Variable Soup: Do you have the right ingredients?
I wanted to take a second and talk a little about one of the big issues I see with newer portfolio managers and traders to some extent. The problem is figuring out which variables to take into consideration in their trades. Whether long or short term, I refer to any position as a trade. There is probably a just right out there, but that comes down to your tastes per say. I don’t ever like to overly question someone else’s trading style because if it is working for them, great. There are many ways to win at this game, but they all take a good bit of trial and error to find what combinations to use and which set of them fits with our expectations and personal psyche the best. The issue most find is there are so many variables out there from technical, fundamental, economic, sentiment; trying to choose can leave even the most intelligent person’s head spinning.
Unfortunately, this short post will not give you the answer, but instead a few things to think about along the journey. Basically, my advice is simple; stay away from the extremes and find your recipe including a variety of flavors that suit what you are trying to serve. In this instance, the worst thing you can do is focus too much on 1 variable and get pigeon-holed into a closed view. There are plenty of studies that show we make worse decisions when our options are binary yes or no. Combine that with the unlimited number of variables that could affect any situations and you can see how this could leave a bitter taste in your mouth when it doesn’t work. I hear a lot of this and recognize the pull in the media and especially social media when a certain meme is being passed about. As an investor, you should never let yourself live in a 1 variable world.
Then we have the other extreme which is the chase to take into account every variable out there….and throw in the kitchen sink while you’re at it. This is like the Brunswick stew of the analysis world (I am not a fan of Brunswick stew). Those who attempt this are always chasing down another factor and bringing something else in to worry about. The problem here is, our brains are designed to put more weight on things we are worried about even if there are more factors in our favor. This can skew the analysis the more variables you get in the mix. I have seen traders who go into every trade worried. I agree you should go in with a healthy respect of risk, but I do not think we should be entering every trade expecting to be wrong. This is a delicate balance and one very important to address. If you go into every trade expecting to be wrong, you find yourself setting stops too tight (yes, you do have a stop, but should place it based on chart variables) or capping the potential gains too early. We all get stopped on things and will figure out how to manage risk with our trading plans, but why go into a trade you don’t have conviction in which becomes more of a problem once the number of variables considered gets above a reasonable amount.
So, the answer comes in a lot of practice and trial and error. Variables can come from anywhere, but we can only functionally keep up with a certain number of them and the changes in the relationships between them over time. We have to put the time in over the hot stove testing our variables. We each have different tastes, so the different variables should be suited to those tastes. As long as the taste we are all looking for is the taste of success.
Good Luck and I hope this helps!