by Jim Paul
Not only will the plan prevent you from the throes of the Five Stages, but it will also bring the positive attributes of games to the markets (more on this shortly). Market positions are continuous processes that make the future less certain than the either/or outcome of discrete events, such as a hand of cards or a sports event. Remember the horse racing example mentioned earlier where we stopped the race in the middle and let you bet again? Unless you create some event-defining parameters, you are in jeopardy of gambling or betting in an environment completely unsuitable for such activities. If you don’t have some means of stopping the continuous process, nothing is locked in — profit or loss — and you’re leaving yourself open to being pushed and pulled around by fluctuating prices, random news events and other people’s opinions. Every price change or news item can be rationalized by any of the myriad of ways there are to analyze the markets. The analysis becomes its own reward; an end in itself; an attempt to be right, which is simply betting. Therefore, the fluid market environment needs operational parameters that make a discrete event out of a continuous process. A plan does precisely that by creating an ending point for a market position. A plan, which determines the stop-loss first, enables you to convert a naturally dangerous, continuous process into a finite, discrete event.
Market participants adamantly deny any connection between what they do and gambling games. The argument is: “There is only the slightest analogy between playing games for money and the conduct of business in a market economy. The characteristic feature of a game is the antagonism of two or more players or teams, whereas the markets are for supplying the wants of consumers.”51 They don’t want other people to think they are gamblers so they spend a lot of time explaining how and why the markets aren’t the same as casinos. But remember from Chapter Seven that most people don’t know which type of risk activity they are participating in. They also don’t understand that it is the characteristics displayed, not the activity itself, which defines whether they are betting, gambling, speculating, trading or investing. This lack of understanding means people are prone to exhibit the traits of betting or gambling on a continuous process (i.e., the market) rather than a discrete event where such activities belong. Apparently, many market participants reject the casino view of the market in word, but not in deed.
However, from my trading and gambling experiences I have learned that the more the markets are treated as a game, the less likely you are to have losses due to psychological factors. Why? Games have rules and defined ending points. Their participants have a game plan. A plan takes the positive attributes of games (not gambling games per se, but the concept of a game) and applies them to the market, giving you the structure necessary to create a discrete event. This means you won’t confuse Speculating with betting or gambling. It also prevents you from betting or gambling on a continuous process. Recall that thinking before acting is the definition of Speculation. Mixing up the order of the process (i.e., acting then thinking), is betting or gambling. Trying to be right (i.e., betting) about an event that never ends means that you will never be completely right. Trying to get excitement (i.e., gambling) from an event that never ends will provide you with more excitement than you bargained for.
Having a plan requires thinking, which only an individual can do — not a crowd. A crowd cannot think any more than it can eat or drink. There is no such thing as a group brain. Since a plan is about having rules, and since mass behavior is not rule governed, having and following a plan means, by definition, you are not part of the crowd. Following your plan imposes discipline over your emotions. Since discipline means not doing what your emotions would have you do, then if you don’t have the discipline to follow the plan, your emotions have taken control and you wind up in the crowd. If you don’t have control of your emotions via a plan, then your decision-making will be based on emotions. That makes you highly subject to contagion because of the hypnotic effect of the changing prices, and you fall into either one of the psychological crowd models mentioned earlier since the crowd epitomizes emotionalism. So rather than monitoring yourself for evidence of each individual emotion, if you avoid the characteristics of crowd behavior you will, by default, avoid emotional decision-making. As my mom used to say, “Weak is he who allows his actions to be controlled by his emotions and strong is he who forces his actions to control his emotions.” If you’re not consciously doing the latter, then you’re unconsciously doing the former, which is precisely Le Bon’s description of the conscious personality of an individual vanishing when he enters the crowd.
This last section has been a detailed explanation of how following a plan keeps you from falling into the three part psychological trap discussed in Chapters Six, Seven and Eight. Obviously, the three don’t have to occur in the order we covered them. That was simply the order given in the definition of psychology back in Chapter Five. The errors can occur in any sequence and form a vicious circle. For example, you could: 1) make a crowd trade after falling into one of the crowd models previously outlined, then 2) confuse the different types of risk activities and wind up betting because you’re only interested in being right and finally 3) personalize a loss when it develops and go through the Five Stages of Internal Loss. Or you could easily reverse the order of number two and three or the whole sequence, for that matter. The permutations are there for you to work out, but the point to understand is that these three mistakes feed on each other and lead to each other regardless of which one you fall into first.
On the next page is a flow chart that gives you the visual representation of what happens when you do not have and follow a plan.
