In this episode of 2Traders Podcast, Darren and Walter look into controlling risk and managing emotions. The two traders discuss the advantages of having a trading buddy.
Walter shares how making a “game” out of trading can lead to unexpected results and he discusses the science behind untangling your own trading biases. According to Darren, often the greatest solution to a problem is accepting human errors and to implement strategies to evade these errors.
Download (Duration: 19:03 / 21.8 MB)
In this episode:
01:31 – out of whack
02:45 – pool of resources
05:37 – trading buddy
07:35 – black and white
10:09 – limited reservoir
12:29 – loop to loop
14:22 – under control
16:18 – snowball
18:03 – dopamine hits
Walter: To keep your self-control, what you do is you look at your trading system and you apply rewards based on how well you execute your trades, not based on whether its a winner or a loser.
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 back to Two Traders. It’s Walter here. Hello, Darren.
Darren: Hello, Walter.
Walter: So, today we have this question: what is more important for the trader? Is it risk-control or self-control? Now I like to take a crack at this one. My thinking here is I’m not going to cop-out and say they’re both important or depends or whatever. Those are the easy cop out. It’s true, it does depend. But, if I paint it into a corner and if I had to choose one, I would say risk-control.
I would say that because my thinking is that if you’ve got your risk under control, in theory, it’s harder to sabotage. I guess self-control to me sort of insinuates that you’re talking about someone who can’t control themselves and just wants to overtrade or do some crazy things and paint outside the lines. I guess, if you’ve got your risks down like the way I look at it, reverse it.
What if you had your risk completely out of whack, but your self-control was great? I still think you’d probably lose. But, if you have your risk under control and your self-control is still a little bit loopy, perhaps you still have a chance. There’s no guarantees but perhaps you’ll still have a chance. I’m going to have to put my chip on risk-control. What say you Darren? What do you say?
Darren: I don’t want to cop-on over but I feel a strong copping out here. I will partly agree with you, risk-control over self-control. But, I still feel that both of them are like stage 2. If stage 1 isn’t right, it doesn’t really matter on either of them because I think they are both closely connected.
The interesting thing about self-control is if you’re focusing on self-control then you’re probably not going to have any self-control. The interesting research on self-control is that it’s like a resource that is not bottomless.
What happens in your brain with self-control, it’s like a pool of resources with self-control. If you set that self-control resource on say, one decision, then on the next decision, you’re going to be more susceptible to break it. It’s going to be harder to stick to it on the second one.
Like people who are trying to diet that will sort of walk past say a donut shop and they like donuts, they might be able to say, “No, look I’m on a diet. I’m going to walk past that shop.” And then, they get down the road and they see McDonalds and they haven’t got the same pool of resources to stop yourself the second time.
This research was done by a guy from Iowa University. His name is William M. Hedgecock. He’s done lots of really interesting neuroscience stuff that relates to financial markets and trading. This is really interesting.
If you’re just saying, “Look, I’ve tested my system. I know it works but I keep making these mistakes of not waiting for my entry or taking my profits early. All I need to do is learn a bit of self-control.” You’ve got a lot of forefront in your mind.
You start trading Monday. The first opportunity where you’ve got to control yourself comes up. You do alright. The second one comes up, you’ve got no resources left to deal with it.
You make the same mistake again and you see these with traders all the time. They can’t break this self-control problem that we all have. That is why it’s so common in traders.
The other interesting thing that he picked up from this was that this goes back to your thing about saying that daily timeframe is a better timeframe to start on, is that after you happen to use self-control. If you have a break from that activity that’s like making you have to control yourself. This pool of resources in your brain gets replenished.
Your idea of trading less and having less decisions to make for difficult risk-based decisions is actually really on the mark. That’s kind of mindful. I mean this self-control thing to me is not something that you can rely on. You can’t just say, “I’m going to use self-control”. We can’t do it. We haven’t got the mental capacity to do it.
Walter: Couple of thoughts that I have. Question number one is what happens if you have a risk manager, is that no longer self-control? It’s like just reporting to your boss I suppose. For example, let’s say you’re a private trader and you do as I suggest — which I suggest to everyone — which is get yourself a trading buddy. Talk to them at least once a week.
If you know… For example, let’s say, I’m a trader and I trade the H1 charts and my big problem is I take too many trades. I take sub-par trades. I overtrade. I don’t take the very best trades.
