Thursday, December 20, 2007

Conquering Fear, a Requirement for Profitable Trading - Part 1

The most destructive element in the human mind is fear. - Dorothy Thompson

Neither a man nor a crowd nor a nation can be trusted to act humanely or think sanely under the influence of a great fear . . . To conquer fear is the beginning of wisdom. - Bertrand Russell

Collective fear stimulates herd instinct, and tends to produce ferocity toward those who are not regarded as members of the herd. - Bertrand Russell

We need not look further than the tragic events of 9-11 to fully understand the meaning of Russell and Dorothy's words. Two weeks after 9-11 my father and I, two of them most westernized Asian-Indian Americans you will ever meet, boarded a flight from Minneapolis to San Francisco. It was the most unpleasant plane rides I have ever taken. The man in our row looked like he was going to have a heart attack when we sat next to him.

While the probability that we were terrorists was on par with being struck by lightening, I still understood the anxiety created by our presence. Even if the probability of an event happening is low, our brains have been wired to fear low probability outcomes if the danger is great enough. After all, one bad judgment and you're minced meat. The harm in fearing the insignificant was small compared to what could happen once disaster struck. Evolutionary Darwinism at it's best.

However, this brilliant evolutionary mechanism has it's downside. Besides the fact that it made my dad and me feel like crap, it can cause the crowd to make unwise decisions. Most of those who supported the Iraq War in its infancy have come to grips with the fact that fear lead them towards an irrational conclusion. The panic that followed from a low probability, yet high impact event made the masses subject to manipulation and self serving propaganda. The course of world history changed because the masses were tricked into supporting irrational decisions influenced by fear.

If fear can cause a nation to act insanely, there's no doubt it can reek havoc on collective markets and individual investors. My biggest leap as a trader was not developing my trading systems. For me, that has come quite easy. No, my epiphany came when I learned how to control fear. I've had the same systems for quite some time, but it was not until I gained control of the fear factor that I became a profitable trader.

Notice that I don't say "eliminate fear". That cannot be done. Thousands of years of evolution can't be eliminated, but we can control the fear impulse by recognizing and not giving in to it. To become profitable, logic must triumph over fear.

One final thought before I sign off. Many traders spend way too much time on the psychological aspects of trading. Remember, the first requirement to trading profits is developing effective trading systems and understanding markets. It is only then that the mental aspect comes into play.

Over the coming weeks, I plan to talk more about fear and trading.

4 comments:

Tom said...

Great sharing! Any thoughts on CVD? RSI close to oversold. Strong Stock...maybe time to go long?

Tyro said...

I still remember the days after the Oklahoma City bombing when they caught Tim McVeigh. Every time I passed a white male driver, I nearly swerved off the road. Scary stuff!


Okay, maybe not. Funny how that works. :(

The Market Speculator said...

Ton, CVD has a decent volume pattern and a nice run up, but I'm hard pressed to find a good entry point with good reward to risk.

Tyro,
I'm still surprised we didn't use that bombing as an excuse to invade Canada.

Kevin H said...

Great Post! I agree with you that many traders spend too much of their time with trading psychology. Great insight on fear.