Happy Canada Day! Happy Independence Day! Happy Wednesday! Even though you might be reading this on a Thursday or really any other day of the week. I hope that everyone is as happy as our puppy friend above and that you all have a great day and an excellent holiday wherever you happen to be and whatever you happen to be celebrating. This holiday timing worked out really well for this blog with the theme of this week’s blog, which is happiness, which happens to be a continuation of last week’s blog in which we were talking about being happy with our choices when it comes to trades we are in.
Last week we talked about being happy with whatever outcome we have in our trades. We talked about this because we really never know what a trade will ultimately do. We put ourselves in the best position possible to ensure ourselves a chance at a winning trade by using good fundamental analysis married with great technical analysis and then we pull the trigger and see what the market gods want to do with us then. This is where we spoke last week about making sure we are happy if the market goes up, down or sideways. I said last week that I know this is a very easy thing to say and a not so easy thing to do. However, I believe that if you practice this like anything else, in time you will master this vital psychological skill.
Last week we talked about the way we can make ourselves happy with whatever the outcome is and that was by using ultra-conservative position sizing. When I say ultra-conservative, I am talking about placing a bet so small that even the most hardened anti-gambling folks would want to place a wager. Let me paint a picture of this very thing. Let’s say you are in a coffee shop looking at the chart of your favorite stock and a stranger walked up to you and said, I’ll bet you a cup of coffee that I can pick which direction that stock will go next? Would you take the bet? It’s only a cup of coffee? Come on now? BTW I am not talking about sitting in a Starbucks where a cup of coffee is the same price as first-year university tuition. I am talking about sitting in a good ole fashion coffee shop where a cup of “joe” is a mere shekel or two, would you take the bet? Ok, I see some of you are still not convinced, what happens if the stranger makes the same bet but gives you at least two to one odds? Would you now take the bet? You are getting a two for one deal!? I am thinking most folks would take the bet and we will go with the average on this one. You see this scenario is a breakdown of an ultra-conservative position sizing example. Let me explain, first the cup of coffee is at most $2. This is usually within most people’s pain threshold. Secondly, we are putting the odds of winning squarely in our favor by reading the stock, remember we were looking at the chart and using our technical analysis to get an idea of what might happen next. Finally, we are adding to our edge in the fact that the stranger was going to give us two to one odds! If you put this all together you will see that this is a good bet to take and you would probably be happy regardless of whether you won or the stranger wins. Think of it this way, if you lose it costs you a cup of coffee if you win you get two cups of coffee and the probability of winning is on your side before you even start.
I think this kind of scenario can play out for anyone, especially in trading as we get to set the overall parameters of any trade we take. Think about this for a moment, if you are a very risk-averse person then only take trades that have a better than 3 to 1 reward to risk setup and only trade 1 share. If you were to do this, soon you would gain enough confidence to do 2 shares and then 4 shares and then so on. This is how the game should be played and this is the second key to being happy with whatever happens in the trade, not only do we have to use small amounts to start but we also need to ensure that we are only taking opportunities that will give us the right reward to risk ratio. If we do this and we have a grasp of how the math and the probabilities work out in the long run then we can be happy if the trade goes in our favor or against us.
So, to recap, to ensure happiness we need to have ultra-conservative position sizing so that even if we lose we live to fight another day and we don’t get emotional about the actual loss and we also need to understand our starting position and how far ahead we are putting ourselves, essentially understanding our edge, from the outset and understanding that if we put ourselves in that position enough times we will have no choice but to come out a winner in the long run.
These two ways of making ourselves happy regardless of the outcome of any one trade will make trading less stressful if one is truly able to buy into these concepts and one puts this into actual practice. Give these two concepts some thought to gain understanding and then test this out in your paper trading account and you will see it in action.
These are two ways we can make ourselves happy before getting into the trade and in the next few blog posts we will talk about how to make ourselves happy after we are in the trade.
Have a great day and a great holiday,