Doing nothing can be one of the hardest disciplines in trading, especially when a stock you missed suddenly takes off. Michael Taylor looks at why the urge to act can be so costly, and why learning to sit on your hands may be an edge in itself.
GCM Resources went up over 400% in a few days.
You might assume this was because it won a big contract, but you’d be wrong.
Instead, Bangladesh’s finance minister told a business audience in Dhaka that the country was weighing coal in its energy mix, and a loss-making AIM tiddler with one stranded coal seam and a decade of waiting behind it shot up as a result.
The company’s own reaction was to “welcome” the remarks. No approval or anything, just a huge change in sentiment. I’m not saying it’s bad or good, but these are the moves that can happen when a company’s risk/reward profile significantly changes overnight.
If you watched the move and felt nothing, then you’re either a monk or incapable of feelings.
Most of us feel something.. Usually “How did I miss that?”, and followed by the potentially dangerous “It might not to be too late to get in”. Naturally, the second thought is the one that costs you money, as the risk/reward has significantly changed again from the point the start started moving.
I’ve come to believe that the hardest part of this job isn’t actually the analysis. It’s the sitting down and doing nothing.
That means sitting through the setup that’s nearly there but not quite, or a stock you’ve been watching for months breaks out only for you to miss it.
It’s uncomfortable to sit on your hands while something you don’t own rips, and watching everyone else make money in a stock that you didn’t buy.
It’s uncomfortable. And the uncomfortable truth is that it’s supposed to be. Your brain is wired against it, and the research on this is better than you’d think.
Why doing nothing feels like losing
In 2007 a group of Israeli researchers led by Michael Bar-Eli published a paper in the Journal of Economic Psychology on penalty kicks.
They studied 286 penalties from top leagues and found that keepers who stayed in the centre saved a third of them. Diving left saved 14.2%. Diving right saved 12.6%.
So how often did the keepers stay in the centre? 6.3% of the time.
These are elite professionals with enormous incentives and years of repetition, and they systematically chose the worse option (the data may have changed since this study became common knowledge, and it’s also almost 20 years old).
The researchers’ explanation was simple. The norm is to dive, so a goal conceded after standing still feels worse than a goal conceded after a heroic-looking leap. It also makes the keeper look stupid. Doing something feels better than doing nothing, even when nothing has the higher expected value (again, at that time).
This is the trading equivalent of feeling like you’re doing something and putting in the effort, when you buy a stock that doesn’t quite meet your criteria, because you want to do something.
Unfortunately, our P&L doesn’t grade us on effort.
Sitting still is hard
In 2014 Timothy Wilson at the University of Virginia and colleagues published eleven experiments in Science.
They asked people to sit alone in a room with nothing to do but think for between six and fifteen minutes. No phone, no book. Most people hated it. And if you saw someone in a coffee shop just looking out the window with no phone or book, you’d probably assume they were a psycho.
Then they gave participants a button that delivered a mild electric shock.
The very same shock those people had said earlier they’d pay money to avoid. And then they left them alone for fifteen minutes.
Two-thirds of the men and a quarter of the women shocked themselves rather than sit there. One man pressed the button 190 times.
The conclusion is that people would literally rather deliver electric shocks to themselves than be bored.
Now, this is a small sample size of 18 men and 24 women in that particular experiment.
But you can already see the parallels in trading. If you sit in front of a Level 2 screen, you’ll feed it and trade something.
Boredom is a physical discomfort, and the market offers you a button to press buy and sell every second it’s open.
And people press it. Brad Barber and Terrance Odean’s paper Trading Is Hazardous to Your Wealth looked at 66,465 households at a US discount broker between 1991 and 1996. The households that traded most earned 11.4% a year against a market that returned 17.9%. The average household turned over 75% of its portfolio every year. The conclusion is in the title and comes as no surprise.
Closer to home, when the FCA analysed a representative sample of UK CFD accounts in 2016 it found 82% of retail clients lost money, averaging £2,200 a head per year. Leverage is part of that story. So is a button that’s always available and a brain that can’t bear sitting still.
You can see the live figures on every broker’s homepage now due to ESMA regulation in 2018. These are the window-dressed figures, and they’re never good.
Regret costs nothing
The reality is though regret costs nothing.
Thomas Gilovich and Victoria Medvec published a review in Psychological Review in 1995 showing that regret has a shape over time.
Basically, people regret the things they did far more than the things they didn’t do. But over a lifetime it flips, and the paths not taken are what people in their seventies bring up.
Daniel Kahneman pushed back and argued that long-run regret over inaction is mostly wistful, and by 1998 the three of them had co-written a paper agreeing on the split: regrets of action run hot (anger, self-blame), and also that regrets of inaction are largely the wistful kind.
Think about what that means at the screen.
Missing GCM produces wistful regret. You wished you’d caught it, but you didn’t. It costs you nothing, and by Friday you’ve forgotten it because the new hot stock has moved.
Chasing GCM up a few hundred percent and then sitting through the pullback produces hot regret. It costs you money, it costs you confidence, and if you sized it like a muppet then it costs you the next three good trades because you’re now trading to get back to even.
None of this means never trade. It means knowing exactly what you’re waiting for, so that sitting out is a decision rather than a failure.
Your job is to define your trades. Mine are boring and haven’t changed much: a Stage 2 stock in Weinstein’s framework, breaking out of a proper base on volume, usually backed by a catalyst, with a shallow enough base that I can place a reasonable stop without it stunting my upside.
When you use ShareScope, the filters do the waiting for you.
Go to Filter → Apply filter → Library and search “Michael”.
My filters will do the work. You can pull up the “10% within 52-week highs” screen alongside the volume filter (300% above the 40-day average). Run them at the close.
The discomfort doesn’t go away
The discomfort doesn’t stop once you’re in. Holding a winner through a 10% pullback without touching it is every bit as uncomfortable as watching one run without you. The urge to press the button never goes away, especially as the paper profits go higher. You just get better at recognising it for what it is.
Jesse Livermore’s line in Reminiscences of a Stock Operator is a century old and still the best summary I’ve read: “It never was my thinking that made the big money for me. It always was my sitting.” And if you’ve never read that book – read it. It really is packed with trading gold.
Sitting out is a skill, and the studies above suggest it’s one we’re built to be bad at.
Your edge as a private trader isn’t information (though I accept in UK small caps it absolutely can be). But the edge that private investors all have is that nobody is forcing them to swing on every pitch.
The more comfortable you can get with being uncomfortable, the better your trading will become.
Michael Taylor
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Free educational content: @shiftingshares
This article is for educational purposes only. It is not a recommendation to buy or sell shares or other investments. Do your own research before buying or selling any investment or seek professional financial advice.
This article is for educational purposes only. It is not a recommendation to buy or sell shares or other investments. Do your own research before buying or selling any investment or seek professional financial advice.
