Detecting high level of pain component in trades above your threshold mental torture appetite or tolerance level is crucial to save your trading career as a beginner.
MONTY’S BUTTERFLIES AND RAIN BOW.
Nineteen-year-old Monty spent the afternoon day-trading penny stocks because his prefrontal cortex isn’t yet fully developed and he couldn’t recognize risk-reward trade-offs if they hit him in the face. This introduces to dangers and demands of trading on your finances and personal health ,spirit and well-being which most traders are not even aware. Most of us are myopic and can not see the uglier side. We self destruct due to our inability to look beyond the bait dangling in front of our eyes.But Risk aversion is not good either.
“Men see the bait, not the hook” – Confucius
RISK AND REWARD ARE RELATED
Although you may be tired of hearing that investment rewards can be increased only by assumption of greater risk,no lesson is more important than investment management.This fundamental law of finance is supported by centuries of historical data.The risk of investing in common stocks and bonds depends on length of time the investments are held.the longer the investors holding period ,the lower the risk.But retunes some times comes only at substantial risk to investors.Total returns could be negative for three years or more.Higher risk is the price one pays for more generous returns.
We would like to double our capital overnight,but how many of us can afford to see half of capital vanish just as quickly? JP MORGAN once had a friend who was so worried about his stock holdings that he could not sleep in night.The friend asked “what should I do about my stocks?” Morgan replied “ sell down to sleeping point” He was not kidding.Every investor must decide the trade off he is willing to make between eating well and sleeping well.The decision is upto you. High investment rewards are always coupled with substantial risk taking.So what is your sleeping point? That is your risk appetite.Finding answer to this question is one of the important investment steps you must take.Sleeping scale can raise your consciousness of risk reward trade off of investment or helps you to quickly recognize sleepless investments or trades.
Risk tolerance is essential aspect of any financial plan and only can evaluate your attitude towards risk.But key to investment to work for you is whether you are able to sleep at night. How did you feel when market dropped 2000 points in January 2008? If you panicked and became physically ill because a large proportion of your assets were invested in stocks ,then clearly you should pare down your portfolio.
MEASURING RISK – THE COST OF BAILOUT
Standard deviation or variance risk due to volatility.Once you measure it you find out if it is within your appetite and within the emotional threshold level.Every price level has reward and embedded with risk.Excess focus on reward and neglecting risk due to bias or greed then the trade off would blow right on your face as you don’t take cautions like smaller positions or further confirmation or tighter stop losses or alternative low volatile trades.(like working with heater treater).Our tendency to get rich quickly leads to this desperation and finally you just bail out yourself by paying heavily .
Small caps and momentum stocks are always attractive to trade due to high beta during rally.But they tend to fall more during market decline so the cost of bail out is also high.Consciousness of this trade off protects you from heavy future payments and sleeplessness.
PSYCHOLOGY OF RISK
Risk is not only like a bill or bail out payment to broker but a painful trouble or personal crisis.Risk is about something which is injurious or toxic and has trade off with reward.Risk reward trade off if calculated in advance ,it becomes bearable if and when it happens.If neglected in overconfidence , trade-off blows in your face and becomes unbearable as you lose more money in a state of shock.You have to endure pain and mental torture.Ignoring risk leads to ignoring protection.Your Risk is the extent of lack of protection for money invested.(like just giving someone money in unsecured transaction) just for lust of expected reward.When rewards are high ,there is no protection or safety for your money.Trade offs are high there and sleepless types.
On the other hand in large cap or blue chip companies risk -reward trade off is low with high returns unlike small caps with high returns with higher trade offs.Good will for Company management and their consistent performance provides your money protection
REWARDS AS INCOME
In addition to our labor income we need investment income to supplement and improve our standard of living.Income and money can provide us present and future welfare and luxury or pleasures to rich traders.With money and income you eat well and sleep well and have to work less as any investment advisor tells you.
