Although the best investors and traders understand the importance of patience, it is one of the most difficult skills to learn as an investor and trader. So much of trading is psychological, making patience a great virtue for investors. Exhibiting patience when entering a trade and having patience while a trade develops are integral parts to successful trading and investing.
How to develop patience?
It is all about training. There is no magic neither a secret tip. Given this, here is something that might help you with this training.
First of all, turn off your news provider as a guidance for trading. Yes, you should be informed about what is happening in the world, but don't waste time tuning in to the financial media to see if anything happened today that warrants a change in your portfolio. This is only past analysis, because they will try to explain what happened, since nobody can predict the market.
Secondly, you need give the position time to develop. Most of time the markets will not follow your way just because you've went long or short. As the relation between risk and reward, patience is becoming a rare commodity in investment and will be rewarded as such.
Also, even if you trade with a short-term focus, you must have a long-term performance benchmark. A short time frame to evaluate an investment performance is too noisy - your differential will appear in the long run. Therefore, it seems much more appropriate to make a judgment about our investments over a year period rather than by a day or weekly.
Another great thing is to start an investment journal to write down why you did the trade, the risks you took and, yes, any emotions or concerns when you was sending the order. You will see that as you do it every day, you will have more rational decisions when you’re not sure what to do about a certain investment. Learning when not to trade will be the first sign that you have now the wisdom of patience.
Sometimes things in life does not work out and people say "Oh, I knew it... Why I've insisted?". We may speak it when we make a wrong decision at work, when we buy a sandwich and do not like the taste, and especially when the markets are not going in our favor.
The process decision making is a complicated task always associated with fears, insecurities, doubts and the refusal to accept the consequences. No matter how confident or full of self-esteem you are (and the ones that are too much, doubts are even greater), you will always have fear at this time. And you will deny any kind of external help just to feed your pride or you will try to find support in all possible external assistance to compensate for the lack of confidence in yourself (in the opposite situation). Both cases - not admit you have any doubts or leave your questions take away your part in the process - are terrible examples of how to make a good decision.
Also, there is a curious fact: these two characteristics, associated with fear of making a wrong decision will lead you to nowhere. You may lose an opportunity because you have not started soon or because you have started too late.
How to get around with it?
Admit you have questions. Doubt every decision that you are taking and do not rely on external comments. Stay comfortable enough to try to understand all the consequences that can happen if you take an action A or B. But, that's the main point, do not expect to have 100% of certainties to start. You will never be 100% sure, and not all of your certainties will be proven as true. Taking risks and acceptance of the consequences are parts of life. Admit it and move on!
"I was looking at the markets and had an idea for a new investment method. As soon as I took an historical series of data and my favorite computer program I've started doing my "backtest"! A few hours later, I've said: "It is alive!", "It works!". Can not wait for my plans of wealth. Everything comes to my mind as I contemplate the beautiful return curve of my "backtest"!
Full of confidence, I'm ready for the real life! "
The beginning of this text reflects the daily lives of those whom try, somehow, beat the market. And at this time, the trader may come across three possible scenarios:
1 - Your new theory does not work after the "start";
2 - Your theory works for a while and then never again;
3 - Your theory is still running and your account increases every day.
After reading some works of Sir Karl Raimund Popper - one of the greatest philosophers about history of science - and a lot of time thinking, we say that a theory can be considered a theory if it has been tested and rejected or if it is not yet known if that is wrong .
One might already conclude immediately: a theory is never right? Yes, exactly. Let us recall here the Black Swan logic (book from Nicolas Taleb, a great work). A theory will never be certain because we will never know if all swans are white and we can not infer that all of them are because we did an historical analysis and we have never seen a black swan before. You are following the reasoning? So let us return to the three scenarios traders face after their backtest.
1 - Your new theory does not work soon after the start
This had happened because the historical data had no example of what just happened and it had bucked his new theory. The dynamics of the market, the information available and the relationship between supply and demand was changed right after he "put to the test" his new method. And this has a strong correlation with the following scenario...
2 - Your theory works for a while and then never again
Although it is very similar to scenario 1, the big difference is in the fact that the current situation of the market still follows the same backtest behavior, or a little worse, the theory is developed with overfiting - over-adjusted. So many customization were made to make the theory profitable that it is impossible to generalize any changes in the market. The backtest learnt everything that happened in the past that makes it have a blind vision of the future.
3 - Your theory is still running and your account increases every day
Finally, we might conclude that this is the winning scenario. The theory works! Yes, indeed, but only to the point where it will be disproved. And on this day, the system will fail and you may have devastating consequences. Confidence in the system and the confidence of the trader inflate as the account balance does. And a very full balloon burst more easily and more strongly that a balloon not so full. The difference between this scenario to the others is that the unlikely event has not happened yet.
So can we say that we have no escape?
Yes, we have. You can not look only at the historical result, but you should look on the positive expectation of returns. Your system will go wrong someday, for sure, and by "go wrong" I do not mean a few days of losses. I mean a sequence of losses, with no "apparent explanation." Let's say the system has only 0.1% chance of failure. That is, on average, only 1 in 1,000 times it will not work. First some points that must be understood:
That said, what should we pay attention? The maximum loss that we can have when the system goes wrong, plus the flexibility to update it. Let's focus on the first thing. Knowing the maximum loss will help the trader to make the calculation of the expected return. Using again Nassin Taleb, we quote the example given in his book "Fooled by Randomness". The market may have a 70% chance of going up and provide 1% gains. If it does not go (the other 30%), the losses may reach 10%. Considering that the trader has $1,000, the expectation of the trader in this case is negative by $230. Why? For every 10 times he wins $70.00 in total, but will lose $300, with a final balance of $230.
It may sounds interesting having a winning rate of 70%, but if the trader does not take into account what will happen in the remaining 30%, its might be a beautiful backtest, which began with a beautiful theory, but will not be worth anything.