One of the eternal challenge for traders is learning from their mistakes. Not only do mistakes made in the financial markets imply actual capital losses they also imply a hit to the trader’s ego. That is why so many novice traders have a hard time taking losses. They let losses grow ever larger in the hope the stock will return to breakeven. The most common prescription for this problem is the diligent use of stop-loss orders.
It might help traders to think about their trades, both individually and by strategy, as an ongoing series of experiments. The hypothesis being that a stock will go up (or down) over some specified period of time. The criteria for failure being a stop loss order being hit. If trades are thought of in this light it might very well help accelerate a trader’s learning process.
An interesting application of this experimentation mindset appears in a WSJ article by Katy McLaughlin talking about the rise of so-called ‘pop up restaurants.’ That is temporary restaurants used to test out new concepts, menus or markets. The point being restauranteurs can test over a limited amount of time and budget various hypotheses on cuisine. She writes:
Pop-up restaurants—temporary eateries that set up shop for a few days, weeks or months in spaces such as hotel lobbies or other restaurants that close for the night—are morphing into a multipurpose tool, used by different strata of the restaurant industry to test concepts, market new brands, engage with a younger audience, or prove to landlords, lenders and investors that they are worth the risk.
This sort of approach closely resembles the themes laid about Tim Harford in his excellent book, Adapt: Why Success Starts With Failure. In it he provides examples of organizations that have systematically set up their operations to take advantage of ongoing experiments. These experiments are often limited in scope (and risk) in the hope they will provide valuable feedback and information. From an NPR interview with Harford:
Harford says that stock-market investors, for example, will engage in the same type of activity — chasing losses, doubling down — in hopes of being able to exit the game without having to admit to any errors. That, says Harford, is not good for business.
“If the whole process of learning from failure means discarding stuff that’s not working, but in fact, our natural reaction is to keep going, to throw more money behind it, to throw more emotional energy behind it … that’s a real problem,” he says.
But it’s a problem that some companies are surpassing by embracing the concept of trial and error, he says. And their businesses are improving as a result.
We note in our forthcoming book how traders who have mastered a particular strategy can expand their repertoire by trying out, in a controlled fashion, other strategies. It may not mean trading a different strategy, but another market with the same strategy. If trading is structured in a way that is risk-controlled and promotes learning then it can help smooth out drawdowns.
The challenge is avoid jumping from one hot strategy to another in hope of catching a wave. This trial-and-error process can only work if it done is a systematic fashion. Pop-up trading may be a too-cute name, but the idea behind it is worth embracing for traders looking for additional challenges.