Trader Trait #3: Anchoring On The Price Paid
At one point or another, almost all of us have been reluctant to sell a sorely depressed holding; CME Group, CBOT or CBOE seats; piece of real estate; or “insert your worst dashed hope here.” It hurts less to tell ourselves that we’ll wait until it’s at least returned to break-even. For no logical reason, we’ve anchored on the price at which we purchased an investment and have let that affect our decisions on whether to hold or sell.
First, this precludes the very real possibility that recovery may never occur; the losses may grow worse. More importantly, it ignores the reality that past prices paid are irrelevant to either current prices or the fundamental value.
Anchoring occurs in our trading activities (and in our personal lives for that matter). But, there, each transaction is considered independently. In investing, anchoring is magnified, because the individual occurrences impact the total portfolio, which is designed to be greater than the sum of its parts. Harry Markowitz was awarded a 1990 Nobel prize for his work on portfolio theory, in which he observed as early as the 1950s: “It seemed obvious that investors are concerned with risk and return, and that these should be measured for the portfolio as a whole.”2 He and countless of his colleagues have expanded on the theme ever since, further strengthening the wisdom of adopting a portfolio- wide rather than a transaction-based perspective to wealth accumulation and preservation.
In the context of portfolio management, the healthy question for an underperforming holding is not, “Will I ever make my money back on this?” but rather, the objective assessment: “Is this holding still appropriate for me today within my total portfolio?” If it is, consider it part of the “cost” of achieving your greater end goals and stay the course with it. If it’s not, chances are good there are better things you can do with the dollars elsewhere in your portfolio. Realizing the loss and reallocating the remaining funds may be the best thing you can do for your continued efforts. Either way, the decision becomes lighter when you remove the moot burden of anchoring.
Trader Trait #4: Projecting Recent Trends Indefinitely
As traders, our jobs require us to become skilled at using leverage to our advantage. While keeping a sharp eye on our positions, strategies and technological tools, the bold trader often will take an increasingly aggressive stance, calculating that what goes up … might go up some more. In trading, adept projecting can be sensible and rewarding. But for wealth preservation, it becomes one of those frictions we mentioned, which detracts from rather than contributes to maintaining your appropriate risk/reward profile.
For the best chance to achieve desired outcomes, wise investors avoid projections and their ultimately random outcomes, and simply maintain particular asset allocations in their portfolios, in strict accordance with their personal goals and risk tolerances. The focus is again on the marginal utility of the wealth, i.e., not whether additional wealth might be achieved, but whether it needs to be, to achieve or preserve the lifestyle you desire.
Trader Trait #5: Extrapolating From Small Samples and Intuitions
As traders, we can and must live by the motto, “What have you done for me lately?” If we can back-test a few months of data and detect a plausible trading strategy, we’re likely to create a system to enact it. It’s hardly an exact science; sometimes intuition alone is our guide. But a determined trader can often make a good living by dedicating small amounts of capital to being right enough, often enough. Through small samples and intuition, small amounts can yield substantial earnings.
As investors of those substantial earnings, the motto changes fast. To echo the sentiments of Warren Buffett in describing his investment strategy: “Our favorite holding period is forever.”3 When investing our personal wealth, we seek to minimize that same short-term “noise” we’ve depended upon within our trading accounts, and instead capture markets’ long-term expected growth. According to a recent Dimensional Fund Advisors article, research has indicated that, “it takes 26 years of data before we can say the equity premium is reliably different than zero,”4 i.e., that stocks are expected to outperform risk-free investments over time. For other styles and strategies such as value or size, the statistics indicate it may take even longer.
As a trader, you reap rewards from small samples, short periods and educated guesses. As an investor you should be prepared to sit tight, like Buffett — not just for months but for many numbers of years — without second-guessing your carefully planned Investment Policy Statement (which you create as your long-term guide). These are the tactics for sustaining or accumulating durable wealth according to sound portfolio theory.
Trader Trait #6: Chasing Hot Streaks
Related to projecting and extrapolations, there may be nothing more exhilarating for a trader than when we’ve hit a hot streak. Even though logic dictates otherwise, like flipping 12 heads in a row on a fair coin toss, we feel that odds favor heads on our next toss too. We may even venture trades in a new market based on our rewarding run in another. If we’re doing so well trading interest rates, we tell ourselves, why not try equities?
In our lightning-fast trading world, we probably all know someone who’s done well chasing hot streaks; we’ve probably experienced it ourselves. Logical or not, perhaps it’s part of our make-up. Which is fine … until we bring it into our personal lives. We may become overly dependent on hot streaks to live beyond our means instead of appreciating that it’s been an uncommonly good year, and reserving a portion of the proceeds in anticipation of the difficult years.
Investing is about smoothing and melding the good times and the bad, so that we can relax and enjoy every aspect of our lives, personal and professional. The goal is to achieve confidence that you have set aside what you need to ensure that your lifestyle can remain intact, no matter how exciting a day it’s been in front of the screen.
2 Harry M. Markowitz, “Foundations of Portfolio Theory, Nobel Lecture, December 7, 1990,” Economic Sciences, 1981-1990.
3 Warren Buffett, “Berkshire Hathaway’s Shareholder Letters,” 1998.
4 Brad Steiman, “What’s the Significance?” Dimensional Fund Advisors,
May 5, 2011.
