Origins of Bias
I’d like to do something completely different today. Mole and I both talk a lot about bias, how it will ruin your account and stop you from trading correctly. But for most of us, simply knowing that we are trading a bias is not helpful. If you are feeling a strong emotive reaction (something that feels like a “eat your broccoli” demand from your mother when you are 5 years old) to taking a long setup in this market… that is bias in action. If you are personally offended by the actions of the Bernank, thats bias too. If you reload slopeofhope.com several times a day, and cant wait for the STU to come out, thats probably a response to unacknowledged emotional pain as well. I’m talking about the emotive “I just can’t do it” that has stopped many of us from taking full advantage of the best bull market of the last decade once Elliott Wave stopped working and P3 was revealed to be garbage.
I’d like to explore bias in a little more detail than we have done up until now, and share with you various mental processes and disciplines that I use to stop one losing trade turning into a cascade of progressively stupider and stupider trades.
PAY ATTENTION – THIS IS COMPLICATED
To our mind (psyche), whats most important to us is the success or failure of the trade we are in right now. Yet logically, what is truly important is the long run positive expectancy of whatever method we use. Losing this trade and the next one, and the one after that, makes no difference over a lifetime of trading.
This disparity between what seems to be important and what truly is important creates emotional pain, specifically fear. It is what we choose to do with this emotional pain that dictates how we will trade next. When we ignore emotional pain, we force the human mind to jump in and deal with it for us. This is the cause of virtually every trading problem you will ever have.
The human mind evolved as a problem solving device. Lock the keys in the car and you will be presented with a number of options…. where is the spare?, call AAA, find a big rock and smash the window, catch a taxi, etc.
The function of your mind is to solve problems. It is literally written into our DNA, you are the function of countless generations of selective inbreeding for problem solving ability. If you present it with a problem, it will try and solve it for you. It will hijack your reality to solve your problems. The problems in trading arise when you try and use your mind to solve emotional problems, which it is singularly incompetent at.
This happens because your mind interprets ANY EMOTIONAL PAIN, as life threatening, invoking flight or fight responses which are unsuitable for trading markets. Toughness, courage, determination… these are fine qualities in an entrepreneur, athlete, soldier…. but they will get you carried out of the markets on a stretcher. I should know, I possess all of these in abundance.
PROBLEM: I AM IN EMOTIONAL PAIN! I HAD A LOSING TRADE, MY STOP IS NEARLY HIT, I WAS WRONG IN MY ANALYSIS, IT FEELS LIKE A PUNCH IN THE GUTS.
MIND: “You have problems. Let me take over, I am the problem solver. I have options for you. We could obsess about charts, distracting you from the crippling emotional pain. We could increase position size, rationalising that when it comes good in a day or two you will double benefit. We could screenwatch a long term chart, emotionally riding each up and down tick to present you with different emotions to cover the ones you have. I could simply stop you from noticing bullish evidence when you are short, that will stop you from experiencing pain. We could externalize a resentment, blaming our failure on the Ben Bernank or Prechter, temporarily blocking the feeling of shame and worthlessness we feel by judging others as inferior”
We have all done these kinds of things in response to a losing trade. Problem is, the human mind is a fabulous servant and a terrible master. When you let your mind start trading, hijacking your reality, you are doing the equivalent of handing a 5 year old an AK-47. Children should not be given automatic weapons! Believe it or not, your mind has a lot more in common with a 5 year old mentality than you would realise. Your mind will throw tantrums when it doesnt get its own way.
99% of traders lose because they all think the same. The common characteristic of losing traders worldwide is that they go to their mind for a solution to every problem. This is particularly so for super intelligent people.
Being very very smart is a hindrance to trading success. You must be “smart enough” to understand markets, if you are TOO SMART, you will likely have to do a lot of psychological work on yourself to avoid blowing up. Despite not having the traditional “smart guy” resume, my IQ tests off the charts, and I blew up leveraged accounts 6 times. Most of the worlds super-bright people are disaffected loners, resentful at the world and unable to function. Einstein didnt have an amazingly high IQ (152), he was “smart enough” to understand theoretical physics, no more.
