Temptation and Greed: Lessons from Sports
Last year we reviewed Dr. Brett Steenbarger's Enhancing Trading Performance, one of our recommended readings. We made the observation that the book should be read by competitors in all fields, not just trading.
It works both ways. Many of the lessons from sports can be applied to trading.
Playing within Yourself
Athletes often mention the idea of playing within yourself. It means not over-swinging at golf, as Harry Vardon, for whom the PGA scoring average trophy is named, always did. Golfers and traders should both check out the quotation on Jon Leland's excellent golf blog.
Harold Reynolds, a great base-stealer and fielder, writes about how he learned to play effectively. He looked at the giants of the game at his position, second base, and came to the following conclusion:
When I was able to reduce them from the giants they were in my head, to
the same size of the man I saw in the mirror, the vision came alive.
They all had a special skill that stood out amongst the group, but once
I set that skill aside, it cleared my vision and I realized not only
were we similar in physical stature, but we basically all had a similar
style of play — catch the ball, hit for good average and don't make
mistakes. After assessing the competition, I concluded that if I could
play within myself, which meant catching the ball, putting it in play
and stealing bases, why couldn't I be an All-Star too?
We could find examples from other sports as well.
Why Players "Reach"
Frustration and lack of success are driving forces. Players who are striving to recover make unsound decisions.
Poker Superstar Daniel Negreanu cites this important lesson:
Bad decisions are born from a lack of focus combined with a lack of
confidence. In order to be at your best, you have to separate the past
from the present, and devote 100 percent of your attention to the here
Bringing this back to trading, Dr. Brett's blog has an excellent series on frustration and trading. The following quotation is from the first part, but readers will benefit from reviewing all three parts.
When a trader emotionally accepts losing as part of the business, loss is not so threatening.
With proper money management, it can be contained and need not pose
more than an annoyance. But if a trader *needs* to make money–perhaps
because of perfectionism, or perhaps because of dire financial
circumstance–then normal loss might be experienced as unusual
frustration. It's the overriding *need* to make money that sets the
trader up for acute frustration.
The Result? A Typical Investor Mistake
David Merkel has a first-rate analysis of an investment scam. He takes a stock that is a likely pump-and-dump candidate and carefully shows how an investor can be taken in by touts. Every individual investor should read this article carefully and be prepared to ask similar questions.
The only thing we might add to David's article is a comment about "why". We know that these schemes work, if only because companies are paid to circulate this "research." People listen because they are trying to hit home runs or drive the ball 300 yards.
The Investor Lesson
Our own education on this subject came about ten years ago. One of our most valued investors asked us to design a program to complement our sector rotation strategy. This caused us to review our methods and record over the prior ten years. While we had done well, there was a major opportunity for improvement. We discovered these two key things:
- Many clients wanted instant winners and home runs. We obliged with our best shots. These speculative plays, as one might expect, had highly variable results with some big losses.
- The "basic strategy" of finding strong themes and more modest valuation advantages actually performed better, and with much less risk.
The request from the investor led to the development of our most successful program. An important element is the definition of the goal — a double in three years. This is a compound growth rate of 24%. It is an aggressive target, but not the stuff of the heady 1999-2000 era.
Do we achieve the target? Of course not, but we get nearly half of it. Reaching for more actually generates a lower return. It is an important lesson.
Investors swinging for the fences should expect plenty of strikeouts!