A Plan and Objectivity
The failure to have and follow a plan is the root cause of most of the other “reasons” (or more accurately, “excuses”) why people lose money in the markets. And while you will still lose some money with a plan, you are certain to lose all your money, eventually, without one. You will enter the market and then draw up your possible courses of action on an as-needed-basis. Unless your timing is perfect, which may happen occasionally but probably not often, immediately after establishing a market position it is either going to show a profit then a loss, or a loss then a profit. But it will be a loss at some point and you will say, “If only I had sold instead of bought, I would have a profit now instead of a loss.” After a series of such trades, you would say, “All those losses would have been profits and I’d be up x amount dollars.” Nonsense! Since your timing will in all likelihood never be perfect, the market would have been against you at some point, providing you plenty of opportunity to make an emotional decision and lose money. You must have a means to remove yourself from “subjectively experiencing” the market while making decisions. Obversely stated, you must have a means to “objectively perceive” the market while making decisions and to maintain that objectivity once you’re in the market. That’s exactly what a plan does.
For the roulette player, the last moment of objectivity is just before he places his bet and the wheel starts spinning, after which he can’t do anything to lose more money than he wagered. For the market participant, the last moment of objectivity is the moment before he enters the market, after which he can still do plenty to lose more money. This is why you must determine your exit and entry criteria during the pre-trade, objective time period when your thinking is clear. You wouldn’t sign off on an unacceptable loss before entering the market, so the decision about how much you’re willing to lose must be made before you get in the market. This keeps you from making or re-making decisions after you have established a position when you would be prone to personalize the market and succumb to the errors discussed in Chapters Six, Seven and Eight.
All effective decision-making requires maintaining one’s objectivity through the use of a plan, regardless of the type of decision being made. To drive this point home, consider the following example. A PBS program on human organ transplantation reported, “The reasons people say no to organ donation vary — few people have act
ually thought about their deaths and don’t plan for it. Family members often haven’t discussed their wishes about organ donation ahead of time. At a time of crisis the decision can be too traumatic.”52 (Emphasis added.) They don’t have any objectivity. They are looking at a loved one lying on a table, body still warm, heart monitor going but brain dead. Facing a personal and subjective loss, they quickly succumb to the Five Stages of Internal Loss. This same phenomenon afflicts investors and traders who haven’t planned ahead of time. Under pressure in the time of crisis, emotions determine their decisions and actions. On the other hand, a plan establishes objective criteria and forces you to distinguish between decision-making based on thinking and decision-making based on emotions (i.e., emotionalism). What’s the difference? Thought-based decisions are deductive, while emotion-based are inductive. Inductive puts acting before thinking; establishing a market position and then doing the work, selectively emphasizing the supporting evidence and ignoring the non-supporting evidence. Deductive thinking, on the other hand, is consistent with the “thinking before acting” sequence of a plan: doing all of your homework/analysis and then, by default, arriving at a conclusion of whether, what and when to buy and sell.
Another way of looking at it is: are you long because you’re bullish or bullish because you’re long? If you’re bullish because you’re long, your decision was inductive and you will look for reasons, other people’s opinions or anything to keep you in your position — anything to keep you from looking stupid or admitting you are wrong. Invariably, you find what you are looking for to justify staying in a losing position and the losses will mount. In his book Teaching Thinking, internationally renowned education expert Edward DeBono says, “A person will use his thinking to keep himself right. This is especially true with more able pupils whose ego has been built up over the years on the basis that they are brighter than other pupils. Thinking is no longer used as an exploration of the subject area but as an ego support device.”53 That sounds exactly like me. My ego had been built up over the years because events seemed to indicate I was a little better than other people. Using thinking in this manner is similar to the inductive decision-making mentioned above: it starts with a conclusion and then looks for evidence to support it. DeBono’s comments describe how people use their thinking when they personalize their market positions. When people personalize a string of successes (or profits) and an unfolding failure (or loss) develops, having come to believe they are infallible, they use all their intelligence as an ego support device to prove that they are right, rather than as a means to determine an appropriate course of action. When people personalize losses, they use their thinking to protect themselves, thereby rationalizing holding onto the position and distorting facts to support their view that they are “right,” not “wrong.”
Philosopher-novelist Ayn Rand was asked one time in a radio interview whether she thought gun control laws violated the second amendment right to bear arms. “I don’t know,” she responded, “I haven’t thought about it.” And she said it in a manner as though it was the most natural thing in the world not to have an answer or opinion. Now here is one of the towering geniuses of the twentieth-century and the architect of an entire philosophical system saying, “I don’t know.” Contrast her approach to that of most people who have pre-packaged intellectual positions, views, opinions and answers on almost every topic, gathered from television, newspapers, newsletters and conversations. Similar to inserting a cassette into a cassette player, they insert the packaged opinions into their minds and hit the playback button whenever they are asked a question. Some people don’t even wait to be asked; they offer their regurgitated two cents worth on every topic they happen upon in conversation. This is particularly true for people’s opinions about the markets. That pre-packaging is the essence of being in the crowd because, as Le Bon points out, crowds always stand in need of ready-made opinions on all subjects. Therefore, having to have an opinion on everything or answer for everything, puts you into a crowd mentality. As soon as you express an opinion you have personalized the market, concerned yourself with being right and entered the crowd. Contrast this to Rand’s approach: refrain from answering until you can think about the subject. Following this approach keeps you objective (Rand’s philosophy is called Objectivism, coincidentally enough) and your thinking can be used to explore the possibilities for an appropriate answer, rather than supporting your ego after expressing an opinion.