RISK AS SLEEPLESSNESS WHEN BAD THINGS HAPPEN
Portfolios sometimes easily lose half of their value in bad market year. Any loss of capital and income will immediately affect your standard of living..If you have no problem sleeping during bear markets and if you have staying power to stick with your investments , your risk appetite is just perfect.Lack of protection for capital and income during down phase of market causes unhappiness fear ,panic despondency and mental torture.Risk is injury or toxicity and is physical thing as much as neither eating nor sleeping well.
INDUSTRIAL Vs FINANCIAL RISK
In industry Risk is referred to as situations in which accidents or fatalities could occur causing physical injury to person.Bursting of vessel ,toxic gas leaks or acid spray are causes of industrial accidents and are called risks.Does the risk imply accidents in financial world ?Yes they are.As it happens in accidents and affected people ,all elements of danger such as fear ,panic, pain ,personal crisis ,shocks despondency and grief even fatalities prevails in financial market when bad things happen.People are driven tobrink of suicides and financial ruin during crisis due to lack of consciousness of risk aspects and impacts.
On lighter side to raise the conscious level of tradeoff ,one has to ask himself ,does he have to go to doctor ever for investing now?Are you ever going to be sick and unwell after losing money?So now you decide how much money you can lose without being unwell and sick before you invest. Tha is your appetite.This is for popular awareness of trade offs involved.Trade offs could be in the form of fever , weakness ,depression ,vomiting ,headache and sleeplessness-all for just investing .
UNDERSTANDING TRADE OFFS
Look at coal mining industry.Reward or compensation is certainly high.But trade off between risk and reward is equally high.Not every body can work thousand feet below ground.Many are going to be sick and many fatalities are reported every year.No body stick to the job for long.Many tend to bailout due to unbearable trade off involved.In trading too ,if trade off is unbearable ,one can not stick to it for long and has to bail out.Not every body can manage his standard of living in bear market for three years.
When trade off exceeds the emotional or physical endurance level,you can not tolerate payment demands and stick to trade.It becomes task and trouble..So your expectation of doubling money is shattered by the tsunami of the reality of having to bear pain of having no protection your money which you failed to realize at the outset.You can be easily made to pay out of fear and run away.There is only fine distinction between physical and emotional pain and they are interchangeable.More cash in market place is always risky for your health.Know the rules of free market and take cautions against possible physical attacks.Trade not when expected reward is high but if pain is going to be bearable.Remember you could be asked to give money to market and you should be able to bear it.
TO SURVIVE INSPITE OF EMOTIONS AND STATE OF YOUR HEART
Your reactions are born in your heart and changes within split seconds and that you neither know or control.Your excitement and pleasure to change your dream of getting rich quickly now could be replaced by fear and mental torture just next moment and your decision could turn contradictory.Something you like now but you may hate next moment.So if you don’t plan at the outset as per your threshold ,you are going to end your trading carrier untimely- a sad end.
Spending and losing money is painful and torture.Your heart is filled with hate and fear.In fear you tend to over think and can not relax and can not sleep. If Fear is unbearable ,you either become passive or quit and run.Ruin is writing on the wall.
MARKET NOT FOR DUMMIES AND ROOKIES
People having no power of resistance or knowledge,the common less sophisticated investors who tend to invest out of thrill and excitement of getting rich quickly at the top of rally ,risk is imaginary fear of weak hearted people who are not progressive.Only the realization and consciousness of fear can temper down the excitement and thrill and resultant discretionary trading based on emotions and gut feeling which ends in sad ending.Creative negative thinking like anticipating adverse news such as negative eco data or political tensions ,fear and consequent rationality to seek some kind of protection for money can be brought to bear into consciousness and replaces the madness of getting rich quickly with big trades.Your greed ,bias and excitement is now mixed and mitigated with caution and puts a brake on your discretion.
LOSS AND YOUR PSYCHOLOGY
Reactions emanate from heart which get filled with discontent ,frustration and dissatisfaction having to bear loss.Happiness and contentment can only return if and when losses are recouped.You hang on to your losses and your ego ,or you go all in to make up and your capital disappears and your broke.Remember gambler fallacy and don’t fall for it.Consequent fear destroys happiness.When you remain strong in the face of fear for long, you get disease ,anxiety ,depression and mental disorders.
