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Try to avoid bias in your trading

30 March 2021

I've spent a lot of time trying to focus on the psychological aspect of trading in the past year. Trading is mostly about psychology at the end of the day. Your method, risk management and money management are all vitally important, but how you tie it all together with positive psychology is ultimately what determines your level of success as a trader.

In this write-up, I'm going to discuss how important it is to avoid "bias" in your trading. It's important to keep an open mind in how you see the market.

"You need to trade what you see, not what you think should be happening or what you 'want' the market to do".

The market doesn't care what you want it to do. You need to be adaptable, open-minded and trade in accordance with what the market is doing. I'll discuss my own personal challenge with overcoming bias and how it has helped my trading in the past year.

Those who have followed my work for a long time will remember that in recent years I have quite often traded option structures that had a bearish slant to them. I did these on my TradersCorner TV show and for my own account regularly. My favourite structure was to trade put spreads. Basically I would buy a slightly out the money put, then sell a deeper out the money put and then also sell a very far out the money put.

This meant that I would have participation on the downside if the market should fall, but I had a defined premium payment that I would lose if the market went higher. The risk to reward ratios on these setups were often pretty good. In many cases better than 1:6. And the fact that the loss if the market went higher was very clearly defined gave me comfort that I'd be fine if the market squeezed higher.

The trouble with these structures was that I'd need to run them to expiry to get the full benefit if they were to work. I'd usually need the market to fall by 10% or 15% at the expiry date of the structure to get the full benefit. If the market fell into my "sweet spot" during the time I was holding the options, but it was too early before the expiration of the structure, I wouldn't get the benefit and couldn't get out early. I needed to get the DIRECTION and the TIME right with these structures. So holding to expiry was really the only way to get the benefit.

I saw many of these structures trade into the money and out the money and then end worthless over the years. Occasionally they would work out nicely, but for the most part they expired worthless and I lost my small premium, so it was no major problem. Ironically the last time I traded one of those structures was a time when it worked out very well. It was in March 2020. I had a Put spread structure on the S&P500 and I managed to get the maximum benefit out of the structure as the market was very weak into that period.

I haven't traded another one of those structures since then. You might ask yourself why not given that the last one was a success.

The reason is firstly, that having those structures on locked me in for a period (I had to hold to expiry for a chance to get the full benefit). Secondly they created a BIAS in my market view. Knowing that I'd have a big payday if the market traded lower meant that I "wanted" it to trade lower.

This bias worked against me as it meant that I wasn't approaching the market from a neutral perspective. As I said before, the market doesn't care what you "want" it to do. It will do whatever it's going to do.

Not having a neutral mind set for the time when I had those options on would cloud my judgement and make me lean towards a bearish bias.

So I made a conscious decision to go back to just trading directionally based off technical patterns as I see them. Trading directionally meant that I could get in and out as I needed to and I didn't have to hold a position for an entire quarter to see the benefit as I did with those option structures.

I have found this to be tremendously beneficial to my trading since then. I no longer have any BIAS. I look at the market from a neutral perspective and trade what I see. I can go long or short as I see fit, and I know that I can get out and change my position if the market dictates that I should do so.

This is equivalent to having the mental flexibility of a jet ski vs a super yacht. The jet ski can turn on a dime. The super yacht can't. Having mental flexibility and avoiding BIAS in your trading is really important.

Trade what you see, not what you want to see.

Adopting this level of flexibility has been tremendously beneficial to my trading and my psychology over the past year.

I'm glad I have managed to remove that BIAS from my trading and I can look back and see how detrimental it was to my results in recent years.

(Note: I do feel that options have a place in trading. They're useful for hedging. They can also be useful in directional trading. I just feel that I was using them in the wrong way and it was creating a bias in my market view which was not helpful. The lesson to remove the bias from my trading has been valuable and my results have improved dramatically)


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