Choosing to lose
My brother-in-law, Tom, recently sent me a New Yorker review of a book entitled The Paradox of Choice. (Ironically, I didn’t run across this review on my own because, as Greg said during a conversation we had over dinner this week, I prefer The Atlantic to The New Yorker because it comes out less frequently—there’s less reading material to choose from.) Let me make a couple of applications to trading psychology.
In the real world, neither people nor firms maximize utility. Life is complicated, the options of the marketplace are numerous, and the human intellect is frail. As Herbert Simon, the 1978 Nobel laureate in economics, observed, any firm that tried to make decisions that would “maximize” its returns would bankrupt itself in a never-ending search for the best options. What firms do instead is “satisfice,” to use Simon’s term: they content themselves with results that are “good enough.”
Traders and investors know the old rubric, “Buy low, sell high.” But a preoccupation with buying low leads to an obsession with entry techniques bent on finding bargains; in reality, exits are more important than entries. Better to hitch your wagon to a star than to miss a move waiting for the star to fall to earth so you get in at a more attractive price. Abandon that old adage in favor of “Buy high, sell higher.” You can’t control what the market does, but you can control what you do: get in on winners (and get out quickly when they stop winning).
It turns out […] that people will often consciously choose against their own happiness. [Psychologist Amos] Tversky and a colleague once asked subjects whether they’d prefer to be making thirty-five thousand dollars a year while those around them were making thirty-eight thousand or thirty-three thousand while those around them were making thirty thousand. They answered, in effect, that it depends on what the meaning of the word “prefer” is. Sixty-two per cent said they’d be happier in the latter case, but eighty-four per cent said they’d choose the former.
There is widespread ignorance of the concept of expectancy in trading (as I discussed a few months ago), which certainly has a hand in irrational decision making. But some traders also exhibit the self-destructive behavior of people who believe that they deserve to lose to the market. Whether thrill-seeking or guilt drives you to throw good money after bad, you are choosing the outcome. Ed Seykota once said, “Everybody gets what they want out of the market,” meaning that nobody continually loses without, at some level, wanting to lose.
But enough of that depressing subject. 
