After a decade of growth, investors and advisors returned to the belief that buy and hold was a prudent investment strategy. All boats float in a rising tide. And many believed their success was due to their own efforts. But Professional traders disagree.
“Anything can happen. You don’t have to know what is going to happen to make money. Every moment in the market is unique.” – Mark Douglas – Trading in the Zone
How did an elite group of financial advisors avoid the -35% decline in February and March of 2020?
Avoiding the 2020 Correction started with a change in beliefs.
“We do not trade the market. We trade our beliefs about the market.” – Van Tharp
As humans our beliefs determine our actions. We hold certain statements to be true. These beliefs control our decision process. Decisions control our actions. Our mental process follows a pattern:
- a trigger appears
- a thought arises
- the body senses
- past experience gives meaning in the form of a belief or judgement
- a decision is made
- which leads to action
This pattern ingrained itself in the fibre of our experience through repeated use.
But it assumes that our belief was right in the first place. Too often we hold on to beliefs that are not true. And fallacies become inseparable from a habit pattern. The beliefs embed themselves into our psyche. “Dark rooms are fearful.” Danger is real in the world, but fear is a choice we make. It is not true that dark rooms are dangerous. When we turn on the light we realize there was nothing fearful or dangerous in the room. But the false belief will hold us back from moving forward. When we act out these habit patterns and we act as if they are true, contrary to evidence.
Professionals traders take the time to test their beliefs. They question whether their beliefs about the markets are true.
We inherit beliefs from our parents, peers, the books we read, and the entertainment we watch. Over the decades these assimilated beliefs have become rules or laws we live by. But what may have been true for our parents’ generation may not be true today. Each generation defines what is true based on new knowledge, experience, and exploration.
The first step every professional trader does is test their beliefs.
Successful trading requires a change in mindset. The markets by nature are counterintuitive. Individuals act intuitive and emotional. Decisions get delayed to the detriment of performance.
One important counterintuitive shift that impacts what we pursue concerns profits. Profits are like smoke, here today and gone tomorrow. Profits should be taken based upon structure. Professionals take profits often, because profits disappear.
The Mastermind Group avoided the -35% decline in February and March of 2020. How did an elite group of financial advisors do what their peers were unable to do to avoid the 2020 Correction? The second way essential shift is a change in mindset.
The chart below is often shown to “prove” that a buy and hold strategy works.
Professionals measure risk by Standard Deviation. The negative side of risk is “losses,” and the positive side “profits”.
The chart below no one ever shows. It illustrates why buy and hold guarantees the investor both the positive and all the negative risk.
This chart more than any other illustrates why the buy and hold philosophy is flawed.
“Losses have a greater negative impact, than profits have a positive benefit.”
Losses can wipe our all previous profits. So endowments and professional traders use an asset rotation strategy. most advisors use a fixed asset allocation strategy.
The second step an elite professional trader does is engage a strategic mindset.
Investment decisions in the retail markets are generally executed by a single individual, the advisor. That holds back the individual advisor or investor from achieving their best results. The difference between retail and professional investment management is that professionals collaborate.
Professionals traders at Goldman Sachs, Bridgewater, and others work together. The results are greater than any one individual would have created on their own.
The Mastermind Group agrees to work together and meet weekly to discuss and share ideas. The input from members improves the investment process and the results. The collaborative advantage means it is harder for cognitive bias to influence the decision process. The cooperative intention, target, and action plan support cognitive dissonance about possible outcomes. This we will discuss further under Toolbox below.
The third step every professional trader employs is taking part in a cooperative decision process. It is this collaborative efforts that allowed professionals to avoid the 2020 Correction.
To trade like a Pro you must trade based on a set of rules. Baseline rules create a structure that avoids cognitive biases. The structure is probability-based and leads the professional to a series of hypotheticals. The trader is now prepared to act.
A few of the tools used by professionals are context questions, binary questions, and cognitive dissonance.
Context questions allow the professional to better understand:
- what has happen in the past
- what the market is currently trying to do
- how good a job it is doing.
The answers to these questions help the trader better understand the landscape the market is trading within.
Binary Questions help the professional avoid the mistakes advisors and investors often make. Professionals avoid focusing on lagging indicators or relying on fundamentals to inform decisions they were never designed for. Binary questions asked in the moment rely on current information. This increases the professional’s precision in decision making.
Cognitive Dissonance is the ability of the professional to hold two contradictory thoughts at the same time. Because anything can happen in the markets. The next bar can be bullish or bearish. Professional trading is not about prediction or timing. It’s based on probabilities between several hypotheticals. Any one of which may trigger an action and remove emotions.
Hypotheticals allow the professional to prepare for many outcomes, removing cognitive bias. When a hypothetical is triggered its acted upon immediately. Without hesitation.
The fourth step for every professional trader: Ask the right questions to execute profitable trades.
The Mastermind Group employs the tools of the best endowments, hedge funds, and professional traders. This strategic approach helped them avoid 91% of the 2020 correction. The concepts outlined above can help you also.
Add the competitive edge needed in your investment process. Equip yourself with a professional mindset. Elevate your solution with a collaborative advantage and protect your clients so that a repeat of the 2020 Correction does not impact their savings.