Eliminating Mistakes

Mistakes are the hubris of most investors / traders and its no wonder they generally are doomed to fail regardless of what superior qualities they may possess elsewhere. But many investors and traders who aren’t affected by that characteristic still fail and the reason for the vast majority of them comes down to avoidable errors, some that they knew about and did not implement and some they did not even know about (the Unknown Unknown).

Right from Warren Buffett to the ordinary investor, mistakes happen by everyone. But while the professional investor understands and rectifies his mistake, the amateur investor believes that the mistake is not his but his bad luck.

The biggest mistakes happen due to the fact that we ignore the Heuristic Biases that affect our way of thought, way we understand things and how we go about implementing them. I come across investors who choose to ignore such biases rather than learn how to avoid the traps laid out by such biases.

I am generally a skeptic of strategies which cannot be tested using a software and while patterns can be tested, ability to code and test is not something I have the ability and hence will rather ignore such strategies than do a manual test which shall suffer from all kinds of biases (Selection of only those that have succeeded being the major bias here). Again, I am not suggesting that patterns aren’t a way to make money in the markets. After all, one of the top Hedge Funds with incredible returns is rumored to use patterns (though they aren’t the general ones we find in every TA text book).

The other day I met this friend of mine who believes in patterns and he was saying about how high a success rate this particular pattern had. The only catch being that you need to recognize it correctly. Wanted to inform my friend that this is a circular logic that leads to one over-estimating the predictive nature of the pattern, but then again, have burnt too many bridges trying to correct the logical errors of others and hence kept quiet.

The same error affects Elliot as well. If the move is not as per what Elliot logic predicts, the way out one is told is to go back and change the wave counts till the current action matches the one that was supposed to happen. If only the broker allowed me to change my trades after they failed 🙂

Every mistake in markets costs not only in terms of money but also can wear us down to the extent that after X number of losses (many of which could have been avoided), we feel that the mistake lies in us coming to the markets in the first place. The churn ratio at any big brokerage firm shows how a large set of investors and traders bow out every year just to be replaced with new sheep most of whom too will bow out in time.

Elimination of mistake requires two things. One, the ability to understand that you are wrong (and not the market) and Secondly, the openness to accept that my chosen method / path / logic is wrong and try to see where and how one can make amends to that.

Checklist is now seen as a proven way to reduce and eliminate mistakes that we have either made earlier or know about it. If you are yet to read The Checklist Manifesto by Atul Gawande, I urge you strongly to do as soon as possible. A checklist before you commit a trade is one of the easiest way to eliminate simple mistakes.

Once known mistakes are reduced, the next step comes in trying and reducing mistakes that we do not know we are making in the first place. Compared to the ability to reduce mistakes that we know is happening, this is quite difficult but not impossible.

To me, eliminating the unknown unknown mistake requires constant effort on part of the investor / trader. Profits occur due to combination of Luck and Skill. There are quite a few ways to separate the two – Bootstrap and Monte Carlo testing being the ones I prefer and use.

Every trade / investment has a expected return and a real return. One needs to constantly check for divergence between them and then focus on whether the divergence is due to something that can be avoided / acted upon or something that we just have no control upon.

Eliminating mistakes is a process and it has no ending since our aim always has to be becoming a better investor today than one we were yesterday. But that requires quite a bit of effort and that can come only if you are passionate enough as well as have the ability to understand, accept and rectify mistakes. If you cannot do that, its always better to invest in MF’s / ETF’s and spend the time in activities that bring pleasure to your mind.

Investing / Trading has no shortcuts to success. You either are the hunter or you are hunted. The choice is yours as to what you want to become 🙂