Trading Stocks With Perspective – (Looks can be deceiving)
Hopefully you can bear with me on this one because I think it will be helpful.
There is a trail through the woods behind my house that follows a river very closely on one side. Sometimes I get up early in the morning an go for a run in complete darkness…with a headlamp on.
One morning I had two separate incidents that occurred on the exact same run that show how perceptions can be completely incorrect with reality.
This area where I live has a ton of deer. They are everywhere…and they aren’t very smart. As I was running north with the headlamp, I noticed a deer up ahead on the right, about 10 feet off of the trail. As I got closer, he didn’t move. I got closer…still didn’t move. Then I was practically right next to the dumb deer, it felt like I could practically touch it. My headlight lit him up as bright as day and he just stared at me, and didn’t seem too concerned.
He didn’t understand that my light was shining right on him and that I could see him.
From his perspective…he saw me, and the glowing light, but did not understand that the light was shining on him. He just assumed that he was completely hidden, but there was this person with a light, no big deal…completely not getting the concept of the true reality.
“What an idiot”, I thought. “I could have shot him (there are lots of hunters in the area) so easily!” I was amazed at how the deer thought he was completely hidden in the dark and he was just staring at the light, not understanding that he wasn’t in the darkness himself any longer.
After I turned back and started heading south, I saw a light coming towards me in the distance, maybe about a half a mile away. It was waaay to the right.
I thought to myself, “Wow, look at that biker on the road over on the other side of the river.”
I was on one side of the river…on the trail, and there is a narrow road on the other side that the headlight was on.
As I kept running, and the light kept getting closer, I noticed that it was moving more and more to my left. Then I realized I was completely wrong. The light (a bicycle rider with a headlight), was on the exact same trail that I was on! As he was coming towards me and I raised my hand to wave in his blinding headlight and we passed without saying a word to each other.
After this, I thought about how I was completely wrong, this biker was on the same trail, the same side of the river, not on the other side! The river and therefore the trail that I was on, had a much larger turn than I thought. I didn’t realize how sharp the bend was in the darkness.
Then I thought back about the dumb deer that I saw heading north. I was just as dumb as that deer! My perception or reality, just like that dumb deer…was completely off. I was completely wrong about reality.
Your perceptions affect your trading
The two incidents I described on that run are happening all the time. After all, we have to gather information from our 5 senses, interpret them, and then come up with a narration about them.
We can never get rid of finding the absolute truth, but we should at least be aware that our perceptions don’t end up deceiving us. We should try to look at things from different angles
We should try to make sure that the opinions that we have formed make sense and try not to “explain away” anything that doesn’t match our opinions.
We should try to not blindly seek confirmation of our preexisting opinions to make us feel better.
I’m going to make an attempt to share with you some of my thoughts about how our perceptions can affect how we see things and how it can affect our trading.
Stock charts – Linear vs. Logarithmic
Take a look at the chart of IFRX, one is linear, the other is logarithmic:
I drew the trendline, which aligns nicely and touches along three major previous bottoms as the stock has trended up.
Now take a look when I change the settings to a Logarithmic chart and did not touch the trendline…which remained exactly at the prices I had previously used from the Linear setting.
Notice how the trendline isn’t touching in those 3 spots that it did previously on the linear setting.
It is only touching in one area at the very bottom left, and is gapped away at the two other lows, which I circled.
Look at how the current price, the point where we need to decide whether we have reached support or not appears to be much closer to the trendline on the Logarithmic chart than the Linear chart! It certainly can affect how you draw the trendlines if you started with the Logarithmic chart than the Linear chart.
What you see depends on your chart settings.
So which one is “right”? Neither. This is just an example of why it is important to change how you are viewing things…your perception.
Before I move on, here is a brief summary of the differences between linear vs. logarithmic charts…
The linear chart displays prices on the Y-axis (vertically) in FIXED PRICES. The difference between 5 and 10 is the same. The distance between 100 and 105 is the same.
The Logarithmic chart displays prices on the Y-axis (vertically) in FIXED PERCENTAGES. The difference between 5 and 10 is what….100%, right? The difference between 100 and 105 is what….5%, right?
At both points of the chart, the change is 5. But it means a whole heck of a lot more when the price is lower than when it is higher.
That is why on the IFRX charts above, the trendline changed. The stock had a huge move, very early, on the left. As the price moved higher and higher, it changed the scale, where a point move here and there was not as significant and important as it had been before the previous move when the price was lower.
To get a better understanding of the differences and when it might be a good idea to use one over the other, this article on linear vs. logarithmic stock charts is helpful.
