Article

All That Glitters Is Not Gold

My wife and I are Olympic junkies. There are only a couple of television shows that we will watch together during the week. But when the Olympics are on, there is a lot of family TV time.

Having played hockey in my youth, I was of course glued to the TV for the men?s USA vs. Canada gold medal hockey game.

The game was as spectacular as we all hoped it would be; clean checking, great play-making, fast action. What more could you ask for? Well, I suppose I could have asked for the US to score in overtime to win the game. But Canada did seem to out-play the US just a bit, so I was not terribly surprised at the outcome. Nor was I terribly surprised at the look of despondency on the US players? faces as they received their silver medals. The fact that they were not expected to make it as far as they did into the medal round did not bring them any sense of comfort. "Being one of the best in the world can mean little if it is coded not as a triumph over many, but as a loss to one. Being second best may not be as gratifying as perhaps it should" (Medvec, Victoria Husted. Madey, Scott F., Gilovich, Thomas. When Less is More; Counterfactual Thinking and Satisfaction Among Olympic Medalists; Journal of Personality and Social Psychology, 1995, Vol 69, No. 4, 603-610). Team USA was playing for gold, not silver.

Tarnished Silver
In the moments immediately after the game, many of the players on the US hockey team were likely experiencing what psychologists call "counterfactual thinking". Counterfactual thinking is the ruminations we go through and the subsequent dejection we experience when we think about what might have been had we chosen a different path or a different course of action. Perhaps some of the US players were thinking about a missed scoring opportunity during the game that would have changed the outcome. "If only I kept my shot low it would have gone in." Thoughts like these are an expression of counterfactual thinking.

Studies have been done in an attempt to quantify the satisfaction of Olympic medal winners. It is no surprise that gold medal winners felt the most joy and satisfaction. However, bronze medal winners expressed a significantly greater amount of joy and satisfaction than did silver medal winners. The medal ceremony at the conclusion of the USA/Canada men?s hockey game demonstrated this clearly. Silver medal winners experience the negative perspective of counterfactual thinking, i.e., "If only we did such-and-such we could have won the gold". Bronze medal winners, however, think in terms that demonstrate the flip-side to counterfactual thinking. Instead of, "Why didn?t I…" or "If only…", they think, "Good thing I did such and such, otherwise I would not have gotten a medal."

In trading we call this the "shoulda-woulda-coulda" thinking, as in, "I shoulda-woulda-coulda" got long there!" As traders we engage in counterfactual thinking many times during any given trading day to the detriment of our mental health.

Most people only get a handful of really good opportunities in their lifetime to make a handsome profit. Maybe Uncle Ned asked you to invest in his startup company. But you passed on it and then watched as Uncle Ned took his company public and made a fortune. Or maybe you ran into a former colleague of yours who climbed the corporate ladder much more quickly than you when he took another job at a different firm. "I was more qualified than him. If only I tried for that job." When we review these past decisions in light of now known outcomes, we engage in counterfactual thinking. And this counterfactual thinking can produce deep feelings of despair and disheartenment.

There was a guy who used to trade in the same pit as me at the CME, the Eurodollar pit. His name was Phil. Phil existed on a steady diet of cigarettes and cherry Lifesavers. I never saw the man eat a meal. Phil stood smashed, chest to back, between two very active traders. Phil rarely raised his arms or his voice to bid or offer the market. Instead, he seemed compelled to announce in a tone that rivaled Eeyore, the dismally gloomy friend of Whinnie the Pooh, "There goes another missed opportunity" every time a good trade passed him by. If it wasn?t for counterintuitive thinking, I don?t think Phil was capable of any thought at all.

As it relates to trading, we think far more frequently in negative "If only I would have …" counterfactual terms such as, "If only I got long there…" or, "If only the market didn?t stop me out before rallying…" instead of from the positive perspective of, "Wow, good thing I left my sell order where I did. Otherwise I would not have gotten filled." The conclusions from the studies of psychologists Kahneman and Tversky, which include "Prospect Theory; An analysis of decision under risk" help to explain why we are prone to think in negative counterfactual terms rather than in the positive.

Kahneman and Tverski studies suggest that the impact we experience from a loss (which, here, we are also including a missed opportunity) is twice as psychologically powerful as that from a gain. In addition, "Regret Theory" identifies that regret exaggerates our irrational behavior and response to loss (or a missed opportunity). Since the psychological pain and regret we experience from a loss (or from a missed gain) is more powerful that the psychological "high" we experience from a gain (or from a minimized loss), we tend to express counterfactual thinking in terms of missed opportunities (negative) rather than captured ones (positive).

