I'm sure many of you have benefited from the rise in cryptocurrency prices and think you are the next market wizard. Some of you may even be contemplating quitting your job and becoming a full-time trader.
There's an old saying in the investing word:
Don't confuse brains with a bull market.
I thought I'd write my first post (possibly one of many) on why trading is not a career choice or investing style you should be considering.
Before I go on, here's a little about me: I've been trading for almost 10 years now. One on those years I was trading fixed income products at a bank and the last 5 years trading full-time for myself and private investors. I heard about cryptocurrencies a few years ago but only recently took a deeper dive into the crypto universe.
Onto the main topic...
We are not built to trade
Countless studies in the field of behavioural economics have shown we don't make rational decisions. Instead, we make quick decisions that are dictated by our emotions. Many studies have also shown that a lot of our decision making process is a snap judgement, which is later justified by our more rational mind.
Here is a brief list of a biases that will impact your decision making when it comes to money:
Prospect theory/loss aversion - we are more sensitive to losing $X than winning the same $X. This bias can manifest itself if a holding onto a losing position too long. The subconscious thinking is, as long as you don't close the trade, you don't take a loss and the pain that comes with it.
Recency bias/Anchoring - we tend to weigh recent information more than older information. e.g. if prices have been rising, we extrapolate this into the future and think prices will continue to rise. Good in trending markets, bad in ranging markets.
Herd behaviour/social proof - we tend to make decisions based off what others are doing. e.g. if others are buying $XYZ, we will be more inclined to buy $XYZ
Overconfidence - everyone thinks they are better than average. If you ask a room full of people, "Who thinks they are better than average at driving?", almost everyone will raise their hands. That can't be the case because by definition, only half the room can be better than average. Similarly, the statistic that 90%-95% of traders lose money, does not stop people from thinking they will be making $$$ in no time.
There's a huge list of these biases and if you would like to read more then Google: Behavioural Economics/Finance.
Don't these biases apply to investing as well as trading? Yes they do. However, trading generally implies more frequent decisions and therefore most instances in which these biases can cause damage to your wealth.
By now you are probably asking, is it possible to fix these problems? yes after years of trading and losing a lot of money you MIGHT become desensitised to making decisions with money.
What about algorithmic trading? It can help but when your algo is in drawdown taking loss after loss, you will be tempted to switch it off. You are still in control of the algorithm. There is not quick fix for mitigating emotional decision making.
Conclusion
Emotional decision making is just one reason why trading is not a good idea. If there's enough interest in this post, in future articles I will cover other reasons trading for a living is no good: variance and drawdown, time commitment vs. opportunity cost and being underfunded to live off your trading capital.
That's all for this post.
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Do you think this post should be longer? Shorter? More detail? Less detail? Any trading/finance/economic topics you would like my thoughts on? I'm always looking for feedback, so please comment below!