Recency Bias: Losing perspective
Recency bias is when you focus on the most recent events (trades) and lose perspective of the bigger picture.
If you’ve had a ton of winners recently, it has been shown that traders tend to stray from their system, brimming with overconfidence.
If you’ve had a ton of losers recently, the tendency is to again stray from your system… boiling over with anger, fear and the desire to “get back to even” by swinging for the fences with irrational trades.
Seeing potential trades while in a rut
We’ve all had times where we are in a rut…seemingly one loser after another. When you are in a losing streak, or have suffered a large drawdown, it is easy to make things go from bad to worse.
I’ve had times in the past where I’ve suffered a long bout of losses and have watch my account dwindle lower and then lost all perspective. What I’ve done a few times when this has happened is actually increase my risk. I’ve tried to gain back all of my losses with a few risky trades, trying to swing for the fences in desperation…trying to get back to where I was.
The right thing to do is to start trading less, or perhaps reducing your trading size until you’ve built your confidence back up. I have noticed that we can lose sight of the bigger picture…the fact that you’ve got a method or system that has worked for a long time, but it is during these dark periods we lose sight of that.
Don’t “revenge trade” by forcing yourself to see something in a potential trade that isn’t really there.
Seeing potential trades when you are on a hot streak
It doesn’t take long feel like you’ve got it all figured out after a hot hand, when you know you’ve “got this” and everything you touch turns to gold. The danger here is to add more risk, increasing your trade size. That is exactly the time when it might be wise to not only keep following your trading plan, but actually reduce your trade size.
I had heard of a trading firm that kept their traders completely in the dark about the position sizing for the trades that they entered. The traders would simply take the trades, and in the background an algorithm, would determine how big the trade would be…how much to risk. It would reduce the trading size as a trader’s win streak increased and increase the trading size when the trader was in a losing streak, with the expectation that each streak would end.
I don’t know how to feel about that…but it is an interesting concept nonetheless.
At least be aware to watch your emotions when you are riding on top of the clouds and try your best to make sure that you aren’t seeing “great trades” that aren’t actually so great.
Confirmation Bias – Searching for reasons to justify your trades
This is a big one in my opinion…where humans have a tendency to find “facts” that allow them to keep and justify their beliefs and theories. Here we are walking a fine line. There is nothing wrong with having beliefs, theories…but we must be careful that we are ignoring other signs that maybe these beliefs or theories could be wrong.
A classic case of this in trading is the use of indicators. There were times when I used so many indicators, that it was comical. Layer upon layers of ribbons were above and below the charts. Doing this is complete overkill.
It gives you a false sense of confidence when you see multiple indicators telling you that you are staring at a great trade. I wrote a post about the dangers of picking indicators from the same group, because they are all telling you the same thing. Be careful not to do this.
There are other ways that confirmation bias can affect your trades…Twitter, Stocktwits, news, essentially….other people’s opinions:
The mind latches onto those opinions that are on your side of the trade and discounts those on the other side of the trade with opposite opinions. You are cherry-picking facts, latching onto things that validate your preexisting beliefs…such as this is a good trade.
And this makes sense, it is human nature. Since the world has so much information, with so much coming at us all the time, it has to filter things out, make assumptions, and pay attention to what is important.
The confirmation bias, might also be called the “yellow car phenomenon“, where if you are thinking about yellow cars, all of a sudden, you will start to notice them more and more. They were there all the time, you just started noticing them.
Multiple Time Frames – See the bigger picture
Before you enter a trade, it is always a good idea to move one time frame above and one time frame below the chart that you trade in.
This way, you gain additional perspective that you might not normally see if you just stick to only one timeframe. Essentially, it is helping you see the forest from the trees.
This was popularized by Dr. Alexander Elder…his Triple Screen Method.
Take a look at what I mean. Check out this chart:
This chart above is not a daily chart however…it is a 5 minute chart of Ford (F).
Now take a look at the weekly chart of Ford below:
This might actually be a peak and actually a time to get out, or potentially short. Right?!
The long term trend for Ford is down. That is a fact. Even if this were going to be a breakout out of this long-term downtrend, wouldn’t it be at least good to be aware of where you are from a larger perspective? I think so.
This is why it is important to get some additional perspective, to step back, move the timeframe up and down, above and below the charts that you normally look at to get some additional perspective of where you are.
The Bottom Line
Try your best to question what you are seeing.
Look at things from different perspectives.
Try to be self-aware of how your beliefs/opinions and past experiences affect how you view things.
Ask yourself if your mood is influencing what you see and the actions that you are taking..in trading and in life.
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