Are feelings more important than facts?
In this episode of 2Traders Podcast, Walter and Darren delve into the idea of odds and probabilities. Should you be more concerned about a possible shark attack or dying in a car crash? Darren examines the importance of how traders perceive “facts” and whether or not feelings should be considered when making trading decisions.
How might a professional South African surfer or shark attacks help you “see” facts more clearly? Walter discusses the importance of Psychology and how you can shift your approach to see these things in a different light.
Download (Duration: 24:39 / 28.2 MB)
In this episode:
00:35 – magic of the internet
01:51 – shark attack
04:14 – pleasure givers
06:32 – availability heuristic
07:29 – gut instinct
09:29 – risky decisions
11:07 – thought-action connection
13:03 – working on the subconscious
15:31 – user error
17:28 – odds do change
19:50 – magic trading system
21:24 – build up resistance
24:26 – big gains
Darren: There’s a lot to be learned from focusing more on the psychological side…
Announcer: Two Traders, Darren and Walter, pull back the curtain on profitable trading systems, consistent money management, and profitable psychological triggers. Welcome to the Two Traders Podcast.
Walter: Welcome to Two Traders. It’s Walter here and hello, Darren. You’re on the line and you’re ready to go.
Darren: Hi, Walter. We’ve not spoken for a long time, have we?
Walter: Yeah but we still show up twice a week, Darren. That’s the magic of the internet so it’s all good. We were talking about different ideas or topics. One of the ones that I thought would be interesting is this idea of odds and likelihood.
I think a really important thing for traders, especially… I believe you have to think this way but let me just give you the question. The question is something like this: We know that the odds of dying from a shark attack are 1 in 3.7 million and the odds of dying in a car accident are 1 in 84. Why is this important for the trader? Why did I even bring this up? What does this have to do with trading?
Darren: I think what you’re kind of angling at here is how our perception of what’s important is usually way off the mark with the facts of what’s important. I guess that’s what you’re angling at.
Walter: Yeah, absolutely! One of the terms that they use is “availability heuristic” which is basically things are reported. What makes the news is five guys in Australia, the five swimmers in Australia, this year that were attacked by sharks.
What doesn’t make the news are the — I don’t know. In Australia, might be what, 500 people die in a car accident every year. I don’t know. Maybe more, maybe less but the point is the car accident thing, that’s really the most dangerous thing in your house. It’s probably your car and yet we’re so worried about shark attacks.
I found it interesting. Actually, I learned this the other day. I take my kids to the aquarium and one of the things that they had this people that take you on tours. He would explain to us that before the movie “Jaws” — and I didn’t know this — before the movie “Jaws”, when a swimmer would run into a shark, they would call it the shark incident. And then after “Jaws”, every single time that something would happen with the shark, it was a shark attack.
No matter what happened, it would become a shark attack which is so funny. It’s really funny, but it’s true. There was the big one that made the news in Australia — and I think worldwide.
There was a professional surfer in South Africa and basically the shark was swimming by and he got his tooth caught in the surfer’s leg rope. And that was a shark attack, right? Because there was a shark involved. It’s kind of interesting.
I think you’re right. What I’m trying to get out here, in this roundabout way, is why is it that we think some things are more likely to happen than others? Other things actually are more important, are more likely to affect us, we don’t even think about. I think there’s a lesson in there for the trader.
Darren: Yeah, definitely. People always bang on about how important Psychology is and we find that quite hard to take on. We think that we’re kind of really just look at the numbers and look at the facts.
But, when we do just some general study of Psychology, we realize that Psychology really is 90% of it. Because like you say, we know the facts that travelling in cars is dangerous but it’s not the facts about that risk that are important to us. It’s how we feel about that risk.
To us cars, are convenient. They’re luxurious, they’re even sort of viewed as being kind of sexy, really. They’re pleasure givers. They’re things that we love and people even name their cars.
My girlfriend, she used to name our car and she was like deeply upset when we have to get rid of it and get a new car, like she was losing a pet or something. So, regardless of what the facts or the data say, we’re going to play down that risk.
The Psychology of that risk is more important. The feeling that it gives us is more important than the facts. You see that all the time in trading.
Walter: There’s a couple of different ways that you can look at this from a trading point of view. One would be the thing that’s most important for the trader isn’t necessarily accessible and isn’t really thought about.
