Spray and Pray
When it comes to trading tactics there are only two moves you can make. You can stick to the single entry/single exit strategy or you can do multiple entries into a position until you get a better blended price that helps you turn a profit. I like to call that method “spray and pray”.
Price action by its very essence is probabilistic. It never follows a clear and steady path. That’s why the multiple entry method is so compelling because in theory that is exactly how you should respond to probabilistic opportunities. You can never know the absolute bottom or absolute top of a move so it’s better to spread your bets, to cast your net wide so as to increase the chance of catching the right price for the turn.
As seductive and as rational as that sounds, the multiple entry tactic is a gateway to trading hell not because of the math involved but because of the ever present psychology of the trader. Whether you like it or not, the more you allocate to a position the more attached to it you become. It doesn’t matter whether you are a seasoned hedge fund manager or a rookie trader we are all subject to the sunk cost bias. Sunk cost bias is simply the impulse to avert recognizing losses. It is perhaps the strongest human behavior pattern in behavioral economics and is primary reason why all classical economic models fail so miserably in predicting outcomes.
This week brings the news of Crispin Odey, one of the more colorful and well known UK hedge fund managers who, in the past four months, lost a decade’s worth of profits betting against the Australian dollar. A prime example of sunk cost bias as Mr. Odey becomes the newest poster boy for the “spray and pray” disaster.
Multiple entry tactic is a perfectly valid way to trade. If you are a fully programmatic trader, it may even be superior to the single entry/single exit approach because of the probabilistic nature of the markets. But if you are trading on a discretionary basis you simply cannot use that method no matter how many times you tell yourself that you have it under control. There will come a point when you will pull a stop and the multiple entry strategy will turn into yet another massive average down pile of losses that will end in a margin call. That will always happen. Believe me. That’s why the single biggest reason to never use “spray and pray” is to make sure that you are never in the position of turning the gun on yourself.