I’ve read a few option books.
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Monday, August 20, 2007

The Psychological Need To Be Right vs. Making Money

In my previous post, I picked one simple example from the book Trade Your Way to Financial Freedom by Dr. Van K. Tharp to illustrate that being right does not necessarily mean making money.

Yes, in trading, you can be right most of the time, yet still lose money in the end. On the other hand, you can be wrong most of the time, but still making money over the long run. It depends on “how much” you gain when you’re right & how much you lose when you’re wrong, more than on the “how often” you’re right or wrong.

Basically, “being right” is represented by frequent / majority small gains but with occasional large losses, which results in a losing money overall in the long run.
In contrast, “making money” corresponds to frequent / majority small losses but with occasional large gains, that causes the trader to make money overall in the long run.

Dr. Brett Steenbarger showed that many people prefer “to be right” in the short run to “making money” over the long run. The psychological need “to be right” (frequent wins) inhibits traders to let the profits run or to accept losses.
As he suggested, “the desire for frequent wins causes traders to take profits quickly; the aversion to losing leads to holding losers in hopes of converting them to winners.”

Yes, it’s not easy to overcome the psychological need to be right. Even if one does know that he has a trading system with positive expectancy, which will make money in the long run if he’s consistent, it may not be easy to accept when consecutive, frequent small losses happen in the row. His pride & self-esteem may be hurt. He may also lose his confidence of himself or the system. All this could negatively affect his subsequent trading performance.

This is another good example why trading psychology is important. Professionals even say it’s the most critical aspect of trading success. It’s not the trading system / strategy, market indicators, fundamental / technical analysis, or your outstanding market knowledge that will bring you success in trading. It’s you yourself that matters the most for your trading success.

Related Posts:
* The Real Purpose Of Trading
* The Fear Of Losing Money

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