The other way to look at it is that there are some things in trading — I mean, these are the two things that pop-up for me. One is that your eyes are on the wrong thing. You’re looking at the wrong thing.
It’s not that important to look at that thing over there. You should be looking at this thing here. And the other one is that we can grossly… Our estimates of the probability of things happening in trading are often wrong.
One thing that brought us home for me was I’ve been working with a group of traders for the last two months. One of the traders has been doing a lot of work and a lot of backtesting and he presented this thing.
I said really what you need to do here is you need to look at different exit strategies. Keep everything that you’re doing at the entry side the same and then just become more and more aggressive.
He was absolutely flabbergasted that it didn’t matter whether he went for a 3R trade or a 5R trade. In other words, he would exit after he made 300% of his risk on the trade or 500% of his risk on the trade.
The win rates stay the same and he never would have thought that another win rate dropped a lot when you win from 1R to 2R. The win rate dropped quite a bit but 3, 4 and 5R basically all had the same win rate.
And I said, “Well, get some more data because we still would expect to go down a little bit.” You know what I mean? When you get down to 5R? He was amazed and it opened his eyes because he learned that, “If I can just deal with losing more often, I can make more money just by shooting for a further target, just by being more aggressive.” And that’s kind of a reminder here.
This idea of availability here, like thinking of shark attacks and worrying about shark attacks every time we’re on the water, when really what we should be worrying about is the ride home from the beach.
How do you deal with that? If you’re thinking about the things that we know as humans, we are focusing on the wrong things as traders. We’re focusing on, for example, we’re focusing on win rate or we’re focusing on not missing out.
Everyone’s making money on Bitcoin. “Boy, I got to buy some Bitcoin.” Or, “this win rate isn’t good enough. I only have a 43% win rate on my trading system. I need to add a filter and get it up to 60% or whatever.” We’ve always got our eyes on the wrong thing.
Darren: I know. The way I dealt with it was to just accept that my thinking is wrong. Michael Mauboussin got a good book that’s called “Think Twice”. Your natural gut instinct is most likely going to be wrong.
I just always think that way and then move on to the next thought which tends to be more rational one. I just don’t believe myself. I try and fight against that. We’re all kind of a bit… We think we’re better than we are, we’re smarter than we are. That is good enough to get us through. I just try and take the opposite stance to that.
If my gut instinct is telling me that 1 to 1 risk reward is the best way to go then I say, “Well, the likelihood then is probably more like 10 to 1.” So, I start from that point and work back. That’s the only way I found to improve as a trader. It’s to take that view on everything.
Walter: You basically are just checking. Like, I think this: “That’s probably wrong and maybe I should look at it at a 180-degree turnaround, just change my view on this. Will consider it.”
Darren: Definitely because most of these feelings are coming from the subconscious. They’re not coming from the facts. It’s rarely the facts. There’s always these biases, human emotions. It’s how you feel that is most likely to drive you.
You think that your backtest is going to determine what you do but it’s not. The clear and obvious way to sort of bring this home is to look at what traders do. We all make the same mistakes in general.
The mistakes that are made the most often, we all make. It’s not about you. There’s something deeper in the subconscious that’s going on there. It’s not something that’s unique to you.
It’s something that’s built-in to human beings when they’re making risky decisions. You have to come here from a different angle. If you’re just going into forums and reading what everybody else is doing, the chances are you’re being fed the wrong information because we’re all making these natural mistakes.
Walter: Let me ask you this: As a trader, being aware of the fact that your instincts are probably wrong and you should be looking at it from a different point of view. You’re always sort of second guessing yourself. Do you think that that works against you as a trader in terms of just taking trades?
In other words, here’s another way to say it. If you’re trading yourself to second guess yourself all the time, does that work against you as a trader? In other words — this is like the American babbling out on me — “We believe that you have to believe on yourself then you can do it.”
I‘ve realized now that’s a very American point of view and can be misinterpreted in other parts of the world. But regardless, my question is do you think that could possibly hurt in some aspect of trading? Not all but some.
Darren: Possibly it could. But really, it’s not about stopping having those feelings. If you’ve got instinct that’s saying, “I should close this trade early.” It’s not about stopping having that feeling.
It’s about putting some checking there and saying, “Okay, that’s what my emotion is telling me. That’s what I’m feeling. but what do the facts say?” If you can just break that thought-action connection for a few minutes then you can consider the actual facts.