And so every week, I’ve got to report to my trading accountability partner and I’ve got to tell her this is what I did. This is the trade I took, this is why I took it. And then, she looks at me and every week and she goes, “What are you doing? You’re not following your rules. This is what we’re going to do. Next week we’re going to limit your trades. You can only take nine. Nine trades. You’ll take them all by Tuesday then that’s it. You can’t take any more trades for the week.”
I guess you could argue, if that works for me as a trader because I know I’m going to talk with my trading accountability partner. I know she’s going to say how many trades did you take this week. It’s not really self-control, is it? It’s kind of like reporting to my boss, I guess. It’s outside of me now. Isn’t it?
Darren: It’s more of like risk-control because you’ve identified the risk in your self-control and you’ve implemented something to deal with that. You know where you’re going to make mistakes. You’ve put a risk control in there to deal with that.
What they find in this research about self-control was noticing that you need to use self-control as depleted. It is actually in the execution so you can put something in there to deal with the bit that you’re going to fail with.
Walter: Give an example. What’s an example?
Darren: Like you said, having someone that you report to. It could be a trading buddy that when you see a trading set-up, and you’re getting this issue of self-control. Do I take it? Don’t I take it.
Then you pass over to someone who knows your system and say, “Is this a valid system? Is this a valid set-up or not.” Then they’ll give you the answer. They’re not involved in the trade. They can just be very black and white and then you execute the trade.
Walter: That’s interesting. The other thought I had here which is besides moving in and outside of yourself and basically taking outside so is it no longer self-control. I guess it’s semantics.
But, the other thought I have was, if you read through the Market Wizard books, what really jumps out to me are the number of Market Wizards who had a catastrophic loss for whatever reason.
Whether they risk too much or some sort of they risk too much on a trade, or they discounted the risk of the market basically running away and not enabling them to get out, or they wouldn’t diversify, or whatever it was. They made some sort of mistake and that kind of set them off in the right direction.
Sort of like a smoker who quits cold turkey and says, “That’s it. I’m not going to smoke anymore. I’m never going to smoke. I haven’t touched a cigarette in 15 years or whatever.” That sort of thing. So that’s what it reminded me.
When you read these stories after stories of these traders — and I guess these books were written in the late 80’s, early 90’s, the Market Wizards and the New Market Wizards. I can link them up in the show notes if you’re like the only trader out there who hasn’t heard of them. But, basically, I guess in theory they could run out of self-control and then 25 years later they make the same mistake but it sure seem like they learned their lesson.
It sure seem like that was like a catalyst that enabled them to kind of find the light so to speak and become a more consistent trader. That’s an interesting thought.
And also you hear like these dieters. They’ll say things like, “Nothing tastes as good as fried bacon. It was nothing taste as good as feeling good feels.” Something like that. Like, they have this mantra that they will recite every time they go by the ice-cream shop.
Instead of going in there getting a donut or an ice-cream they’ll say, “Nothing taste as good as feeling good feels” Or, “Being thin feels…” Something like that. I don’t know the saying.
It’s like they’re using a technique or something, a strategy. I get what you’re saying about the research about I guess like a limited reservoir of self-control and once you’ve depleted, it’s gone.
What’s the solution? Is it to move outside yourself and have a trading accountability partner? For example with dieting, people can think about the goal. Think about the end-result. I want to look like this. I want to feel like this.
It’s not worth it for me to eat that biscuit or that ice-cream cone or whatever. It kind of refocuses them and recenters them on what’s important. Is that a possibility or what do you think based on your research?
Darren: Definitely. I think what we need to get past is this idea of, “I’ve got a trading plan. Just trade the plan” because all the research suggest that that’s not something that we can do.
Just having your trading strategy and saying to yourself, “All I need to do is follow this trading strategy and I’ll be alright is missing the point.” That is something that we’re not built to do so you need something a bit more than that. You need to go beyond your technical trading strategy and look at the strategy to ensure that you execute it.
Like, what we’ve talked about on a lot of the other podcast. You need to think about your Psychology strategy. You need to have something in place. They can be stops, like you say, or they can be trading buddies or they can even be routines that you put into your trading strategies.
They aren’t about whether it’s a set-up or what you do with your stop loss. Things like after taking a trade, you then go and run around the block or you go and walk the dog or something like that. You need to think about that element of a strategy as well which most people overlook.
Walter: I just thought of a great thing. Like, if you’re that trader who needs that rush or whatever you take your trade, what you do is you move next to like an amusement park. You just live close to it.
