Rationalize This!

Boris Schlossberg

One of the best articles I’ve seen this week comes from Motley Fool. It’s called Why You Never Learn From Your Investment Mistakes and I going to quote from it liberally because I think its one of the most important issues for us as traders to understand.

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“You’re a monkey. It all comes down to that. You are a slightly clever, pants-wearing primate. If you forget that you’re nothing more than a monkey who has been fashioned by eons on the plains, being chased by tigers, you shouldn’t invest. You have to be aware of how your own psychology affects what you do.

Take one of the most powerful theories in behavior psychology: cognitive dissonance. It’s the term psychologists use for the uncomfortable feeling you get when having two conflicting thoughts at the same time. “Smoking is bad for me. I’m going to go smoke.” That’s cognitive dissonance.

We hate cognitive dissonance, and jump through hoops to reduce it. The easiest way to reduce it is to engage in mental gymnastics that justifies behavior we know is wrong. “I had a stressful day and I deserve a cigarette.” Now you can smoke guilt-free. Problem solved.
Humans are one of the only creatures that engage in this self-deluding behavior. In their excellent book Mistakes Were Made (But Not By Me), Carol Tavris and Elliot Aronson write:

A dog may appear contrite for having been caught peeing on the carpet, but she will not try to think up justifications for her misbehavior. Humans think; and because we think, dissonance theory demonstrated that our behavior transcends the effects of rewards and punishment and often contradicts them.”

One of my favorite movie lines of all time comes from Big Chill. Jeff Golblum and Kevin Kline as peeing in a Michigan forest and Goldblum says, “Don’t knock rationalization. Where would we be without it? I don’t know anyone who’d get through the day without two or three juicy rationalizations. They’re more important than sex. Have you ever gone a week without a rationalization?”

Traders are some of the most prolific rationalizers I know. In a world where so much of what happens to you is outside of your control, the urge to rationalize your actions is especially strong. But the Motley Fool article goes on to say that successful traders don’t rationalize They analyze what they did wrong and try to correct it. Yet this can also be a terrible trap. Sometimes you did nothing wrong. Just because three trades in a row missed your target by a pip, does not necessarily mean that you must change your strategy. One of the of the hardest things to do in trading is to budget for losses. because we simply can’t accept losing and will try to do anything in our power to rationalize it away even it means quitting on what may ultimately prove to be a winning strategy.