Those with extensive experience in the market will know that it is possible to be wrong and profitable. This article discusses why.
The need to be right
Although the need to be right will partly be related to ancient survival instincts, a big factor is the way we are trained at school. The whole system of tests and exams rewards being right. The more often that you are right, the higher up the academic ladder you climb, and the more praise you receive from your teachers and parents.
The problem with the need to be right
There are a lot of problems with this way of thinking. The need to be right assumes certainty, it assumes that there is a concrete correct answer. This type of thinking risks breeding a “know it all” mentality and that can result in being unkind, impatient, insensitive, and lacking in empathy. These are not exactly characteristics to be proud of!
Needing to be right can stifle the development of new ideas for fear of being wrong. Those who feel the need to be right tend to be poor listeners, and they tend to be more closed-minded.
The way we are trained has led to myths about being wrong. For example being wrong is equated to failure or ignorance. Some even erroneously equate being wrong to being bad or evil.
The reality is that being wrong and making mistakes provides extremely valuable learning experiences. People usually learned a lot more from their mistakes than they do from their successes.
Of course this depends on the situation. When we sit in the exam, yes it is important to be right if you want to achieve a positive outcome. If we are talking about a life-threatening situation, yes being right is absolutely crucial. However when it comes to the markets, that is a whole different ball game. Where the markets are concerned, there are more important considerations than being right if you want to succeed.
Defining “right” in the markets
How do we define being right where the markets are concerned?
- Price direction
- Magnitude of price movement
One might predict that the price of a stock is going to rise, and if price does indeed rise then one could say the call was correct. That is where most people end their definition. However, there is a lot more to it. Even if one is correct about the direction of the move, was the magnitude of the move also predicted correctly? A price rise of a fraction of a percent is very different from a 10 percent price move. Even if that prediction was correct, did the price move occur over the anticipated time scale? Even if one made the right call on all of the above, were the correct decisions made and acted on appropriately? Was the decision to buy in or sit it out? Was the purchase made at the right price at the right time? Was the position sized appropriately? Was a stop loss decided upon and acted on?
As you can see, being right in the markets is multi-dimensional. Where the markets are concerned, there is something far more important than being right or wrong. Being profitable. It is more important to talk about profit and loss rather than being right or wrong. Our primary goal is to be profitable in the markets, yet so many people become distracted with being right.
Win loss ratio
The win loss ratio is the ratio of the total number of winning trades to the number of losing trades. The win loss ratio could be considered to be a measure of how often a trader is right. Someone who claims to have 100% wins is either trading very rarely or has a ton of inside information.
The win loss ratio does not take into account the size of the wins or the losses. Someone with a high win-loss ratio is not necessarily in profit. For example, they might have made 10 trades of which eight were small wins and two were losses that wiped out all of the gains. This is where risk and reward matters. It is important to try and keep your losses small and maximize your gains. Of course that is much easier said than done.
The “wrong” portfolio
If we were to use the metrics of right and wrong, here is an example of a portfolio that could be considered “wrong”.
•Stock A -1%
•Stock B +30%
•Stock C -20%
•Stock D -10%
•Stock E +800%
It could be said that this trader/investor has been wrong more often than they have been right. If this person ran a mining stock newsletter, they would like be berated by their subscribers about how often they were wrong. However, the profits in this portfolio dwarfed the losses, making the whole portfolio very profitable. Sadly, despite this it is the “being right and wrong” that many concentrate on.
Although being a “know it all” serves well for exams, it won’t get you too far in the markets. The market couldn’t care less who is right or wrong. Imperfection is something that should be accepted. Consistently buying at exactly the right price at the bottom, and selling exactly the top is an unrealistic expectation. However, that does not mater as long as you make an overall profit. For success in the markets, your primary goal should be profit, not being right.