ne­man, one of the pi­o­neers of cog­ni­tive fi­nance, ex­plains that heuris­tic be­hav­iour, akin to the rule of thumb, is di­a­met­ri­cally op­posed to hard facts which are based on - you guessed it - data.

The best way to avoid selec­tive mem­ory is to keep a track record of all trades - and the dis­ci­pline to fol­low your writ­ten plan. It is also im­por­tant to step back and re­assess your trad­ing strat­egy from time to time to en­sure that you haven't lost your way and moved into a "gam­bling" mind­set. An­other as­pect that de­ter­mines your suc­cess rate as a trader is your level of knowl­edge and your will­ing­ness to spend time and ef­fort "pa­per trad­ing". Pa­per trad­ing en­tails go­ing through the com­plete trans­ac­tion us­ing live data, in­clud­ing anal­y­sis, plan, etc with­out push­ing the "EN­TER" but­ton at the end.

Of course, with no real money at stake, your be­havioural bi­ases might not resur­face but your suc­cess rate will im­prove. The more ex­pe­ri­enced you are, the eas­ier this will be­come for you. It is also con­sid­ered wise to back test your strat­egy for up to five years thereby en­sur­ing that it is ro­bust to all pos­si­ble mar­ket con­di­tions. Many soft­ware pack­ages pro­vide this func­tion.

Al­though trad­ing oc­cu­pies lit­tle space in the aca­demic cur­ricu­lum of most univer­si­ties, it is the ul­ti­mate re­spon­si­bil­ity of ed­u­ca­tional in­sti­tu­tions to bridge the gap be­tween the­ory and prac­tice and pre­pare stu­dents for the chal­lenges they will face in the work­place. The Amer­i­can Univer­sity of Shar­jah has taken this com­mit­ment a step fur­ther by cre­at­ing an in­ter­ac­tive trad­ing floor de­signed to be the ex­act du­pli­cate of a typ­i­cal trad­ing room found on Wall Street or in a DIFC in­vest­ment firm, in­clud­ing the same live feeds, in­dus­try soft­ware and an­a­lyt­i­cal tools.

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