One of my favorite psychology ideas comes from the poker literature – specifically Mike Caro’s “threshold of misery”. Mike’s point, paraphrased, is that there’s a difference between how bad a situation is objectively and how bad people feel about their miserable circumstances. Sure, as a situation gets worse, we feel worse. But eventually we hit a point where they feel about as shitty as is possible. Analytically speaking the situation can get worse, but there’s only so bad you can feel about it. That boundary is the threshold of misery.
Mike’s point was that people make stupid decisions around the threshold because the psychological risk/reward ratio is different from the real one. If your dog just died, you don’t really care if you get a traffic ticket on the way home from the vet. The dog’s still dead. But rationally speaking you should care – that ticket will still cost you $237 or whatever. In poker the manifestation was that players who had just taken a huge loss would subsequently make stupid bets in an ill-fated chance to get even. This was of course totally destructive from a monetary point of view, but actually “correct” psychologically – if they won and got back to even, they felt better. If they lost, they couldn’t feel any worse. Think of it as a psychological call option on their results
As a poker player, it’s basically impossible to avoid sometimes falling into this state when the cards break bad, and when it happens your bankroll is dependent on doing one thing and fast: quitting the game. Just go home and come back tomorrow. Of course, doing this is dependent on recognizing the problem in the first place, which is not so easy since you’re in a bad mental spot.
Trading is analogous on this point. I’d wager there are MANY short term traders who are break-even or better on their first trades of the day, but massive losers after that if the first trade goes bad. Again, the remedy is simple: quit for the day. And in order to do that, you need to recognize there’s a problem. One of the trading blogs I sometimes read (Andrew Menaker) recently posted an interesting question you can ask yourself to help determine that:
It’s a simple question, but then we don’t really need complexity here. What we need is an anecdote to a common and costly problem. And that question seems like a good start. If the answer is “This is a chance to get even” then quit for the day.