As an illustration, let?s assume you only execute the following two trades on a given trading day:

Trade 1:
The first scenario is one where you take a long position. After you are in, the market rallies exactly to your profit target and your sell order is filled. Even though the market did not trade one tick above your sell order, enough traded at that price to get you filled. And it?s a good thing, because the market went straight down from there.

Trade 2:
The second scenario is one where you again take a long position. This time, though, a bizarre piece of news comes out and the market breaks down to your sell stop, fills it, and then rallies right back to your entry and then further to your profit target.

Given these set of circumstances, you will spend far more time and energy thinking (with despair) about the "If only" as it pertains to your loss ("If only that crazy piece of news did not come out…", "If only I had my stop one tick lower…") than you would thinking (with a sense of relief) about your first trade?s positive outcome ("Good thing I had my sell where I did. Just one tick higher and I would not have gotten filled.") The frequency of each occurrence is less a contributor to the amount of time we think in negative or positive counterfactual terms. Rather, the psychological impact of a loss (or a missed opportunity) helps explain why we spend far more time thinking in negative counterfactual way.

So how can we as traders avoid this vicious cycle of negative counterfactual thinking and the troubling thoughts they produce? The first step is to clearly define what your opportunities are going to be. All other "opportunities" are just market noise.

Clearly Defined Opportunities
You can sit in front of your trading screens and have a dozen different markets in front of you. But if you have not defined how and why you will trade each of those markets, every moderate market movement in any of those markets will feel like a missed opportunity. The reality, however, is that the only true missed opportunity is the trade that your indicators tell you to take, but you don?t.

As I?ve talked about before, the art/science of trading can be broken down into three key components:

1. A set of High Probability Indicators that generate High Probability Trades
2. Consistent execution of those trades
3. Successful management of those trades

If you perceive every movement of the market as an opportunity, you will drive yourself mad! It is only your High Probability Trades that are your legitimate trading opportunities. If you pass on those, then heck yeah, then you should be upset. That?s when you?ll really feel the impact of counterfactual thinking, because a very real opportunity went by. Why you let it go by is a whole ?nother article.

Content vs. Complacent
The second step to overcoming the damaging influences of counterfactual thinking is to be filled with a sense of contentment with your trading and Trading Business Plan.

A successful trading business is built upon the understanding that not every trade will be a winner. In fact, it is possible that a successful Trading Business Plan can include a set of High Probability Trades that either break-even or incur a small loss 50% of the time. And yes, some of those small losses will be generated by stops that are triggered to the tick. Many more of those losses, though, will be generated by market movement that goes significantly through your stops. Counterfactual thinking, however, is heightened by "closeness", like just missing the lottery by one number. Because of "closeness", we tend to think that we are stopped out to the tick far more times than we really are.

As you embrace your trading system and identify growing profits, you will have an increased ability to be content with your trading results. But do not confuse contentment with complacency. Complacency does not propel you forward; it only keeps you stuck with a "this is as good as it gets" attitude. Contentment, on the other hand, allows you to be filled with peace and joy with your silver medal, yet you still have the drive to go for the gold. As a Christian there are two verses in scripture that are applicable to this which can be found in (Philippians 4:12-13, NIV) and (Philippians 3:14)

You can?t change your past poor trading decisions, behaviors, or outcomes. But you can learn from them to help shape your future success. You can admit that you tend to think with skewed perceptions about outcomes that, in the end, are simply a functional part of your trading system and Trading Business Plan. When you understand that it is human nature to think in these counterfactual ways, you empower yourself to take control of these thoughts and dismiss them as skewed perception. The best part is you don?t have to wait four years until the next Olympics. The next trading opportunity is just ahead.

Bill Provenzano can be contacted at Upside Breakout

Bill Provenzano is a 20-year veteran trader of the Chicago Board of Trade and the Chicago Mercantile Exchange and an equity owner at the Chicago Mercantile Exchange since 1992. Having made the transition from pit trading to screen trading, Bill understands the struggles that pit traders face in making that conversion.

Inspired by a sermon one Sunday morning, Bill created Upside Breakout, a biblically based coaching and mentoring program for traders seeking to raise their trading results to a higher level for a higher purpose.