Abstract
Trading micro accounts can be an arduous task, but it's my belief that the majority of that demand is psychological. Two factors play the largest role: Inherent resource scarcity notions & framing effects. To abate these effects we can use concrete financial information to combat inherit resource scarcity notions, while using the same information to battle the negative frame. This places the trader in a positive mind set making him/her more likely to choose probabilistically, a less risky choice, but also even if he/she does frame the trade negatively they are more likely again, to choose to the less riskier decision. Read on to discover how...
If you've ever traded an account under 10,000, under 5,000 I know you can still taste the fear of trading with such minuet funds. Where one mistake, large enough, can end your trading career. I recently attended a talk Philip Pearlman gave regarding psychology of market participant behavior. One epic example resonated so deeply within me I was inspired to write this blog. The topic was resource scarcity. It immediately dawned on me (trading a micro account myself) how resource scarcity combined with framing effects are a lethal match, but one that can be remedied.
Resource scarcity is something we no longer have a concept of, as Dr. Pearlman pointed candidly towards multiple platters of chicken wings that went untouched. Run out of resources? Are you crazy? Not in this life time. But this is a very valent concept for traders, always! Resource scarcity is as deeply embedded in us today as it was our ancestral brotheren (ever find yourself over loading your dinner plate at a family function or eating extremely quickly for no reason?). Your cash, your leverage is finite, as is oil & drinkable water, you just may not feel like it is. These resources can be depleted, some will just take longer than others. Though our resources are finite we can lose without losing it all, while building a renewable source of resources (eg farming).
The next concept is framing effects. Amos & Teversky first discovered framing effects in the early 1980's with a simple study suggesting that when a problem is framed positively versus negatively (gain vs lose) we make different choices. To summarize a very complex study which you can read here, the main results were as follows. When a situation is framed positively we choose a less risky decision. When a situation is framed negatively we choose a more risky decision. In the example below you would be given these sets and asked to choose from first, either 'A' or 'B', then 'C' or 'D' for set 2. The results of the studying were staggering: 20% of people choose 'B' while 92% choose 'D' (the more risky choices). Reversing that, 80% choose 'A' in in set 1, while 8% choose 'C' in set 2 (the less risky choices). Furthermore, similar patterns held for varying amounts and probabilities. I modified this example from Econoport.org. For further inquiry a great paper is Levin I, et al 1998 paper, "Not All Frames are Created Equal." Notice how how set 1 contains the word 'gaining,' while set 2 makes use of the word 'losing'.
Gamble A: A 100% chance of gaining $3000.
Gamble B: An 80% chance of gaining $4000, and a 20% chance of gaining nothing.
Gamble B: An 80% chance of gaining $4000, and a 20% chance of gaining nothing.
Set 2
Next, you must choose between:
Gamble C: A 100% chance of losing $3000.
Gamble D: An 80% chance of losing $4000, and a 20% chance of losing nothing.
Here's the kicker...The very essence of the micro account is negative! Here's why. We're consistently told from the "experts" control your loses, control your loses and the other famous saying... control your loses. This banter negatively frames all accounts, but especially micro accounts because this is all we are told. What compounds this effect is that one wrong move can send you packing, perhaps even from your house. The anxiety that is produced through this notion also negatively frames your account. Lastly, you may also be unsatisfied with your micro account further compounding this negative frame. You may feel an anxiety, a lingering feeling that you need it to grow larger to some unknown amount, or that your gains aren't large enough. A negative frame combined with strong feelings of anxiety form a solid basis for why so many new traders and those with micro accounts take huge risks and get wiped out of the game. Veteran trader Shineguy said this in his interview with Howard Lindzen, "One big lose, that's all it takes."
How can you remedy this idea? Drawing on The Cognitive Theory of Noise (CTN), talked about here by Phil Pearlman, we can establish a prescription. Abating these feelings negative feelings towards ones account by cognitive exercises. Just as Dr. Pearlman said in his talk, "You're not going to tell a guy who walked into your office saying, I just got divorced, fired, and am comtemplating sucided, to just snap out of it." There are two issues that must be address your hard wired conceptions of resource scacity & your negative feelings towards your account.
