The Most Important Skill to Master

Highlights From Chapter 13 of Psychological Analysis by Adam Sarhan

I took some time off from reading to catch up on other aspects of life this week, but I still managed to finish The Obesity Code by Jason Fung on Memorial Day.

I also made a bigger dent in Mastery by Robert Greene, and I’m starting to get close to the end of Project Hail Mary by Andy Weir. 

Most everything else shifted to the back burner for the week, but I plan to start working through The 21 Irrefutable Laws of Leadership by John C. Maxwell soon. 

As a group, we’re coming to the end of our time with Psychological Analysis by Adam Sarhan, which has been exceptional. This book has done an excellent job of reinforcing all of the trading principles I’ve learned over the years while also providing a support structure for my mental hurdles. 

This week, we tackled Chapter 13, which broke down everything we need to understand about risk management. As usual, Sarhan started us out with a perfect summary of what to expect from the chapter:

As a trader, your single most important job is to compound your returns over time, and the best way to do that is to successfully manage risk. The market is a place where people can exchange risk for a potential reward. 

One of my biggest takeaways from all of Jack Schwager’s Market Wizards books was that every trader Swagger interviewed, regardless of their trading style, made a point to emphasize the importance of risk management. 

With that in mind, let’s take a look at some of the interesting points Sarhan made in his chapter on the subject. 

Successful Traders are Not Gamblers

Successful traders are not gamblers. Traders take informed and highly calculated risks. They do the hard work that most unsuccessful people do not want to do. (178)

Trading is no different than any other pursuit. The people who are willing to put in the work will always fare better than those who are not ready to match that effort. 

I’ve said before that the biggest advantage I’ve had throughout my life is that I’ve always been able to outwork everyone else. However, I recently learned from From Strength to Strength by Arthur C. Brooks that I won’t be able to maintain that pace forever, so I need to adjust. 

I’ve put in years of hard work, but now I need to transition into using the wisdom acquired during that time to take “informed and highly calculated risks.”

Undertrade, Undertrade, Undertrade

Legendary global macro trader Bruce Kovner said, “I would say that risk management is the most important thing to be well understood. Undertrade, undertrade, undertrade is my second piece of advice. Whatever you think your position out to be, cut it at least in half.” (181)

I mentioned the Market Wizards books in the intro, and Sarhan uses a quote from Market Wizard Bruce Kovner saying that risk management is the most important thing. He advises to undertrade to the point of cutting your position size in half. 

Looking back at my trading history, I’ve probably been guilty of overtrading for almost my entire career. I also made a horrible call going off the deep end trying to regain some of my losses at the end of 2021. 

It’s funny how you can spend so much time studying what not to do and then slip up and make those mistakes anyway. Hopefully, those lessons will sink in now that I’ve learned them through my own experiences. 

Getting Punched in the Face

Being successful in this business is about making smart decisions and taking proper action over and over again - even as you are getting punched in the face (such as when you are in a drawdown). (188)

Sarhan takes the 80/20 rule to the extreme, arguing that trading success is 99% psychology and 1% everything else. He also stresses that having the right psychology is the only way to survive the market punching you in the face. 

This 99/1 idea is fascinating because I find that the 99% psychology part tricks me into spending the bulk of my time focused on doubting the 1% part. How crazy is that?

One of my biggest struggles in this area is that I base my personal opinion of myself on recent trading. Not only is that unhealthy, but it also forces you to make foolish trades in a flawed attempt to get even for the year…over and over again. 

Live a Better Life

It’s a universal truth that anyone who takes responsibility for their life tends to live a better life than people who do not. (188)

Taking responsibility for results in trading (as in life) is another key to long-term success that requires the proper mindset. 

I’ve spent the bulk of this email talking about my shortcomings. This is one area where I actually have things figured out. 

I’ve always been very good at taking responsibility for what happens in my life. But come to think of it, I wonder if that approach is forcing me to subconsciously take responsibility for trades that go against me? 

What do you think?

On the Verge of a New Hot Streak

The second you are about to give up due to the pain of a losing streak, watch out - you are probably on the verge of a new hot streak. Unsuccessful traders get caught up in the emotional highs and lows and make careless decisions that end up causing their financial ruin. (189)

The point where you are ready to give up on trading is the exact point where things are about to turn around for you. Don’t let your emotions cause you to throw in the towel. 

I’ve been getting pretty close to giving up on the market these past few months, but something changed for me this week. I’m not exactly sure what it was, but I’m right back to being as passionate as ever. 

It might have been this part of the book that woke me up. 

This Time is Not Different

At this point, it is critical for you to understand that this time is not different and that is just the nature of how markets work. You are not special and, no, this is not the first time this has happened to someone. (189)

You are not special, and there is nothing new in the market. Ride the waves as they come, but don’t let them convince you that human nature has fundamentally changed. 

I’m not sure this chapter is completely responsible for reversing my opinion on the market this week, but it played a role in some respect. 

Since I started with a Market Wizards reference and included Sarhan’s quote from a Market Wizard as a highlight, I think it’s appropriate to close with one as well. 

I’ve written multiple times in my trading journal this past week that I’m done messing around with stocks that might go higher. 

Instead, I’m going to follow the advice from Market Wizard Jim Rogers and wait until I see a big pile of cash sitting in the corner. I’ll be ready to walk over and pick it up when that happens. Until then, I’m just going to keep reading. 

We have two or three more weeks with Adam Sarhan and Psychological Analysis, and then we are moving on to something new. 

I’m back in on stock trading, but I still think it will be interesting to check out Money Master the Game by Tony Robbins for our next read. Hopefully, we’ll have some strong disagreements with some of his advice, making for interesting conversation. 

Have a fantastic and profitable week filled with positive energy!