By Martin Tillier
Last Tuesday, like many people, I channel surfed as I watched the US Presidential election results, skipping between CNN, CBS, Fox News and MSNBC. I happened to be on Fox at around the time Ohio, and thus the election, was called and my surfing stopped. I was fascinated by the reaction of a panelist. Karl Rove, former senior advisor to the George W Bush administration and the driving force of the “Super-PAC” American Crossroads, was demonstrating behavior I had seen all too often before. He was in complete denial. This is not a political point I am making. I am sure many Democrats exhibited the same traits in 2000 and 2004.
This reaction, however, was very public, and the liberal sector of the media seized on it as evidence of something bad about Republicans. Anybody who has worked in a trading room, however, is only too aware that this is a very common reaction in certain situations. It says nothing about Karl Rove other than that he is human, and certainly tells us nothing about anybody else.
What it does provide is an example of probably the biggest mistake traders and investors can make.
Most people, when they have a significant emotional or financial investment in something, lose the mastery of objectivity. Rove demonstrated it perfectly last week. He had convinced himself that Romney would win. He had said so regularly and American Crossroads had poured hundreds of millions of dollars into the election. As the results came in he buried his head deeper and deeper into the sand. What could have been just another electoral defeat became a disaster in terms of his image. This behavior is not limited to traders and politicians. People who are behind on their mortgage know that communication is key, but they still often refuse to pick up the phone. I am not a psychologist, nor have I played one on TV, so I am not sure of the correct terminology but, as I said, I’ve seen it before.
There are some well known cases. Older readers may remember Nick Leeson, the man who broke Baring Brothers. I certainly do. Most of the time the loss is not hundreds of millions though; it is just more than it should be. Successful traders are good losers. I don’t mean this in the sense that they accept losses gracefully. I have seen too many broken phone handsets to assert that. Rather, they limit their losses, take them and move on.
This is why, when I discuss an idea, I usually highlight a logical place to cut the position for a loss as well as a target level. Last week I changed my view on Apple (AAPL) from bearish to bullish below $550. I also mentioned what I think is a logical stop-loss level at around $511. It looks like we may get there. If you have bought on the way down and it does keep falling, you have to stop somewhere. It is better to get out on your terms than get squeezed by the market until you cannot bear any more pain. You can always come back to the idea, but you will likely make a better decision when the disabling pressure of a continuing loss is removed.
In order to make that cut, however, you have to accept what the market, or any other data source, is telling you. Sometimes an idea is based on a belief that certain numbers will improve. If you have bought Yum Brands (YUM), for example, on a belief that Chinese growth rates will increase, you should monitor indicators of growth.
If they don’t tell you the message you are looking for, accept it. Don’t go all Karl Rove and assert that the numbers are wrong, the compilers have made a mistake, or anything, anything other than that you were wrong in the first place.
Traders and investors alike need to understand that to err is not just human, it is inevitable. Whether you are watching price action over a couple of hours, or analyzing long term economic indicators for trends, you must accept what the numbers tell you. For a trader, this is easier once you recognize that around half of your trades will probably lose money. Restricting those losses then becomes more important than denying them. Even if you are in it for the long haul there has to be a point at which you will accept a loss. In the long term, buy and hold is great for companies that do well. Those that bought and held General Motors (GM) before 2009, not so much.
Usually desirable traits such as positive thinking and conviction can easily become liabilities in certain contexts. Watching a smart person deny reality on national television was funny to many, but if you don’t learn from that behavior the effect on your investments will be anything but amusing.