Greed and Fear Revisited: Outcome vs. Opportunity

In trading, Greed and Fear are often condemned by many people. Greed is thought of as a companion of Fear, and both are considered to be bad when found in traders. I want to propose a different way to think about Greed and Fear. I agree with Mr. Gekko, that Greed is good, and I will go even further to add that Fear is good, also. However, they are only good for you if you are greedy and fearful of the right things. Otherwise, they are vices and not virtues.

My trading psychology in the past has always been this:

A mindset of maximizing my profits (or winning trades) and minimizing my losses (or losing trades) right now on THIS trade.

This mindset is focused on the outcome of the current trade. I believe that an outcome-based mindset (whether it’s P&L focused or win/loss focused) is where Greed and Fear cause us to fail as traders. The flipside is that this same mindset is also the source of profit for many successful traders, as they fade the losers.

I submit that traders SHOULD be greedy and fearful, and that the following should be the mindset for a successful trader’s Greed and Fear:

A mindset of maximizing your exposure to profit opportunities (Greed), and minimizing your exposure to loss opportunities (Fear) at all times and in all trades.

Notice that it is not the actual profit or loss itself that is the focus, nor is it whether your individual trades are wins or losses. The focus is on your exposure to profit and loss opportunities! This is a critical distinction, and one that I have seen come naturally to truly great traders–they think probabilistically and not deterministically. It does not come naturally to me, and I have only recognized this small bit after 5 years of trading experiences.

To explain further, the outcome-mindset focuses on specific trade outcomes. Each individual trade outcome then becomes vitally important. This can happen from a psychological weakness, or from a position that is sized so large that it is “too big to fail”, or a number of other things. But the effect is that you will skew your judgement toward making THIS trade be maximum winner, by perhaps holding on to an underwater position in the greedy hope that it will come back and be a win, and a fear of realizing a loss on THIS trade. You may take profit way too soon, because you need to chalk up a “win” to offset your last losing trade. Or you may never want to exit a winning position, for fear of missing out of the rest of the move, and ride it back down, possibly to a loss. Profits left on the table knaw at the minds of traders with incorrect greed and fear focuses. Trades are forced, due to need to get a win, or make back a loss. All of these errors come because we are greedy to get the most profit on THIS trade, and fearful of realizing any loss on THIS trade. Why? Because that is the focus of our Fear and Greed–the immediate result of the current trade. The real end result is that profits are cut short, and losses are magnified, putting a huge drag on your expectancy. This is all from my experience.

As I mentioned before, I have observed that the successful opportunity-minded trader still has Fear and Greed, but has a different focus for them. He will instead be focused on his edge, the probabilities, the statistical realm, and trading the plan based from it. The trade outcomes will fall as they may, and the pros shrug it off and press on, win or lose. The successful trader will let a winner ride only until the stats tell him his edge is gone, and no more! Greed tells him this is best for expextancy in the long run, though he may not get out at maximum possible profit this time. If a trade doesn’t act right, the trader with an opportunity exposure mindset will reduce that exposure by getting out quick, losing small. Fear tells him this is best for expectancy and avoiding a huge loss in the long run, even if the current trade goes right back in his favor after the exit. Trades will not be forced without the planned scenario unfolding, because to do so would be exposing the account to excessive risk (i.e. loss opportunity). If a trade goes well, and is playing out as planned, the opportunity-minded trader will increase his exposure to this profit opportunity by adding to the position, or even just remaining in the trade. You never know which individual trade might be a big winner, so the successful trader doesn’t get fearful and emotionally get out with small profits, but maintans exposure to profit opportunity and rides until his statistical edge is exhausted. After the fact, he may notice that he could have had X points more had he done Y, but it doesn’t bother him psychologically because it’s not the focus nor the criteria for his success. If the data shows that he should alter his rules, over time he will, but one loss (or a small streak) doesn’t send him back to scrap the system and start over. Neither does the specter of a missed profit outcome. (The Phantom of the Pits has his Rule #1 and Rule #2 that go along with these ideas exactly. Read it if you never have.)

In effect, the opportunity-minded trader is continuously trading, tick by tick, bar by bar (or whatever their timeframe is) judging the exposure to profit or loss opportunty as the trade progresses. In reality, that exposure is the ONLY thing that a trader can control. Nobody (with perhaps the exception of Goldman Sachs) can control the outcome of any one trade.

Conversely, the outcome-minded trader makes only one trade–right at his entry. From that point on, the failing trader will be married to the trade, because his mindset is that this trade HAS to have a positive outcome, and that it must be as positive as possible. And the outcome is the opposite more often than not.

Ugly over at was one of my first daytrading heroes when I started learning back in 2004/5, along with Trader Mike, King Jamie, Trader-X and Maoxian (all found in my blogroll). Ugly used to begin every blog post with “Good Morning. My name is Ugly, and I am a loser. I have it in me to do serious damage to my account”. Ugly feared to expose his account to gigantic losses. By maintaining that focus on exposure, he was shielding himself from making the kinds of choices that turn your account into a smoking crater.

Just controlling downside exposure can help your bottom line significantly. Pressing winners helps on the other side of the coin. In the end, the opportunity-focused trader wants the same thing as the outcome-focused trader: net profits. It’s counter-intuitive to many, but just like in life, success comes to those who consistently play for the long term. There will be a few lottery-winners, but for most the only serious chance for success is to do the hard work and make the hard choices NOW to get what you want later. It feels good to imagine you can control THIS trade outcome, but it is folly. Kick the outcome control drug found inside your brain, and get yourself straight. Make every trade so small that any one trade can’t really impact your account or your psyche. Wealth is built by consistent application of a trading edge, along with a little luck at times.

In summary, traders should be Greedy and should also be Fearful. Greedy to maximize exposure to a profitable opportunity. Greedy to press winners. Greedy to play consistently to increase long-term profits. Fearful of breaking their own rules. Fearful of their weaknesses. Fearful to make any one trade too important, too big to fail. Just like winning a sporting event is made up by many smaller plays or scores, so winning at trading comes through taking many trades, winners and losers. It’s just that the losers are small and the winners much bigger.

So how does an outcome-focused trader perform the mental judo to get his Greed and Fear focused on opportunity exposure, where they belong? Leave a comment if you have any suggestions, and I’ll have a few in future.

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One Response to “Greed and Fear Revisited: Outcome vs. Opportunity”

  1. Alex Says:

    Great post!

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