Praise for Trading from Your Gut

Brain Science
Neuropsychology has taught us that the physical structure of the
brain is prewired with certain tendencies designed for survival and
reproduction of a species. These tendencies or instincts function
similarly to a series of prime life lessons that are with us when we
are born and that the brain applies opportunistically. These prime
lessons are also referred to as cognitive biases, and some would
suggest that these biases represent faulty thinking processes. This is
incorrect. In most circumstances, cognitive biases are very useful.
However, in specific limited scenarios—particularly in trading and
finance—they can trip you up.
To become a master trader, you need to retrain your gut to over-
ride cognitive biases in specific trading circumstances. Traders also
need to understand these cognitive biases to avoid herdthink.
When you’ve gained control over your cognitive biases, you can
choose the appropriate course of action: anticipating the herd, doing
the opposite of the herd, or avoiding any action while the herd
panics.
In the next few sections, we explore some of these prime lessons
or biases, along with the specific trading behaviors that each lesson
precipitates.
36
T
RADING FROM
Y
OUR
G
UT
From the Library of Daniel Johnson

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ptg
Gun-Shy: He Who Runs Away Lives
to Fight Another Day
The instinct for avoiding unnecessary risk can be very powerful.
This is a trait that ensures survival under conditions of danger and
uncertainty. When deciding whether to risk getting eaten by a croco-
dile, a lion, or another dangerous animal, humans needed to mini-
mize risk as much as possible. The rule “Better safe than sorry”
makes sense for most people most of the time. Driving at a prudent
speed, eating a healthy diet, keeping in shape, using child seats in the
car, and avoiding unnecessary risks pay off in longer life expectancy.
But in trading, avoiding risk will prevent you from becoming a
good trader, let alone a master. Traders trade in risk; it’s that simple.
Master traders view risk as an important and necessary ingredient in
any potential trade. They know that the very best trades are often
the ones that are hardest for most people to make because of the
perceived high risk. The very fact that a trade is difficult to initiate
makes it less likely that others will also make that particular
trade. The lack of a large number of traders taking a similar position
makes it much easier to make money during the subsequent price
movement.