Thoughts, Trading

Trading Discipline and Prada Knockoffs: The Slippery Slope of Bending Rules

Last week while I was trading, I hit my day stop during the morning because I neglected to put a stop and wanton selling spiked the market down. I knew that I should stop trading, but my limbic system took over the steering wheel and I did 4 more trades, losing more money, before I managed to stop myself.

As the day progressed, the market dropped further, and what looked to be a terrific opportunity to get in a short trade came by. So I was torn between adhering to my day stop, and taking what looked to be a terrific short (high probability, low risk).

In the end, I did not take the trade and stopped trading for the rest of the day. Process-wise, in terms of following my trading plan, stopping was the right thing to do. Results-wise, taking the trade at that time would have recovered all my losses and made a decent sum because the market dropped heavily thereafter with two levels of puking. Ouch!

What stopped me from taking the trade were three things:

  1. I knew that I need to follow my trading plan, and maintain trading discipline. If a day stop can be ‘bypassed’ when what seemed to be a good trading opportunity came by, then that isn’t really a day stop anymore. It defeats the whole purpose of having a day stop.
  2. I recognized that my judgment might be impaired, due to the losses suffered in hitting the day stop, and the 4 revenge trades thereafter. So what seemed to be a great trade at that time might be due to my conscious mind being blindsided.
  3. I recently watched this video by Dan Ariely (link here) where he talked about an interesting experiment.
    • So he gave a bunch of people fake designer sunglasses, and that led to them cheating more than normal (compared to a control group) in a subsequent game. Essentially, even if people are not consciously aware of it, when they do something that they know is not entirely right (e.g. wearing fake sunglasses), internally they self-rationalize and lower their integrity threshold so as to make their actions acceptable. That lowering of their thresholds led them to commit further acts of cheating, and even tints their perception of others (they think that other people are cheating as well). That is a very insidious slippery slope that people don’t even realize they are sliding down on.
    • I figured that if I break my trading rules now and take the trade, I would have subconsciously lowered my defense in terms of maintaining my trading discipline, and that will have repercussions because I would then naturally be more inclined to bend my trading rules on the fly in future. This potential knock-on effect is scary, so I stuck to my guns and stopped trading.

So it’s good that I followed my trading plan, but of course I was (and still am) sore about missing that really good trade. Because of that incident, I modified my trading plan to introduce a soft day stop before the hard day stop is reached. When the loss threshold of the soft day stop is hit, I will have to scale down my position size. That limits further damage, makes it harder to hit the hard day stop, and yet still allows me to continue trading.



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