To address resource scarcity in trading you'll need to really grasp the bearings and take inventory, so to speak, on your financial standing. This is included but not limited to such things as:
Lets say Joe Trader has 5,000 in his account and is unwilling to leverage his 5k into 15k. Joe is willing to take a $50 lose on each trade but is looking for a $150 move each time (a 1/3 risk/reward ratio). If Joe were to get stopped out of every trade he make at least 100 trades. Joe proceeded to approximate a number for his yearly ROI and found four great sources: national saving account average, the average return on the Dow Jones Industrial Average, Nasdaq, and S&P 500. Joe could then develop a number based on competing market assets. Joe wants his return to be higher than all these assets, otherwise he would just purchase those assets directly. Joe established a 10% ROI goal for the year. With 100 trades to make and a 10% return goal; Joe is challenging his biology with accurate knowledge of his resources framing them now in positive terms. Here is the trick, now that Joe knows he had 100 trades to make he uses this number in conjunction with $50.00 lose per trade. If you notice this is choice 'C' when a situation is framed negatively. The underwhelming majority chose 'D', but you won't anymore! The next step is critical, when joe places a trade he says to himself "I have X (100) trades to make, with a potential gain of $150. I will set a stop lose of $50." Here joe has now framed everything positively. This increases his chances of taking less risk probabilistically, but also forces him, if he happens to slip "off the wagon," to think in terms of choice 'C', (A definite lose, not a probabilistic one).
The moral of the story is to begin thinking (framing) in terms of positives, not negatives. We use concrete financial information to combat the inherit resource scarcity notions, while using the same information to battle the negative frame. This places the trader in a positive mind set making him/her more likely to choose probabilistically, a less risky choice, but also even if he/she does frame the trade negatively they are more likely again, to choose to the less riskier decision.
Gamble C: A 100% chance of losing $3000.
Gamble D: An 80% chance of losing $4000, and a 20% chance of losing nothing.
Here's the kicker...The very essence of the micro account is negative! Here's why. We're consistently told from the "experts" control your loses, control your loses and the other famous saying... control your loses. This banter negatively frames all accounts, but especially micro accounts because this is all we are told. What compounds this effect is that one wrong move can send you packing, perhaps even from your house. The anxiety that is produced through this notion also negatively frames your account. Lastly, you may also be unsatisfied with your micro account further compounding this negative frame. You may feel an anxiety, a lingering feeling that you need it to grow larger to some unknown amount, or that your gains aren't large enough. A negative frame combined with strong feelings of anxiety form a solid basis for why so many new traders and those with micro accounts take huge risks and get wiped out of the game. Veteran trader Shineguy said this in his interview with Howard Lindzen, "One big lose, that's all it takes."
How can you remedy this idea? Drawing on The Cognitive Theory of Noise (CTN), talked about here by Phil Pearlman, we can establish a prescription. Abating these feelings negative feelings towards ones account by cognitive exercises. Just as Dr. Pearlman said in his talk, "You're not going to tell a guy who walked into your office saying, I just got divorced, fired, and am comtemplating sucided, to just snap out of it." There are two issues that must be address your hard wired conceptions of resource scacity & your negative feelings towards your account.
To address resource scarcity in trading you'll need to really grasp the bearings and take inventory, so to speak, on your financial standing. This is included but not limited to such things as:
- How much are you willing to lose on each trade, but also how much are you willing to gain before you exit the trade?
- Given your current strategy how many loses can your account with stand before you have to throw in the towel?
- What are my long term return on investment goals for the year, for the month?
Lets say Joe Trader has 5,000 in his account and is unwilling to leverage his 5k into 15k. Joe is willing to take a $50 lose on each trade but is looking for a $150 move each time (a 1/3 risk/reward ratio). If Joe were to get stopped out of every trade he make at least 100 trades. Joe proceeded to approximate a number for his yearly ROI and found four great sources: national saving account average, the average return on the Dow Jones Industrial Average, Nasdaq, and S&P 500. Joe could then develop a number based on competing market assets. Joe wants his return to be higher than all these assets, otherwise he would just purchase those assets directly. Joe established a 10% ROI goal for the year. With 100 trades to make and a 10% return goal; Joe is challenging his biology with accurate knowledge of his resources framing them now in positive terms. Here is the trick, now that Joe knows he had 100 trades to make he uses this number in conjunction with $50.00 lose per trade. If you notice this is choice 'C' when a situation is framed negatively. The underwhelming majority chose 'D', but you won't anymore! The next step is critical, when joe places a trade he says to himself "I have X (100) trades to make, with a potential gain of $150. I will set a stop lose of $50." Here joe has now framed everything positively. This increases his chances of taking less risk probabilistically, but also forces him, if he happens to slip "off the wagon," to think in terms of choice 'C', (A definite lose, not a probabilistic one).
The moral of the story is to begin thinking (framing) in terms of positives, not negatives. We use concrete financial information to combat the inherit resource scarcity notions, while using the same information to battle the negative frame. This places the trader in a positive mind set making him/her more likely to choose probabilistically, a less risky choice, but also even if he/she does frame the trade negatively they are more likely again, to choose to the less riskier decision.
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