The Goldman Sachs Senate Hearings sparked a memory of this piece I wrote back in the Fall of 2006 about the Psychology of Shorting Trades. The fact is “shorting” while an essential part of trading, is not a natural thought process for most people. Trade Well, Dr. Doug

I have spent a number of years of my life immersed in the world of competition. First as a collegiate baseball player, then as clerk on the CME floor, next as a trader at the CBOT, later as an electronic trader off the floor and finally (for the past six years) as a trading coach to top hedge funds and high net worth traders. My Ph.D. in sport psychology has helped me understand how athletes and other competitive individual’s think while my background as a trader has allowed me to see the game from the inside out. As a performance coach to elite traders and athletes, I have learned that there is no point in making something more complicated than it has to be.

Trading is actually a simple game if you look at it logically. At any given moment in time, there are only three things any market can do: move up, move down or move sideways. That leaves us with only three choices to make (buy, sell or do nothing). The market does not know or care what your position is at any given time. It simply is a machine absorbing liquidity from billions of sources at any given moment in time. Realization #1 is you are not special.

Now, let me ask you all, “Why are you trading?” The obvious answer is “To Make Money.” So if that is THE reason, then how come so many traders make trading decisions like they are trying to be “Right?” The purpose of this article is to encourage you to take a step back and think about how you think about trading. More specifically, I want you to think about how you think about Longs and Shorts.

It continually amazes me that traders tend to have a long bias when they look for trades. Rather than looking for the “low hanging fruit” or where the “easy money is,” they are drawn to focusing on trying to make money on the Long side – even when the Short side is what the market is paying. It is as if traders believe that there will be a bonus check given to them if they make their profits “the hard way.” Some of the questions I have explored with my clients are as follows:
• Why do traders feel more comfortable going Long than selling Short?
• Why do traders tend to look for reasons to get Long, rather than just following the money, especially during bear markets?
• Why do traders view selling Short as a “hedging strategy” rather than an alpha generator?
• Why do traders tend to exit Short positions quicker than they do their Long positions?
• What factors contribute to making it so difficult to change a trader’s perspective?
• And, most importantly, what strategies can I coach a trader to use in order to gain objectivity in their decision making and achieve consistent, profitable results?

To address these questions, I have identified 6 Mental Barriers as well as solutions a trader can implement to achieve their performance potential.

Sampling Bias
As we all know, the market has historically gone up over time. While there may be periods of downward movement, we tend to think of the market in a bigger picture. On smaller time frames (minutes, hours, days, or weeks), this is problematic as it gives a false read on what the true current trend is. Remember, as traders, you are not investors. This means that it is very possible to be wrong in the short term even if you may prove to be right in the long term picture. So what happens when a trader gets stuck in Long position that is going against him? He refers to his sampling bias and says to himself, “Well if I hold it long enough, it will come back.” Again, in the bigger picture (as an investor) the trader may be right (because the market has historically shown that it goes up over time); however, as a trader, this type of thinking causes him to hold onto a losing Long trade sapping him of emotional capital as well as opportunity cost as he hopes, wishes and prays for the market to eventually go up. The solution is H + W + P = E. Hoping + Wishing + Praying = Exit the Trade because, in the end, taking the loss will allow you to clear your head and get back in the game.

Consumer Mindset
Have you ever walked into a store, taken something out of your pocket and sold it to the person behind the counter? Most of us have never done or even thought of doing this. Throughout our lives, we have been conditioned to be consumers. We buy things. Even when we sell something, it is something we bought previously from somewhere else. In real life, we don’t create things from thin air – even if it is something we built on our own, we purchased or found the materials from somewhere else. The point is we never sell something we don’t own in the first place. In fact, when we hear about people in society selling services they don’t own or fail to deliver, we call them deceitful and charge them with crimes. The bottom line is buying (going Long) comes natural to us because we are conditioned to be consumers. It is a socially accepted behavior and when we trade the markets, initiating Long positions feels more comfortable. As humans, we prefer to experience comfort, which is why most traders tend to look for reasons to get Long, rather than sell Short. The solution is to be aware of how you are conditioned to be a consumer and avoid only doing what is most comfortable to do.