You dont need to be smart to trade, just SMART ENOUGH TO UNDERSTAND TRADING
My point is this. We are part of a mind/body/spirit trinity, which eastern philosophical traditions have known for centuries. Now I’m not getting all hippy on you, what I want to discuss is the deep roots of bad trading.
Lets separate the three bits.
1) You. The part of you which has everything necessary to be profitable, today and forever. The part of you which is perfect and untouched. The authentic YOU, your spirit, your soul. If you have been trading unsuccessfully, you probably get GLIMPSES of this state. When trading feels effortless, you are in the drivers seat. Athletes describe this peak mental state as “in the zone”. Its critical to anchor this peak trading state when you experience it, so you can replicate it. This state of peak performance exists ONLY in the present moment. Fear of what might come next (fear of powerlessness), fear of loss (fear of being worthless if we fail in the markets), mental trauma from past trades…. All of these things are CONSTRUCTS OF THE MIND. These fears will stop you from being profitable, they are all illusion, and they do not exist when you operate from the present moment.
2) Your body. Like it or not you inhabit a sack of meat. Its no different than a dog or any other animal, it feels primal emotions all the time, fear is the most important. The problem with trading is that virtually any fear you experience your body interprets as life threatening.
3) Your mind. The mental voice most of us have. It attempts, all the time, to convince you that YOU ARE YOUR MIND. Psychologically the mind is like a 5 year old child, clever and precocious, but not wise. The nature of your mind is OBSESSIVE, like a dog with a bone, it wont want to let go of a losing trade or trading strategy, even when it is revealed to be poor.
If you stuck with wave theory long after it stopped working. If you prayed for p3 when it just wasnt happening. If you kept top picking and refused to get long… your mind was in control, and not you. Disastrous!
The most important thing you must understand before beginning any internal work, whether its psychoanalysis or buddhist meditation, or anything else is that YOU ARE NOT YOUR MIND. Your mind is chatter, your mind is distraction and obsession.
When I was 22 I bought my first cool car, a lotus elise. It was a truly awesome little sportscar, and I had lots of fun in it. When Porsche released the 996 shape 911 I was convinced that I had to have one, that this car would make me truly happy. And it did, for about 2 weeks. The following year my mind told me that I would be happy if only I had a black ferrrari 360. And I was, for about 2 weeks. Insanity is repeating this process, again and again.
This is how the mind works. It says “sorry about lying to you all those previous times, but this time the car/woman/sunglasses/shorting the es futures is the one thing that is guaranteed to make you happy forever”
Giving in to the tantrums of the mind is like scratching a mosquito bite. It feels heavenly while you are doing it, but stop for a second and you are itchier than ever!
For many of us the feeling of trading badly has all the characteristics of addiction, its incredibly painful emotionally and has the key components of all emotionally self-harming addictions , obsession and compulsion. The obsession, that further analysis will somehow make a bad trade good, and the compulsion to trade even when we are losing, it has all the hallmarks of a serious drug addiction and emotionally its identical. The insanity that this time will somehow be different is no different than the insanity of a crackhead or heroin addict.
This last week I traded well for the week, exceptionally in some respects (though it was not mistake free). I passed on a seductive, but foolish, top picking exercise which in earlier years would have had me all in short. I am particularly pleased with my decision to exit my long euro trade at the 1.3620 level, and reenter when it broke to the upside. However I was stopped out of a yen trade which, to my eyes was particularly promising.
Since that was the last thing that happened for the week, I woke up in CRUSHING EMOTIONAL PAIN.
Now we get to the meat of the situation here. Pay attention.
The pain is FEAR. Its a physical pain, it HURTS. What is it?
There are primal fears which virtually all fear is made of. The two relevant to trading are fear of worthless and fear of powerless.
– Fear of being worthless. This idea, that if we fail in the markets we will be NOT WORTH LOVING, is interpreted by the body as “IF WE CANT SUCCEED IN THE MARKETS NOBODY WILL LOVE US AND WE WILL DIE” As I said before virtually all fear is interpreted by the body as a flight or fight life threat, causing a flood of brain chemicals that guarantee you trade badly.
