Being eager to be proven right, we find it emotionally difficult to adjust the new reality of having been proven wrong. While we invested our funds in the market, we invested our ego in the trade.
Keep that thought aside for a moment and let’s play with another one. Markets are a place where what is commonly believed is already in the price. It is difficult to make money in markets doing what everybody else is doing or thinking. Getting the two ideas together, we get that eagerness to be proven right is likely not the way to make money in the market. It’s kind of a full stop here to the thought experiment because there does not seem to be any alternative. Entering trades eager to be proven wrong sounds like a non-starter.
We want to be proven right in every other sphere of life, so it is difficult to have our mental framework make an exception just for the markets. Moreover, the very thought of being wrong stops us from action. We would not put trades if we expected ourselves to be wrong. Sort of there is ‘destruction in the seed of creation’ paradox here.
However, there is an interesting example of George Soros. His underlying philosophical belief and the corresponding mental framework arising out of it is that he is wrong; everybody is wrong; the entire market is wrong. That markets are a derivative of ground reality and prices are set by public perception of that ever-shifting underlying reality. But instead of getting into critical analysis of that mental framework, let’s explore actions that emanate from that belief.
If I believe that am wrong and so is everybody else, the sting of mental stigma is taken out of being proven wrong. Instead of trying to be more right, the focus shifts to being less wrong. Less wrong not in terms of frequency because the belief is that we are wrong all the time. But less wrong in the sense of losing less in terms of amount. It might seem like a convoluted way of arriving at the age old ‘keep your losses small’ adage. But the change in mental framework makes you significantly more comfortable emotionally about being wrong. No wonder Stanley Druckenmiller has described Soros as ‘the best loss taker’ he has ever seen.
All market players crave asymmetry in the form of more upside than downside. Investors try to attain it through valuation where market valuation is lower than intrinsic one with underlying assumption of reversion to mean over time. Traders try to attain it through price-based set ups which provide a greater upside and a set limited downside. But for somebody like Soros who is very good at taking losses, the asymmetry moves from being outside to internal. One’s very personality becomes an edge which can mean success in markets even in absence of any external edge in terms of fundamental or technical analysis. For somebody really good at taking losses, even coin flipping could be a profitable strategy. Same security, same price – heads I go long, tails I short.
