The best trading advice I could ever give you, is to forget everything you know about goods and learn how an item is traded with no preconceptions. You might be wondering what could be perilous about familiarity. Familiarity is great, it’s comfortable, it’s reassuring.
And the danger of accepting risk? Obviously we have to acknowledge that there’s risk involved in trading. But there’s no danger in that.
Here’s where you’d be wrong.
By the time we’ve reached adulthood, we’re very familiar with the goods that are traded in commodities markets. These things aren’t nearly as intimidating to our intellect as is analyzing a financial statement of a company, or absorbing the information that’s involved in market position or competitive intelligence. Wheat, crude oil, gold are intellect-friendly. We’re comfortable with them because we grew up with them. Some valuable trading advice however, would be to give the more intimidating things their due worth.
But this familiarity builds over-confidence in us regarding our knowledge of them. Since they are easily visualized in familiar images (corn, wheat, oil, gold), we feel familiar with them and have the notion that we already know a good bit about them.
We’re thinking that we’ve already “got it.” The sense of caution that would ordinarily challenge our limited knowledge of trading isn’t there. Not like it was the first time we picked a company to buy stock in. That was intimidating precisely because it was so unfamiliar, and we were cautious.
But we tend not to be cautious in commodities. In fact we have over-confidence — a false confidence — because we’ve bought corn in the store, and we know what it is, how it tastes, that it grows in a field. That, unfortunately, doesn’t mean we know anything about trading thousands of bushels of corn in the markets.
The complexity of profitable trading goes far beyond what most people have experienced in their lives.
This over-confidence — actually a kind of fearlessness — results in a catastrophic action, that is, we start off too far up the learning curve. This is a huge obstacle to learning.
The world of trading is an industry in and of itself and is comprised of a very large body of knowledge. Advice on trade is plentiful. Most bodies of knowledge have a progressive learning curve. Math, for example, begins with counting, progresses to addition, then subtraction, multiplication, division, fractions, decimals, algebra, trigonometry, calculus, and beyond.
If you jump in at fractions, but never learned counting, addition, subtraction, multiplication or division, you’ll have a very difficult time. It’s guaranteed you will struggle.
The danger of familiarity then, is that it instills a false sense that we understand the complexities of the markets. This makes us not cautious enough against the possibility of catastrophe. We probably won’t even recognize it until it’s too late and our fearless trading has emptied our account.
Then there’s the problem with acknowledging risk. It may seem surprising, but often, the most successful traders and investors have a low tolerance for risk. Take Warren Buffett’s trade advice rules for investing:
1. Never lose money.
2. Never violate rule #1.
The NFA requires all brokers to have their clients acknowledge the high risk involved in trading, and that’s a good thing. But there is an interesting effect of risk acknowledgment. Subconsciously it raises a person’s risk tolerance.
By actually putting your name to paper that you’re accepting and acknowledging the risk, your tolerance for risk goes up. Even if you’re nervous when reading the disclosures, your fears of risk are suppressed by formally agreeing to accept the high risk.
Combined with the false over-confidence that comes from the sense of familiarity, the conscious acceptance of the high level of risk has now both consciously and subconsciously prepped and primed the new trader to take large risks, that is, to be “risky”. This is not the frame of mind we should ever get into. Take heed of this valuable trading advice and develop the mind-set of a successful professional trader.
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