Remember, participating in the markets is not about egos and being right or wrong (i.e., opinions and betting), and it’s not about entertainment (i.e., excitement and gambling). Participating in the markets is about making money; it’s about decision-making implemented by a plan. And if implemented properly, it’s actually quite boring waiting for your buy/sell criteria to materialize. The minute it starts getting exciting, you are gambling.
The only way to combat falling into the opinion trap is to follow Rand’s lead: think before you answer — if you even answer. If someone asks you what you think about the market, avoid personalizing the market by answering something along the lines of: “According to the method of analysis I use and the rules I use to implement the analysis, if the market does thus and such, I’ll do this. If the market does such and thus, I’ll do the other.” This response expresses your deductive thinking in the form of an objective plan rather than inductive thinking in the form of a subjective opinion. The response is also consistent with viewing the market objectively, instead of subjectively which would lead to personalizing your successes and profits, as well as your failures and losses. Answering in the manner just described is not an attempt to absolve you of responsibility for your decisions. On the contrary. Taking responsibility and taking something personally are two different things. It is possible to accept responsibility for the ultimate outcome of a decision without internalizing the intervening upswings and downdrafts, and postponing the final outcome to the constantly postponed future, hoping the loss will turn around so you can be right.
It was pointed out earlier that confused semantics is responsible for a lot of the confused thinking about the market. Your choice of words has a powerful effect on how you regard the market, and reveals which of the five types of participant you are. For example, if you say, “I’m right,” or “I’m not wrong,” you are a bettor and you have implicated your ego which invariably you will try to protect. If the home team loses a game you could say “we lost,” and thereby implicate your ego in the losing event. You could even claim, “We didn’t lose” and make excuses like: “The officials made bad calls,” or “A good player was sidelined with an injury.” That’s internalizing an external loss. But how much harm is done? If you bet $50 on the game, you can make excuses and maintain the perspective that you actually won. And doing so won’t cost you an extra cent because you still only lost the $50. But if you don’t predetermine how much you can lose and are willing to lose in the market, the “I’m not wrong, or “I’m not losing,” perspective will wipe you out.
The lesson here is: Taking either success or failure personally means, by definition, that your ego has become involved and you are in jeopardy of incurring losses due to psychological factors. And we have already discussed that these are the type of losses that are so devastating. They cause the small loss to become a bigger loss and then become a disaster. Remember, Edison didn’t take the failures or losses personally and he succeeded brilliantly (no pun intended). If unlike Edison you take the failures personally, or like Henry Ford you take the successes personally, you are setting yourself up for disaster. If your estimate of your self-worth rises and falls with your successes and failures, wins and losses, profitable and unprofitable business transactions, then your self-concept will be in a constant state of crisis. Having tied your self-worth to the vicissitudes of factors beyond your control, you will be primarily concerned with protecting your ego rather than trying to determine an appropriate course of action.
A person’s self image “should no
t be dependent on particular successes or failures, since these are not necessarily in a man’s direct, volitional control and/or not in his exclusive control. If a person judges himself by criterion that entail factors outside his volitional control, the result, unavoidably, is a precarious self-esteem that is in chronic jeopardy.”54 (Emphasis added.) Therefore, your self-image should not be a function of what you have accomplished, but how you have gone about doing it. Think of it this way: if you have a million dollars in the bank, but you stole it, your self-esteem can’t be very high. If you earned it, your self-esteem is quite high. Therefore, judge yourself by the degree to which you objectively defined the parameters/conditions that would constitute an opportunity, and how well you adhered to them. In other words, pat yourself on the back or kick yourself in the backside, depending on whether or not you develop a plan from a method of analysis, implement the plan via rules and then follow the rules.
As we saw earlier, people lose in the markets not because of the particular type of method of analysis they use, but because of the psychological factors involved in how they fail to apply their particular method. The only way to control those losses is with a pre-established plan. Participating in the markets without a plan is like ordering from a menu that has no prices, and then letting the waiter fill out and sign your charge card receipt. It’s like playing roulette without knowing in advance how much you had bet, and only after the wheel stopped letting the croupier tell you how much you lost or won. If you wouldn’t do that in a restaurant or in a casino, why would you do it in the market that has so many more variables and so much more money involved? Operating without a plan, given the fact that a market position can continue indefinitely, makes the future even more uncertain and you are apt to lose a lot of money if you haven’t pre-planned your actions. Without a plan your losses grow while you’re being pushed and pulled around by price movements, random news events and what other people say. Therefore, the disciplined use of a plan, with the stop-loss defined first, is the only way to prevent the losses due to psychological factors. Losses will still occur due to analytical factors but those losses are normal-course-of-business type losses. If you find those losses intolerable, deal with them by re-examining your method of analysis and refining your rules, but not while you’re in the market. The point is to keep from compounding those losses with losses due to psychological factors.