Barry Ritholtz has a great post up today that will make perfect sense to anyone who has been trading for any reasonable period of time. He traces, as he did in his book Bailout Nation, the many ways in which a reluctance to take losses has led to poor outcomes for banks, nations and the global economy. Ritholtz writes:
Seeing how people handle losses is revealing of their character and integrity. Hiding losses is what rogue traders do. Its also what rogue banks do, and apparently, rogue nations…
Until we purge the bad debt from the financial system, we will be stuck with a long and painful de-leveraging.
Please, won’t someone in Washington or Brussels or Tokyo understand the importance of this simple trading rule? Take The Loss already!
Traders are nodding their head in recognition. The only problem is that there is a big difference between traders and politicians. Traders have a limited amount of capital by which they can operate. Taking losses is imperative to maintaining an ability to trade. Despite this demonstrable fact traders find it difficult to keep losses small. Politicians on the other hand, up until now, have had a nearly unlimited pool of capital which they can throw at the problems of the day. Taking losses was always the last option considered.
In another fashion traders and politicians are exactly alike. Neither of them like to be wrong. Admitting you are wrong and minimizing losses is an important step for any trader to master. Michael Martin writes in The Inner Voice of Trading notes why taking losses is so hard:
Smart people don’t like being wrong. You’ve built your whole life on living the life of success. It’s more comfortable because that’s what you’re used to. As a trader, you’d rather stay in a losing position and wait for the market to prove your thesis correct than take one of many consistent small losses. (p. 7)
It goes without saying that politicians like to think they are the smartest guys in the room. Politicians have often spent their entire adult lives getting to the positions they are in. They are therefore likely complicit in the policies have led us to the economic mess we now face. It therefore stands to reason that getting them to admit their mistakes and cut losses short is going to be a monumental task.
Take the loss. (Big Picture)
A guest post from Michael Martin on finding your own “inner trading voice.” (Abnormal Returns)