Do Not Trade Stock in the Red Zone
"Happy families are all alike; every unhappy family is unhappy in its own way." So begins Tolstoy's Anna Karenina. Similarly, successful stock traders avoid making self-destructive stock investing decisions. The specifics are idiosyncratic; the general lesson is to constrain the lizard brain that lurks within each of us.
All of the tips I've suggested can be understood as efforts to get control back to the investors' rational side and away from that lizard brain. While the lizard brain is great for lizard-like activities like finding food and shade, in financial or stock market, our instincts are the enemy.
My friend David the oil trader has learned how to avoid such mistakes on his way to a lucrative stock trading career. In Chapter 4 we heard one of David's secrets is that "he knows when the buying is real." I learned another of David's secrets one day in the 1980s. In order to profit from an anticipated rise in oil, I bought a single oil futures contract, which represented 1,000 barrels of oil. For every penny's rise in the price of oil, I stood to make $10.
Almost immediately after my purchase, however, the price of oil started to decline. My losses began to mount: $10, $30, $70, and more. This wasn't any fun at all. Furthermore, because I was a student, these amounts became a significant portion of my net worth at the time. I took the pain of my losing position for about 30 minutes, by which time the loss exceeded $200.1 turned to David and said, "I've got to get out." He said, "I got you out a long time ago, I just wanted to see how much pain you could stand."
Over the years I've learned that David almost always exits his losing positions very quickly—just as he got me out of my trade almost immediately. He'd rather take a quick and small loss instead of letting the position eat away at him financially and emotionally. He summarizes his philosophy by saying, "I don't trade in the red zone." By that he means that losing trades (those in the red zone) are exited very quickly, while he's willing to ride his profits (trades that are in the black) for much longer.
Don't trade in the red zone.
While David interprets this strategy literally to exit losing positions, I interpret it more broadly. I suggest that people not trade in the emotional red zone. What's the definition of a psychologically defined zone? The answer can be drawn from the legal efforts to restrain. In the 1964 Supreme Court case Jacobellis v. Ohio , Justice Potter Stewart wrote that, he could not define, but stated "I know it when I see it."
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bond stock ~ futuresSimilarly, there is no objective definition of the emotional red zone, but I think we know it when it happens to us. If an investment is eating away at us, we should consider exiting. (Such considerations should, of course, be done in an unemotional manner.) "Use the Force, Luke. Let go." The spirit of Obi Wan Kenobi suggests that Luke will know the right answer himself. Similarly, the specifics of avoiding the red zone are different for each person. The result, however, should be the same for all.
An investor who avoids the red zone, should, for example, be able to (i) go on vacation for weeks and not look at the stock market, (ii) increase or decrease any position, (iii) take large price changes in all stock markets without having to buy or sell anything, and (iv) sleep without thinking about stock investing.
Those who can develop such a no-red-zone system can never be forced by their emotions nor by stock market dynamics to make a decision. The first step to making money is not "plastics" but to avoid letting the lizard brain make emotional and costly investment decisions. This is not easy because, like Michael Jordan, the lizard brain can't be stopped, "just contained." Those who contain the lizard brain will have taken the first step toward profiting from mean stock market.