Losing money is not a music or a romantic film which you can forget easily.Bad things are not forgotten easily.They are like horror movies that makes you ride the roller coaster of painfully emotional trip.In stock market,romantic and horror films alternate very quickly or run parallel like in multiplexes.So know what to expect as thing could blow up right on your face.Dont be tricked by what you see now or what you feel.
BUSINESS PESPECTIVE GROUNDS YOU
Prospect of bearing risk reward trade off best realized with business analogy with deterministic outcomes with trading where outcome is deterministic.You as a contractor have to pay penalty for delaying completing work or failing to deliver goods in time.Risk is known and calculated and expected bearing of pain is in front of you.So you take cautions to make a deal that does not hurt you if bad things happen.Those losses you can easily absorb and take in your stride.
Bad things happen in stocks and you have to make an imaginary deal which does not hurt you if trade goes against you.
1.think trading and investing as business
2.Expect bad things happening which is called Risk
3.Expect consequent mental torture and lack of relaxation
4.Can you bear that ?
This is how one should analyze trade off or demand of trading a position.Make informed choice not impulsive one.
In troubles like having to pay is fearful.Your capital and income are lost and it impacts your standard of living in addition to ego torture.You can not relax and rest peacefully and have to live in fear or get nightmares or even get insomnia too.If you chose to hang on to losses you have watch it continuously without rest.I remember the experience of fear when lost to volatility due to a stray Korean missile.Missile landed no where except on my head.No kidding.Hanging on to losses gives you no time and freedom to do anything with your money on call- a real trouble.you may have to go to doctor and take some medicine only after your wife advises you to do so.I measure trade off with pain killers associated with a trade.Life can not be smooth ,easy and relaxed until the trouble is over or trade is closed.So much for discretionary trading.
Yes when looking into trade off to bear, you uncover imaginative bad things in your mind and balance it with your psychological make up based on past experiences and decide if you can bear it or be comfortable.by how much suck and fear without losing sleep.
LOSSES AND YOUR EFFICIENCY
Psychological implications of bad emotions such as fear ,panic and troubles varies from person to person.Some people may break down with small losses.They can not relax as their trade off index is low.Bad emotions if exceed your threshold affects your health energy and efficiency and makes you wooly headed.
BAIL OUT RANSOM IN TRADING LIFE AND GLADIATORS’ FATE
Trading life is going to be cut short pathetically if you don’t keep your EMI under control and it becomes like your mortgage being lost or you have to sell the house immediately. EMI and trade off are no different.If interest rate rises ,your EMI looks scary and unbearable.Dont trade like gladiators .Trading carrier comes to an abrupt end as it happens to life of one of gladiators and they know this.Avoid gladiator syndrome to survive in the game.Your trading life is extinguished when assumed trade off is beyond your breaking point.
Expect rewards but expect Risk too.Can you take the trouble? Know your risk appetite depending on how much fear you can handle not how much money in your account.Beyond your risk appetite ,you will break down ,hence limited resource.Back calculate the expected reward from your risk appetite and decide position size.
This is like pressure vessel which has a designed pressure and safety valve,If more gas is supplied into vessel ,safety valve pops or vessel bursts.So you have to determine this critical value of risk appetite Once this is ascertained ,you can estimate how much to invest into portfolio ,mutual fund or into a trade easily.and you can cut losses easily and run or you have to hang on only to quit when all capital is wiped out and you can not bear pain to stick.Sell or close till the sleeping point or wait to be unwell.
There is pressure of rewards and pressure of risk.The pressure of rewards is to controlled in balance with tolerable loss bearing pressure.Your safe pressure of bail out ransom is constant and could be set lower than your overconfidence.
FEAR – A LESS SOPHISTICATED VIEW
Fear is a bad condition you have to worry about constantly and mind is subjected to overthinking with no relaxation like preparing for tests , exams or clients meet.It is terrible state and panic is fast torture of your body and mind..Solution is not risk aversion but trade off estimation.Position sizing ,tight stop losses , choosing comfortably volatile stocks ,cutting losses ,avoiding discretionary trades ,not being tricked ,or not playing with gambler fallacy can be palatable to your risk appetite.
Not kidding really.