Positive expectancy is a foundational concept in our business. It is the idea that whatever system, whatever algo, whatever visual setup you use will result in profitable trades. The whole point of trading is that you need a method that is not just simply blind luck gambling in order to win in the long run. So backtesting, front testing, live testing are all good and necessary steps to finding something sustainable and robust to trade.
The problem comes with expectancy. Expectation is the single most toxic thing in trading.
Think about what happens. Say you research an idea. Code it. Chart trade it. Maybe demo trade it. Maybe dime pip trade it. Backtest it some more and feel really good about it. The moment you turn it on — what’s going through your mind? You are excited! You are ready to make money! You are primed for success — you are Dale Carnegie, Tony Robbins, Michael Jordan all rolled into one!
It doesn’t matter if you are a triple Ph.D. data scientist working on the most complicated market-making algorithm ever or a just a regular Joe retail trader looking to pull some pips from the market. As human beings, we all expect positive results.
And of course, we get the exact opposite. Not only are market conditions different from the backtest or different from the past two weeks of price action, but they are literally transformed into such a challenging environment where every single trade you take turns into a stop.
Suddenly you are 5%-10% in the hole. You a miserable and frantic and teetering on the state of what poker players call “tilt” — a moment when you lose all rational faculties and start just trading randomly, swinging wildly at the market in a desperate attempt to. Just. Win.
Because you expected success. Think about it. You are never as vulnerable as when you expect something to happen. It’s almost never the results that kill us psychologically it’s always the expectation. The market, which is the ultimate poker game, knows this very well. The very point of all good poker players and market traders is to psychologically destroy their competition through deception and subterfuge. Once your opponent is defeated mentally it’s a piece of cake to defeat them physically.
So the market, in its very perverse way requires skills that are the opposite of everyday life. To win you actually need to walk into the ring expecting to lose — because lose you will. Sometimes, like in the current Alice-in-Wonderland market for what may seem like an eternity. And the only way you will survive the pressure is to step into the arena expecting to lose. In the market, the power of negative thinking is the greatest superpower of all. Because if you expect to lose, you will trade small size. You will control your bankroll. You will take every trade. You won’t lift stops.
By expecting to lose, you will do all the right things to win in the long run.
I am always amused by financial planners who ask, “What is your tolerance for risk?” Clients always murmur something like “20%”. Do you know what the real answer is? ZERO. Nobody puts money in the market because they expect to lose — which is why I am certain that Ma and Pa Main Street who have been brainwashed to buy every dip and hold the ETF forever, will puke up all the gains of the past decade at 50% loss because there will be a time when the market does not come back. Not in a month. Not in a quarter. Not in a year. Not even in a decade and none of them will have the trading skills and the mental strength to understand just what kind of a sucker bet they made.
Oh and by the way, if you still believe in the Horatio-Alger-pull-yourself-by-the-bootstraps-power of-positive-thinking approach let me leave you with this quote from Michael Jordan.
“I’ve missed more than 9000 shots in my career. I’ve lost almost 300 games. 26 times, I’ve been trusted to take the game winning shot and missed. I’ve failed over and over and over again in my life. And that is why I succeed.”