How Cheating Makes You a Better Trader

Boris Schlossberg

From BBC.com

“Marissa Sharif, an assistant professor of marketing at The Wharton School at the University of Pennsylvania believes that cheating can help you reach your goals.

An all-or-nothing approach to goals is all wrong, Sharif’s research suggests. She says we should instead be building ‘emergency reserves’ into our goal-setting process.

In one field study, 273 people used a smartphone app to count their steps for a month. The first group was asked to reach an individualized specific step goal, for example, 7,000 or 10,000 steps per day, seven days a week. A second group needed to hit their goal on five days or more. A third group targeted their steps over seven days, but with two ‘emergency skip days’ per week (that didn’t roll over). A fourth group’s skip days were spread across the month.
The people who were allowed cheat days reached their step goal more days per week on average than those without them. They also took more steps on average.

Sharif says this type of cheating works in two ways. First, people resist using up their reserves, in case they’re needed later. They also feel bad about wasting them in a non-emergency scenario. Second, if you do need to use your ‘cheat,’ you feel less guilty about falling off the wagon in the first place and are thus less likely to give up on the overall goal, she adds.

This ‘cheating’ mindset helps people to keep sight of their longer-term vision, says Leena Rinne, productivity expert at US consultancy FranklinCovey. “While goals are initiated by making a choice to achieve something, it’s the choices in the moment that get you there. And, one of those choices is to allow yourself some ‘emergency reserves’.”

This week I ran an interesting poll on my Twitter page which collected nearly 400 answers. I asked, “For traders what’s worse -- being impatient with wins or impatient with losses?” The responses were almost split down the middle with the latter just edging out the former by 53% to 47% and I’ve got to say that I strongly agree with the majority in this case. It’s worse to be impatient with your losses and the reason has a lot to do with Ms. Sharif’s research.

First of all, I think we can all agree that being impatient with your wins or losses is bad. But that’s really not the point. We are not trying to achieve an ideal. We are trying to find practical ways to generate profit as real flawed human beings. And if that’s our goal then letting your losses run to their stops is actually better than cutting them short.

The reason, of course, is that the more we cut our losses short, the more losses we will have. Only someone who has never traded in the markets is under the illusion that having tiny stops and large targets is the way to trading riches. If you have a 10 pip stop and a 100 pip target your chance of losing is 95% or more. You chance of winning is about as good as lotto. Markets simply don’t give you money for nothing. Prices ebb and flow all day -- FX dealers do their best to make sure of that because that’s how they make their money. Add on top of that the general randomness of newsflow and your chances of timing a 10/100 trade are virtually nil. Maybe you’ll get lucky for the first few times but eventually, the market will just grind you out with a thousand paper cuts. Try it for a month and see for yourself.

But cutting losses short is not only bad math, it’s also bad behavior. Remember, what Ms. Sharif’s experiment proves -- if we give ourselves a small reservoir of failure we are much more like to continue our tasks. The single biggest problem with being impatient with your losses is that it will quickly drain the reservoir of failure. In my experience, most traders can only tolerate 3 stops in a row. By the fifth consecutive stop they begin to question the whole enterprise and by seventh most quit.

That’s why if you are going to cheat in trading, it’s much better to do it on the profit side. It’s better to take profits early (even though that is of course not optimal) simply because it will encourage you to stay in the game. And the longer you stay in the game, the better you’ll become at reading the market and the better trader you will be. Being patient with losses will not guarantee profits, but it will buy you time and build the emotional reservoir to persist in your pursuit of trading mastery.

PS -- let me just be perfectly clear. Being patient with losses DOES NOT mean letting losses float indefinitely. It simply means not closing out prematirely before trades hit their stop.