You take that trade and you’ve got your annual pass at the amusement park or whatever. We’ll just pretend that they’re open year-round, and then you go there and you just scan your annual pass and you go ride the loop-to-loop roller coaster. It’s just like your trades are already locked-in. It’s already in.
Darren: Yeah. I mean, these are things that nobody talks about in trading forums. Nobody, you won’t find a single. You might find 1 thread in 5000 that talks about this kind of ideas but all of the study, all of the data suggest it’s really, really important.
There’s the perception gap that’s going on. When you look at the facts, if it’s true that most of us lose, most of us make the same mistakes, then most of us are using pretty much the same technical strategies that has to be outside of that where the answer lies.
It’s glare in the obvious. But, the worst thing we do as humans is deal with the glare in the obvious, isn’t it? Alcohol is legal in the UK so everyone thinks it’s fine but the facts about the health risk from alcohol, a glare in the obvious and we overlook that.
Then you have something that’s illegal like cannabis and we’re all like unfair of it because the government say it’s bad for you. The facts say that anyone’s ever died from cannabis but our perception of it is just completely the opposite.
Walter: Yeah, exactly. So funny, isn’t it? What you’re saying about alcohol I think, that’s why when you’re trying to get somebody off the alcohol or whatever, what happens is you’ll have an intervention.
You have like the family and friends of the alcoholic they all come in and they say, “Look you really have a problem here” because we all think, “No, no. It’s not me.” It’s the same thing.
“I don’t really have a problem here. I’ve got this under control. I’ve got some self-control here.” But really, you need a trading accountability partner. You need a bunch of people to look you in the eyes and say, “Nope. This really is an issue.” It’s crazy.
In theory, let’s say, you’ve got your risk control right and you risk the precise amount you should. You got everything right about that in your trading but if your self- control is out of whack, then you just go crazy.
You take too many trades and that’s going to affect the risk, obviously. You do need to have both of them. I agree you do. If I had to choose I’d say, “Well, maybe I can get the risk down” and you have self-control. Can it still sabotage it? Can’t it?
Darren: I wouldn’t say, “If your self-control is out of whack.” I would say, “Your self-control is out of whack.” It is. You just have to accept that. Self-control and just trade the plan is not going to work. It won’t work for you.
You have to accept that first definitely and then I suppose what you need to do is in your risk-control, you need to put in implement systems that deal with that fact. I think that is the approach.
Like you say, even guys who’ve made a lot of money trading and perhaps even have funds have this issue with self-control. It’s not a question of intelligence or experience. It’s a human-emotion-bias-psychology issue.
You see, when people blow up it’s very rarely that they make one mistake and blow up. What tends to happen is they make a small mistake and they’ll try and correct it and they’ll make another small mistake and then, they’ll try to correct it by making a bigger mistake and it kind of snowballs like that.
They keep thinking that self-control is going to help them out but the more small mistakes they make, the less this resource gets depleted more and more. They can do less and less about it and it snowballs and then they blow up.
Then they’ll sit there two hours later saying, “I just lost 70% on my account. How did I do that?” I definitely say your self-control is out of whack. Deal with that rather than just trying to fight against it.
Walter: There’s a book that I’ll put in the show notes called “Fake: My Life As A Rogue Trader” by David Bullen. It’s a story about basically exactly what you just said there. How they took a forex loss of 360 million. It’s about an Australian bank but it’s exactly what you say about the snowballing thing because that’s true. I just want to share something with the listeners here. This is something that you’re very interested in.
The thing that I found most useful for me and I’ve shared this with other traders is to make a game out of it. What you do to keep your self-control. What you do is you look at your trading system and you apply rewards based on how well you execute your trades not based on whether it’s a winner or a loser.
What that does is the neuroscience behind that is you want to win the game. You get a little hit. You get a hit of dopamine when you buy something. You get a hit of dopamine when you win. This little games on your watch, your phone or whatever.
And that’s kind of what I try to do with my trading as I set it up that way so that I get dopamine hits for following the system. I don’t go back and change things based on wins or losses. That’s just something I found to be very useful.
I really think everyone should get a trading accountability partner. I think that’s the number one thing. But if this is something that you are really into then the other thing that I would recommend is that you make a game out of it basically.
Darren: I will put the link to this article about self-control in the show notes as well because it’s really a good read. It’s really interesting and quite eye-opening.
Walter: That’s awesome. Thanks a lot. Sounds very good. Well thanks, Darren, for your time. I really appreciate it.
Darren: Great talk again, Walter. I will see you next week.
Walter: See you next time. Bye.