Then you can say, “Hang-on a minute, in my backtest this is what I did and the probabilities look pretty good doing that. Really, despite the fact that I’m feeling this urge to act now and do something different to what I planned, it’s probably not the right course of action.”
Walter: What I find it helpful is to think, just to use this phrase, “What if I did this?” You know what I mean? You feel yourself going in one way and you say, “Hang on ,what if I did this?”
For me, that’s a useful phrase if you want to snap out of the mode that you’re just falling to naturally and just consider other options. Same thing when taking a trade. Like, when I trade and I buy the Euro right here… Who’s selling it? Who is looking at the same chart thinking this is a sell? You know, that sort of thing.
Darren: Another good phrase is, “What is the worst that can happen?” Generally, if you’re 1 to 1 and in a winning trade, the worst that can happen is that trade is a loser. I think for a lot of people that is the biggest fear.
Although, again, that’s happening subconsciously. They think that they’re quite happy to accept some losses in return for their wins and the probabilities of playing it, I think, will be fine.
But, the reality is in the moment that fear of losing is deep down and it’s probably really what’s driving your decisions. Again, it’s not the rational data that’s driving your decisions. It’s that 90% subconscious deep inside that is really making the decisions for you.
Walter: That idea right there that you just said, that’s been like the biggest thing for me this year. It’s what you just said right there, working on the subconscious. I think that’s a really important area.
How is it that so many people, you look at the data and it doesn’t really matter what market you’re looking at. You’re looking at the data and all sort of says, most people playing the trading game, they lose. Most people lose. So, why is that? It’s like we’re built this way. We’re built this way to make the same mistakes.
Darren: I think if you knew that fact and then you started to say backtest systems and came up with your own systems and back tested them and you never find any positive expectancy in any systems.
Then, that would go someway of being able to accept that the reason that everybody loses is because it’s almost impossible to find an edge in the market. But, as most of us who have been around a while know, coming out of a system to test that has positive expectancy is fairly easy.
There has to be something else going on and that’s where you’re focus should be. What else is going on? Our gut instinct is to look at the strategy solely, isn’t it?
Walter: Exactly! It’s like you’re reading my journal this week, Darren. It’s really funny that you’re saying these things. This is exactly what I’ve been working on like I said most of this year, really.
Exactly what you said. If you think about it, you can dig up strategies on the internet and they’re going to have a positive expectancy and yet, good luck finding somebody. More than a handful of people that are actually using that to good effect.
It’s got to be something else. It’s not difficult to manufacture or pull out of your ear, a strategy that will make money. The difficult part is to actually execute it and do what the system says to do. That’s the difficult thing.
That’s what I find so fascinating about trading. It’s the fact that, of those two pieces, the one that everyone focuses on is number one which is system and finding an edge. When really, in the end and like you say, if you’re a listener and you’ve been trading for more than a year or so, you’ll probably work this out which is “it’s me”.
It’s what they call “user error” in the software world. What am I doing? How am I not making this work? It’s something about me that really I need to look at here.
Darren: Again, finding out that bit of data that is you is one thing but then deep down the 90% is going to be saying, “It’s not really me.”
Walter: Exactly. That’s not me. That’s other people. Not me. Not me.
Darren: Even when the facts are glaring you in the face that it is you, you’re not going to feel that. It is unlikely that you’re going to feel that. I think if we go back to the odds of a shark attack, regardless of what the figures say.
It’s 1 in 3.7 million. That figure is not like a law. It’s not a fact. That’s just where we are at the moment. You’re going to be thinking, “I’m going to be unlucky this time because those odds don’t represent this time that I’m going swimming.”
There’s this uncertainty in that number. It’s not like Algebra where X equals 3 or something. There’s uncertainty with that. The same problem applies in the market. You will do a backtest and work out your probabilities but that isn’t a fact going forward.
There’s uncertainty in those. You’ll never really know the probabilities. You get an idea of what the probabilities were in the past but that can change going forward. Again, deep down, you know that as well. That’s where the problem comes because you lose faith in those, that data that you’ve got. Your fear takes over.
Walter: Exactly. And the odds do change like in the example of the shark attack. If I am going out for a swim in the Red Triangle or in South Africa and I see a bunch of seals floating around and stuff like that, I’ve got to think that boy there’s going to be some big sharks down there snacking on those seals.
Whereas if I’m in Bora- Bora and I can see all these sharks and those little lemon sharks or whatever, they’re well-fed. There’s plenty of fish around. I think, it’s alright.