– Fear of being powerless. Fear that we need to know the future or have some control over our environment to stay safe in the markets. This is why wave theory and cycles are seductive. The idea, that we can know the future, that we need to know what will happen next to stay safe, is a classic illusion of the mind. The mind believes that if we cannot stay safe we will DIE.
The best trading comes from an emotional place of “I dont know what will happen” I explicitly express my powerlessness over the markets, out loud, every single day that I trade. There is a taoist saying “invest in the loss and let the mind be free”, if you start from a place of not expecting to win you wont be surprised by anything.
Question: Imagine you have a dog. The dog is scared of thunderstorms. It starts to HOWL WITH PRIMAL FEAR when the lightning and thunder starts. Do you lock it outside where you dont have to hear it whining? Or do you let it sit inside, with you, and soothe it? Are you compassionate towards it in its fear, knowing no better, or do you rationalise that it cant die from the thunder so it should just harden up and stop bothering you?
Your body is no different than a dog. Its a sack of meat, and when you lose a trade it experiences FEAR. When you go to the mind for a solution, you IGNORE THE PAIN AND FEAR OF THE BODY. In this action you sow the seeds of future bad trading.
Going to the mind for the solution is the cause of every problem we have in the markets.
Think about this simple but powerful statement. When your body experiences fear it is essential for you to not abandon yourself (in drink, food, drugs, obsession, rationalisation, sex, consumerism, anything) but to stay present, experiencing the fear equally with it. If you do that your MIND WILL NOT TAKE OVER, and the stupid trading that often follows a losing trade WILL NOT START.
Emotions are unpleasant. Fear is painful. What is self harming, is to force your body (sack of meat) to go through painful experiences alone. Over time, you can stop mentally running away from pain and towards pleasure. When unpleasant emotions have no hold over you the bias will stop.
All bias is a function of unwillingness to experience emotional pain.
Think on it!
OK Every market went up, except the NQ. So if you took the foolish top picking scenario, you are not stopped out yet if you took it in NQ (as advised), but the odds of this working are less than 50/50 now.
No doubt wavers will be emboldened by the textbook 5 min 5 down then 3 up wave. Im inclined to agree with them, but I dont have any actual factual basis for this, so this must be counter trend bias seeping in.
Bottom line. We have $indu still dramatically stronger than the other indexes, NQ failure to follow is very stinky for further upside. We still have no reason to get short, but the long case is very suspicious. Leading stocks like AAPL and NFLX not making new highs with the broader index is not indicative of a turd of a turd wave, which is the big fear here.
My advice, stand aside from this market until we get some real downside. The form of the downside will tell you EVERYTHING. A few days of sideways working off an overbought condition is a very good buy, and a retest after a quick shakeout is a very good short.
The real news is the dollar.
There are only two things that can happen now.
1) Highest probability option is now that the dollar is beginning its terminal phase, we need to see a breach of the trendline to confirm.
2) Still a reasonable, but not highest probability outcome is a SAVAGE bear trap, seeing early dollar bears trapped the wrong way, and providing the impetus for the first move of the dollar rally.
The Euro shows it quite clearly. My squeeze chart shows the bollingers squeezed inside the keltners. Statistically, this indicates an overwhelming probability of a massive move in either direction, no way to tell which one.
Now if you are long, as I am, the odds favour a test of the upper bollinger. If it passes that test, we could breach critical support in DXY and you want to get and stay long for the trade of the decade as Bucky halves in value very quickly. Now what I suspect is the higher probability outcome is that we go up to the upper bollinger, paint a sell setup and fall like a rock, trapping Euro bulls wrong-way.
Overwhelmingly the odds favour one of these scenarios. Now I’m not the sweat off an option trader’s armpit, but I’m sure some of you option gurus could come up with a crap-tac-u-lar strategy for this, especially with the $vix where it is 😉
How do we know which is going to happen? The trigger point on this weekly retest variation buy setup is what I’m watching