Dealing with Uncertainty

As humans we like certainty. When something doesn’t happen that we’ve decided should (that dangerous word again), it’s a little annoying. If something else (usually an outcome we don’t want) keeps happening instead, it tends to drive us up the wall. So it really stems from control. Look around you – the human race has devised an infinite numbers of devices and contraptions with the idea of controlling the previously uncontrollable.

But trading is never certain. Today in the indices, I was reminded of how important it is to be comfortable with uncertainty and to remain flexible in how we trade. The indices broadly broke out of their recent range-bound monotony with some vigor. And I think about how those who struggle with uncertainty will almost certainly have found today a difficult session.

HOW TO RECOGNIZE THE PROBLEM

The lack of ability to deal with the uncertainty effectively isn’t always acutely obvious and often has a progression of behavioral stages. What frequently happens when traders cannot cope with uncertainty is that they struggle to take legitimate setups when they occur as they are unconvinced they will work. But time and time again, they see these trades go on to work out. They then become more susceptible to taking trades which are sub-optimal – partly through frustration and partly through not wanting to miss out.

Inevitably these trades are less likely to work. Once in a trade (which by now a trader has convinced themselves of the fact that it will be a winner) profits are taken early (the need to make the trade a winner and thereby prove the trader’s original conviction) and losses are held beyond reasonable levels (because taking a loss confirms that a trader’s original idea was undeniably wrong). In the former case the trader feels silly for having exited early, but the conviction of being right about the trade is cemented. The latter tends to create feelings of betrayal and mistrust that clearly are not conducive to effective trading.

STEPS TO TAKE

1. Be in no doubt what a setup looks like and what its ETS are (entries, targets, stops). By having a clear picture of how you trade, there is no room for ambiguity – you know when you have a trade and you know when you don’t.
2. Simplify your method to what you can handle. Involve too many variables in a strategy and you’ll lose clarity in the moment and find that you are nervous about taking trades.
3. Be aware of and accept anxiety about a trade, but do not let it control your actions.
4. Rate yourself on how well you’re following your plan not and not on the actual results. Of course it’s also important to track the theoretical performance of your plan, as trading a strategy you know is a losing one won’t last and will create other problems. Your actions are controllable but the opportunities that the markets present are not.
5. Really work on getting the whole “probabilities in trading” thing. It’s not about finding the most likely strategy to win – in fact there are plenty of profitable systems out there that have pretty unspectacular win:loss ratios. It’s about adapting your mind to accept the chances of taking a loss and embracing that risk.
6. Be humble and accept your own fallibility – it’s important to work on trying to eliminate the majority of your mistakes, but you are still human so the odd mistake is inevitable. Also accept that you can act correctly and still come out with a losing trade. Probabilities again.
7. Don’t be under-capitalized. Having a small account really creates a huge psychological problem that somewhere down the line you’ll have to deal with. A small account can get you going, but if you’re trying to make money, every trade takes on an unreasonably high degree of importance and inevitably fosters an undesirable attachment to outcomes.
8. Surrender to the market and don’t try to win or not lose. Do your work and accept that the outcome on any single trade is unknowable.
9. Meditation and exercise help reduce stress. Stress is a huge factor in allowing emotional judgments to take over from logical judgments and it is often generated in situations where we feel uncertainty or we have lost control (even if we never really had it anyway).

Trade well.

For more updates from Mark and the team at NetPicks, be sure to visit their trading tips blog at NetPicks.com.