Even Greats Like Druckenmiller Make Mistakes. So Learn From Them.
The reason that trading and investing can be so financially rewarding is that it is very difficult. The biggest obstacles that we face are internal. Knowing the rules of great trading isn’t so hard, but actually acting on it is tremendously difficult, because emotions always come into play.
Stanley Druckenmiller is considered by many to be one of the greatest investors of all time. He tells a story about how he sold all his technology stocks in January 2000, because valuations looked absurd, with prices-to-earnings over 100 in many cases. After this sale, he watched a couple of "gunslingers" continue to rake up huge gains. It was driving him crazy to miss out on these gains. He couldn’t help himself and had to play. He bought $6 billion of technology stocks in March 2000, and within six weeks, he had lost $3 billion on that single bet.
When he was asked what he learned from the experience, he responded, “I didn’t learn anything. I already knew that I wasn’t supposed to do that. I was just an emotional basket case and couldn’t help myself. So, maybe I learned not to do it again, but I already knew that.”
Druckenmiller knew what to do to a far greater degree than most investors, but he still had to wrestle with emotions that drove him to do the wrong thing.
The big challenge in trading and investing isn’t developing effective strategies, tactics, and methodologies that should produce profits but actually sticking to the rules and taking the necessary actions at the right time.
Computerized trading deals with the issue of sticking to a rule book quite well, but the problem is that every stock and every market has unique circumstances. Great traders know when to bend the rules and have a certain level of flexibility that computers don’t have when they face a situation that is unlike others.
Humans often have an inclination to believe that "this time it is different" when it comes to the market or specific stocks. This causes constant problems when we change our rules, because we feel we have to adapt. The reality is that the market and stocks are never different in some ways, but they are always different in other ways.
There is no easy solution to being misled by our emotions. All we can do is constantly remind ourselves of the basic principles that help to keep losses small when we make a bad decision and maximize our gains when we find a winning stock.
There are certain things I’ve been working on since the day I started trading 30 years ago that I still have to work on every day. A good example is that every year, I make a resolution to trade bigger and be more aggressive when I feel like I have a good trade. Far too often, I don’t push hard enough when I have an edge, and I end up with small gains in exceptional situations.
My emotion is to not take on too much risk ... but I'm not taking into account how I can control that risk with stops, partial sales, time frame diversification, and other tactics.
One of the primary reasons so many traders and investors struggle with their emotions is that they never have very clear rules to start with. They have some vague concept of cutting weak stocks at a certain point, but no specific parameters, so when a stock does act weakly, they end up with an emotional response instead of a planned strategy.
The best way to deal with emotions is to be very aware of them and to understand when they may be driving you to act in a certain way. The nature of trading is that if you aren’t feeling some stress and anxiety about a trade, then you probably aren’t trading big enough for the trade to matter. You will always have doubts about a trade, and your emotions will push you to do the wrong thing. Develop a game plan in advance and then be cognizant of how you feel as your trade goes through its inevitable ups and downs.
Great traders are wrong quite often, but they recognize that it is just part of the process and that they aren’t impacted by the emotions of losses. They just keep going and try to do the right thing, which ultimately leads to profits.
More Trading Basics
- The Most Important Thing I've Learned in 25 Years of Trading
- Day Trading Is Very Difficult: Here Are 6 Tips for Long-Term Success
- Most Day Traders Fail. Here’s Why and What to Do About It
At the time of publication, DePorre had no position in any security mentioned.