What Marriage Therapy Can Teach You About the Markets

Boris Schlossberg

Don’t worry. I am not in counseling. My relationship is fine, thank you very much, because my wife and I naturally do two things that all therapists seem to prescribe -- we give each other plenty of space and we accept rather try to change each other’s behavior.

But I am not here to talk about my marriage, instead, I want to discuss Esther Perel’s marriage therapy podcast -- “Where Should We Begin?” which contains a wealth of wisdom for any relationship you have, including the one with the market. You may not have heard of Esther, but she is definitely internet famous with a TED talk that has been seen more than 13 Million times and a best selling book called Mating in Captivity.

Every week Esther does a therapy session with a troubled couple that she then edits into an hour-long podcast. The podcast has the voyeuristic pull of a detective story as she prods and pulls the hidden bits of each person’s background to create complex and fascinating explanations for why we do the things we do.

But mostly the podcast is remarkable for the throwaway pensees that Esther dispenses throughout the show in her Belgian accented English. One of her key ideas is that “You can either be right or you can be married.” which any successfully married person will tell you is eminently true.

In markets, this can be summarized as “You can either be right or you can be profitable.” The more I trade the more I appreciate the absolute truth of that idea. For the longest time, I believed that you needed to trade with large negative risk-reward ratio because you needed to be “right” to win. But as I started to develop systems that move closer and closer to even money bets I realized that being right is hugely overrated.

If you can learn to accept your spouses worst habits your marriage will be much happier. No matter how many “tweaks”, no matter how many “behavioral adjustments”, no matter how many “talks” you have your spouse is unlikely to change. People almost never change their core self and neither do the markets. Capital markets, in fact, are far more efficient and far less pliable than people and that means your opportunity for profit is more limited than you think. I used to always tell traders that you can win big or you can win often, but you can’t win big often. Now I’ve come to accept that your edge can be even slim yet viable. If you can win 55%-60% on even money bets you will be set forever but that means you must be accept losing. A lot. Trades come in streaks and a 55% edge can easily result in 4,5,6, sometimes even 7 losers in a row and still be viable.

Which brings me to my favorite Esther Perel saying -- be reflective, not reactive.

Anyone who knows me for more than a minute knows that I am the embodiment of reactive behavior. There is no debate I won’t join, no argument I won’t start, no fight I won’t jump into at a moments notice. And of course, that behavior spills over into trading all the time. Did I get stopped out? Well, f- that, I am going in again, at double the size because the market is full of morons and doesn’t know what it is doing. Of course, reactivity rarely succeeds.

So today I tried something different. Today was ECB day and after Draghi’s lame attempt to bluster his way through what is clearly a hemorrhaging Eurozone economy, I was convinced the euro should fall. It did initially, but the drop was shallow and I was stopped on the rebound. Pissed, I re-shorted again but price refused to buckle. That’s when I decided to take Esther’s advice to trade reflectively rather than reactively. One of my oldest and truest trading rules is that if funda points one way and price goes the other trust price. Much as it pained me to do so at that moment, I reversed the trades in the late afternoon NY session even though I saw no reason for why the pair should rally. Of course, rally it did, because sellers ran out of orders and dealers were able to squeeze the late shorts for 20 pips into the close. Thank you very much. Acting reflectively beats acting reactively anytime.

As traders we spend all our time looking at some logical construct to beat the market, forgetting that at the core trading is a psychological rather than a logical enterprise. Our relationship with the market is a kind of marriage. In some cases that relationship may be even more durable and more intense than with our spouse. To trade well we all need Esther Perel’s therapy from time to time in order to keep the spark alive.

The Secret Law That Governs The Markets

boris Boris Schlossberg

In one of the best investment columns written this year titled “How to Make Volatility Your B-” Josh Brown goes through the step by step process of dollar cost averaging demonstrating why it is the single greatest investment strategy ever created. Brown shows how consistent and steady buying of an equity index will beat any hedge fund return anywhere, anytime.

The idea is that some of your capital will have massive double digit returns as you scoop up assets at firesale prices and some of your capital will have average returns and some of the capital may even have negative returns as you pay up during market rallies but the overall value of your holdings will almost certainly rise over any 10 year period of time. The only way that this strategy would fail is if stocks slowly but surely drifted to zero over a 10 year period in which case you probably would have much bigger issues to worry about. As long as equities have an upward drift you simply can’t do better as an investor than dollar cost averaging into the index.

The dollar cost averaging strategy of success relies on two factors -- the natural upward drift of equity markets and the much more important idea of the law of large numbers. The law of large numbers simply says that outcomes will almost always reach their expected end, as long as you have enough samples. For example if you flipped a quarter 3 times in a row chances are good that you could get all heads or all tails. In fact 12% of the time that’s exactly what would happen. Does that mean that the coin is rigged? No. It just means your sample size is very small and highly biased. Flip the same coin 1000 times and the probability that heads or tails will fall within a few basis points of 50% are almost assured. Do it 10,000 times and they are practically guaranteed.

The law of large numbers is an amazing principle. It essentially tells you all need to know about how to get rich. Just chop up risk into tiny little pieces and take many ( hundreds or even thousands ) samples of that risk and over time you will be much wealthier than you are now. Of course this little mind experiment assumes that the risk you consider is actually worthy. For example if you dollar cost averaged gold for the past 50 years you would still be worth a lot of money ( if for no other reason that you would own a lot of gold!) but not nearly as much money as if you bought the S&P 500. Still even in that example you can see the power of this principle in action.

That’s why it always amazes me that traders routinely ignore this foundational idea of risk control. In fact I think that the primary reason why most lose money in the market is that they don’t appreciate the power of the law of large numbers. The underlying concept behind the law is that you need to trade SMALL. There is actually some poetic irony in that dynamic. You need to do a lot of trades in order to assure yourself of long term success and the reason you need to trade trade small is precisely because you need to be able to withstand the bad runs that will inevitably occur.

The first thing that I do in order to improve a trader’s performance is to make them trade so small that it seems almost miniscule. Frankly it almost doesn’t matter what system they trade, reducing size has an instant and dramatic impact on performance. They stop panicking and execute the strategies much more effectively. Marry the law of large numbers with a sound trading algorithm and you have nearly a full proof recipe for success.

Don’t believe me. Look at high frequency firms like Virtu that trade millions of shares per day 100 shares at a time and haven’t had losing days in years. As an individual trader you don’t need to mimic the hyperkinetic pace of HFT shops, but you do need to slice risk into tiny increments just like they do. It’s truly unbelievable that the answer to 90% of our trading problems lies in size rather than strategy, yet so few traders take advantage of the key law that governs the markets.