It’s the same with trading. If I took a trade, let’s say 5 minutes before the end of the week and I had a really tight stop, what’s going to happen? The spreads are going to widen, there might be a gap over the weekend.
When the markets fire up again next week, I might not only be stopped out but I might have lost more than I had bargained on because the market could gap over my stop loss level. That kind of thing.
Whereas, if I did the same thing in the middle of the week during the European session, maybe the chances of the market pushing through beyond my stop may be quite slim. You know it’s the same thing, I guess. The odds do change.
The person who never goes and swims in the ocean, their odds of dying from a shark attack are basically zero, aren’t they? It’s like the guy who never plays the lotto. He’s never going to win.
Even the people who play the lotto have a very very small chance of winning but at least they have a miniscule chance. I think there’s a book called “Against the Gods”. I don’t know. I’ll put it in the show notes.
Which is this idea of people didn’t really understand probabilities and how to define risk throughout history. There’s kind of a history of risk. I’ll put that in the show notes for you guys. But that’s kind of the game, isn’t it?
The first part of trading is identifying your edge and working out your numbers and figuring out what the odds are. What the probabilities are. The second part of trading is teaching yourself and learning how to manage yourself so that you execute your trading system.
That’s really trading. That’s really what it’s all about. Finding an edge, defining the edge and then executing it and working on yourself so that you can continue to execute it. But, I don’t hear a lot of people talking about that.
I hear a lot of people talking about magic trading system and how this system is better than the other system. There aren’t a whole lot of people talking about how you can trick yourself into executing your strategy.
Darren: What do you think about with this risk and perception of the risk? Most of us find sharks scary and we consider them high risk but you find the people who are sorting everyday about a guy goes diving in South Africa and he’s like a cameraman or something and he’s obviously seen a lot of sharks.
Now, his perception of the risk with sharks has gone away completely to the point where he’s not really afraid of sharks. He knows he needs to be aware of them. He goes and dives well with sharks everyday and he doesn’t fear them anymore.
Is this the way to deal with these issues with trading? It’s to you kind of have to experience going against the fear if you like and then you can progress.
Walter: I think you can inoculate yourself to build up a resistance, just like a good drug addict. You know what I mean? You sort of build up a resistance. If you first start trading with a really tiny amount it almost doesn’t matter. Like, it really, it doesn’t matter. It’s real money but if you can just build up that way.
I think what you just describe though is exactly what we see with cars. When you first start driving… I remembered when I first start driving I used to tell people, “I can’t change the radio right now. I’m driving.”
Now, I could probably watch a DVD, text somebody, pull a dummy out of the seat from the back seat. You can do all these things at once because I am like that abalone diver or whatever, the cameraman in South Africa. And we’re all what way, aren’t we?
If you drive a lot, you get to the point where the cars, they don’t look dangerous anymore. They don’t feel dangerous. It doesn’t feel scary when you’re driving them but when you first start driving, it was. I think you can do the same thing with trading.
To answer your question, I would say work yourself up to a way that you can build up a tolerance just like a good drug addict where you basically start out with that little bit and you get just such a high from that trade.
As you trade more and more, and you opt the risk on each trade then you get to a point where you’re focusing on execution and you’re no longer in the thrill of the trade, so to speak.
Darren: Yeah, definitely. You just need to look at the mistakes that you’re making and think a little lot deeper about why you’re making those mistakes and buy into this whole idea of Psychology being important first. Really buying into that for a bit.
If you spend a lot of time working on strategy and entries and where you put the stop loss and what indicators you use, just put that to one side for a minute. Just trade the system that you like and something really simple.
Just zoom in on your feelings, the decision making process, the Psychology of it all and really that’s where you can make massive improvements in your trading.
It’s difficult to do because even when you’re born into this… Even now, I still find myself drawn to thinking to remove entries and looking at this moving average instead of that moving average. “What if I traded this pattern?”
But, if you do buy into the Psychology as being important, you will get to the stage where you look at these things and then your memory clicks in. It’s not really going to make any difference in the long run. I think there’s a lot to be learned from focusing more on the psychological side.
Walter: Absolutely. It becomes pretty clear as you progress as a trader. It’s about learning about yourself. That’s really the big gains.
Thanks, Darren. We’ll see you next time. Thanks a lot.
Darren: Okay, Walter. Thank you.