Equilibrium
People have been taught to accept some realties of our physical world. Reality #1: What goes up must come down. To test this, please feel free to throw a golf ball in the air and see what happens. Reality #2: What goes down must come back up. To test this, take a football and try to hold it under water. In addition to these applied situations, we must realize that our bodies follow a similar up/down cycle. Think back to your college days when you were pulling an all-nighter to cram for a test. Once the test was over, do you remember taking the time to “catch up” on your sleep? Simply put, the longer you stayed up, the longer you had to sleep to get yourself back to “normal” functioning and equilibrium. As people, we live with these behaviors and accept them as part of our existence, taking them for granted and not paying much attention to them. What traders fail to realize is that how they think and act is directly reflected in how they trade and think about trading. The solution is to use tools like daily journaling (I have my clients follow a clear 18 step process) to gain additional insight into how you think, feel and function in all types of situations so you can improve the quality of your trading decisions.

Rationalizing Ownership
When you buy something it means you own something. Studies have repeatedly shown that, despite the actual real value of something, people tend to value something more, once they take ownership of it. For traders, this ownership takes the form of emotional, intellectual and physical capital invested in the trade. The longer a trader takes to think about a trade before he or she puts it on, the stronger their ownership bond to that trade is likely to be. Unfortunately, this type of emotional thinking causes traders to rationalize Long positions that are moving against them. Compounding this problem is a basic ‘hope’ instinct traders have which causes them to think that as long as they still own a position then it is considered an “unrealized” loss and still has the potential (no matter how unlikely) of making them money. Once they exit the position, this emotional, and sometimes fantasy based, experience disappears and they are left with the harsh reality of failure and financial loss. I have found that people do not like to experience harsh realities, however, as a performance coach, it is my job to tell them what they need to hear rather than what they want to hear (they do enough of that on their own). Traders that rationalize ownership do not succeed. It leads to ego, stubbornness and blow-ups. The solution is to have a clear game plan which outlines the appropriate risk/reward levels before the trade is executed. Fixed stop orders can be used to circumvent the rationalizing instinct which is bound to kick in if the Long position begins not to work. I have found that even the most committed ownership rationalizing trader is able to see clearly and objectively once they are no longer in the trade. Put another way, if your buddy has had a few too many drinks, it may be difficult to get the car keys out of his hand, but it is clearly the right thing to do and he is likely to thank you for it once he sobers up in the morning.

Zero is Bottom
The markets have a clearly defined Zero-value. This has several important implications. First, traders often discount the possibility of something becoming absolutely worthless (i.e. going to zero), so the more the price goes down, the greater the traders’ tendency is to believe that it has a higher probability of going up again; therefore the temptation to catch the bottom and go long becomes compelling (despite its irrationality). Traders must realize that how they are hardwired to think as people is not necessarily the way they should think as a trader. There is a reason why 90% of people who attempt to make a living as a trader end up failing and it is not because of intelligence, information, technology or effort. In a nutshell, I believe failure in trading is because of a lack of self-awareness. The solution is to compartmentalize your thinking. When you are interacting in society or at home, let yourself think like a person; but when you sit down to trade, you need to think objectively by evaluating risk/reward as a trader should.

Emotion-Logic of Longs and Shorts
This final mental barrier shows that Long positions have limited risk and infinite profit; whereas Short positions have limited profit and infinite risk. Seeing this, implies that at any given time, taking a Long position has the potential to be much more lucrative than taking a Short position. While this information may be graphically accurate, the solution is that traders must, once again, think like traders and not like investors or the average person for that matter. As mentioned before, it is very possible to be wrong in the short term and right in the long term. Remember, the market can be wrong longer than you can be solvent.

All in all, the best traders view Long and Short as interchangeable vehicles to make money. Generating profits on one side or the other does not make it any more or less valuable. If you find yourself getting caught up in some of the mental barriers I have outlined above then I encourage you to take a step back for a second to think about how you think about trading by asking yourself one simple question, “Why am I Trading?” If the answer you come up with is “To Make Money,” then how about you make today the day you start the rest of your trading career by focusing on making money instead of trying to be right.

Dr. Doug