Trading Tip #4 – Being Able to Admit When You’re Wrong
I’ll never forget the last conversation I had with my ex-wife just before we started our divorce. I sat her down, looked into her eyes and told her, “I’ve spoken to every expert and mathematician out there. They’ve told me it’s theoretically impossible to be wrong every single time.”
As a trader, one thing I know I am good at and have no issues with is admitting when I’m wrong and then changing direction quickly. It is an essential quality for being successful.
Being right is overrated. I would rather be wrong and profitable than try to prove I am always right and be a bad trader. After managing hundreds of traders and trading for over 22 years, I have seen that the one trait that’s most important for being a good (or great) trader is the ability to know you’re wrong and take action quickly.
In reality, being wrong is not a major issue. The most important aspect is what you decide to do afterwards. I’ve always taught my traders, as well as my executive coaching clients, that pain and pleasure can be the key towards a successful career. The biggest issue that many traders have is the inability to admit they are wrong. The truth is that on the trading floor, 60% to 70% of our trades each day were bad trades. What we learned to do was cut our losses and ride our winners.
There are too many people, in both business and in trading, that I’ve seen destroy what could have been a lucrative career simply because they were either too arrogant or too insecure. These were people who would do whatever it took to prove to others how right they were instead of quickly changing their course of action and redirecting their thoughts and energy to a more profitable outcome.
Odd as it may sound, I ended up making more money in trading when I was wrong than when I did was right. This was due to the fact that when I realized I was wrong I could quickly reverse my position or get out and cut my losses.
Let me give you an example: There were times I would be long five lots of crude oil (5000 thousand barrels of oil, which seems impressive but is not). If I was long five lots of crude oil at $95.10 and sold it at $95.11, I made $50 on the transaction. Let’s assume I am long five lots of crude oil at $95.10. The market starts drifting lower – $95.09, $95.08, $95.05, then $95.02 – and I start feeling the pain of a losing trade. I begin feeling that I am wrong, so I hit a 50 lot bid at $95. I go from being long five lots of crude oil to being short 45 lots (45000 barrels ).
The market trades at $94.99, then $94.95. At $94.90, I buy back ten lots, then at $94.88 another ten lots. The market bounces back and I cover the remaining 25 contracts at $95.00. The five lots I was originally long were enough to show me that I wrong and it was time to get out and reverse and follow the trade through the other side. I lost $500 on the first five contracts I was long, but I ended up making $2,200 on the 45 lots I was short, earning $1,700.
There are many times that, instead of just admitting that it’s a bad trade, the trader does what I feel is one of the worst things that can be done – they add to the losing position. There can be false justifications in the traders mind for doing this. He might say to himself, “There is support” or “The market has to go back up.” And we all know there is NO hope in trading.
The real issue in adding to losing positions is that many times, it works. People use dollar cost averages, and if this works six out of ten times then the trader might feel that it is worth it in the long run. Trust me, it’s not.
Take, for example, Trader 2 initializing a long position in Apple at $690, just after 9/19/12 when Apple settled at $702.10. There are analysts on the financial news networks and blogs saying how Apple is expected to go to $1000 in the near future. The market rallies over $700 and slowly starts drifting lower, then it gaps lower to $678. The trader continues to add to his initial buys at $690, convinced that the he is right and that this is just a minor correction in the market. He says to himself, “The market always comes back.” Apple continues to drop to $500, at which point this trader could have made the trade that ended his career.
So, the key to this trading tip is straightforward. Stay light on your toes so you are always able to get in and out of positions with out mental stress. Never stay married to a bad position and, as I spoke about it in Trading Tip #1, leave your ego at the door. Trade within your own size, and be able to admit when you’re wrong quickly, get flat or reverse. I have said, and will continue to say, in my trading and business blogs, that being flat is often the best position. It is the one and only position that you lets you look at the market from both sides realistically, honestly, and without prejudice.
Remember you can always get back into a trade. No traders are perfect, so don’t try to be.