Editors' pick: Originally published April 14.
I have met your nemesis, and it is ego.
Don't take offense. Ego is my nemesis as well. It's the nemesis of every trader out there. It's the nemesis of every institutional manager and is at the heart of every spectacular portfolio implosion in history, from the Dutch Tulip Bubble, to Long Term Capital Management, to MF Global. So, hey, we're in good company.
As humans, we have a psychological need to be right about a decision. It is immensely satisfying to look an adversary in the eye and be able to say, "I was right, you were wrong. Now live with your stupidity!" It's childish, but immensely satisfying nonetheless. It's how ego feeds.
It's when we feed this need to be right instead of managing our risk that we experience divine retribution. In a twist on Longfellow, whom the gods would destroy, they first make proud.
I don't care if you're managing $10,000 or $10 billion, think back to the worst trades that you've made. I'm talking about those trades you don't like to think about, those trades where you risked too much, or where you refused to liquidate a losing position and then let it get away from you. I guarantee that you were absolutely convinced you were "right" about the trade and let it go on far past where it should.
At Maverick Trading, the prop firm where I'm a trader, we have a saying coined by our head of coaching: "I'd rather be profitable than right." What he's saying is that it doesn't matter if you're right or wrong on this one trade here, or that trade over there. What matters is total portfolio profitability. Not necessarily profitability today, but profitability this month, this quarter, this year.
About a month ago, I was speaking with a trader who was interested in trading with us. The S&P 500 was trying to break through 2000 and he was convinced that it was going to roll over and head back down, and he told me he was getting short right then and there. I had to tell him to stop. Then I told him that his opinion was his opinion; it wasn't the market. I told him that if he was convinced things were headed south that he should sell short the two weakest sectors but be long the two strongest as well.
There's nothing wrong with being neutral until the market makes a decision. Once it confirmed, then feel free to get more aggressive to one side or the other. When you allocate your portfolio on a gut call without confirmation, it's not a trade, it's a gamble.
When you can keep your focus on total portfolio profitability instead of being right or wrong on a trade, you know you're developing the mindset to trade professionally. You don't focus on being all long or all short. You don't bet the farm on a single trade. You never put yourself in a position to take a catastrophic loss. In effect, you grind it out, singles and doubles, week in, week out. You let statistics work for you, you manage your risk and you collect your profits.
We all have our biases. We all have our ideas about where the market is going, otherwise we wouldn't be trading. For the record, I think the S&P 500 will end the year up 15% from last year with a lot of teeth gnashing between now and then. Am I going to bet the farm on it? no. Am I going to make statistically intelligent trades, manage my risk, and move on? Yes. To quote another Maverick Trading maxim, you need to trade the market in front of you, not the one you want it to be.
When you can separate opinion from action, then you can begin to trade professionally. When you can trade the market as it is rather than how you want it to be, then you're ready. When you can take the small loss and move on rather than hold on to a loser to simply feed your ego, then you're on the road to success.
You will never vanquish your nemesis, ego, but you will be able to keep it at bay. Is the recent action a true breakout or a blow-off? Time will tell, but I'm waiting for confirmation either way. Feeding ego may feel good, but humility pays the bills.
This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.