Janice Dorn, MD, PhD
Neuropsychological Trading Coach
Janice Dorn, M.D., Ph.D., has been a full-time futures trader since 1994. Doctor Janice holds an M.D. in psychiatry and is board-certified by the American Board of Psychiatry and Neurology in general psychiatry and addiction psychiatry. She holds a Ph.D. in brain anatomy. A graduate of Coach University, she is a pioneer market psychiatrist and financial neurobehaviorist. Doctor Janice has written over 500 articles on the financial markets and coached over 600 traders worldwide. She is the Global Risk Strategist for Ingenieux Wealth Management Group, Sydney, Australia.
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The best place to live on this curve is the spot where you can deal with the emotional aspect of equity drawdown required to get the maximum return. How much heat can you stand? Money management is a thermostat—a control system for risk that keeps your trading within the comfort zone…Gibbons Burke
The conflict that traders experience each time they put monies into the market is to balance risk and expectation. The real conflict has to do with calculated risk. Do you bet $100 to make $100 or do you bet $100 to make $500?
Everything is risky, and risk is everything. The most successful traders know that they are one trade away from ruin, and focus constantly on ways to embrace risk by managing it.
Many traders will try to “hedge” themselves against their exposure by attempting to do things, such as exotic hedging strategies, with which they are not familiar. One example of this is the options seller who becomes enticed with the idea of bringing monies into his portfolio by picking up premium. If this individual is selling naked options, he is trading off the certainty of adding monies to his portfolio with the very real possibility of unlimited loss. He might have some initial success where everything looks great. (It always does when monies come into a portfolio.) However, the risk of ruin looms in a big way, and it is only a matter of time until that trader is slammed. Instantly, option premium monies disappear from his portfolio, and all that's left is the trader feeling like he was picking up quarters on a railroad track, until one day, he stooped over to pick up one more and the train ran over him.
Traders who engage in risky business, such as selling naked options, must be ever-mindful of the risk for ruin, because it is always there. If something in the markets seems too good to be true, it likely is. Unfortunately, the gullible and untrained are preyed upon by the hypesters, the shysters, the criminals and the crooks who send message after message into your rat brain that everything is just fine. These predators know your weaknesses, and they prey on them through outrageous offers of instant riches and fancy talk that makes them sound credible.
One great thing about John Lansing’s commentary at www.trending123.com is that you always know what he sees and how he feels about it. In the nightly updates, John tells you about the chart analysis. John holds your hand in the live trading room and does what he can to keep you out of trouble. In book chat, John educates you about the basis for much of his analysis. John also never hides the way he feels and is acutely aware that analysis has limitations. That one reason I am writing this series about risk. It is time for every one of you to take a hard look at what you are doing and thinking about your hard-earned money when you put it into the markets—i.e., at risk.
The Oxford Dictionary defines risk as “hazard, danger, and exposure to mischance or peril.” My favorite definition of risk is "the intersection of opportunity and danger." In markets, risk is often equated with variability of return from investments or trades. As an example, most people believe that investing in government bonds with fixed, guaranteed annual rates of return is much less risky than investing in a biotech startup company or a volatile tech stock. In the final analysis, traders are weighing risk constantly and asking themselves the type of questions posed in the introductory paragraph of this article.
It boils down to this: How can I make the most money with the least risk? It is this simple question (with a not-so-simple answer) that traders and investors ponder every day, and that must be in the back of your mind every time you put your hard-earned monies at risk in the markets.
In light of this, we must be constantly mindful of the fact that risk is about the future. We are dealing with uncertainty, and we don’t know what we don’t know. Human beings as a group tend to be uncomfortable with uncertainty, and this is nowhere better reflected than in the markets. The oft-repeated mantra, “The markets don’t like uncertainty,” is nothing more than a reflection of the psychology of the tens of millions who are trading and investing in an open, adaptive, complex system and constantly trying to turn something uncertain into something certain. There is never certainty, and thus the challenge is to expect the best and prepare for the worst. In the final analysis, markets are about psychology, and trading and investing are 100% psychological and neuropsychological.
In fact, some of the most incredible descriptions and solutions to the whole topic of risk-taking in the markets have come from the study of psychology. These descriptions are being translated into real-time imaging studies of the human brain. In the not-too-distant future, we will be able to actually visualize what goes on inside the brain of a trader or investor in the process of making financial decisions. Earlier this year, we saw the first demonstration of functional neuromagnetic resonance imaging (fMRI) of the human brain applied to the common trader error of cutting winners and letting losses run. This concept, first conceptualized under the broad rubric called Prospect Theory, was the basis for the Nobel Prize in Economics awarded in 2002 to Daniel Kahneman. Kahneman and his colleague Amos Tversky (who died before the Nobel Prize was awarded) showed that people are risk averse in the realm of profits and risk-taking in the realm of losses. This is just another way of saying that we sell winners too soon and hold losers too long.
I will write much more about Prospect Theory and its ramifications in future episodes of Exquisite Risk. For now, here is a real decision matrix for you to ponder:
Which of the following do you prefer?
- A gamble with an 80% chance to win $4,000 and a 20% chance to win nothing; or
- A sure gain of $3,000.
Which of the following do you prefer?
- A gamble with an 80% chance to lose $4,000 and a 20% chance to lose nothing; or
- A sure loss of $3,000.
I look forward to hearing your answers, so please feel free to write to me or post on the Trading Wisdom Message Board.
When I started writing, I thought if I proved X was a stupid thing to do that people would stop doing X. I was wrong…Bill James
Until Next Time,
Good Trading and Brain On!
Janice Dorn, M.D., Ph.D.
janice@thetradingdoctor.com
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