Forex Trading and Gambling Similarities – Words from William Eckhardt

A basic theme that runs through Eckhardt’s comments is that what feels good is uaually the wrong thing to do. As one example, decision theorists have demonstrate that people consistently prefer to lock in a sure win rather than accept a gamble with a higher expected pay off. They also prefer to gamble with a loss, even when the bet has a worse expected outcome than a sure loss alternative. These instinctive preferences runs counter to perhaps the most fundamental principle of successful trading. Cut your losses short and let your profits run. Just because this aphorism has becom a cliche makes it no less valid.

Another example of counterproductive instincts is what Eckhardt terms “the call of the countertrend.” Selling on strength and buying on weakness appeals to people’s desire to buy cheap and sell dear. While such trades may feel better at the moment of implementation, following a counter trend strategy is almost inevitably doomed to failure.

Trader’s excessive concern regarding their current positions involves yet another example of the detrimental impact of gravitating toward comfortable actions. Taking profits before intended objectives are reached so that the market won’t take away the gains, holding positions beyond intended loss liquidation points in the hopes that the market is only witnessing a retracement, and liquidating positions before stop loss points are reached because of the fear of losing are all examples of actions intended to make current positions feel better. However, all of these actions are likely to negatively impact long-term performance.

People’s natural inclinations also lead them astray in systems trading. The more closely a system is fit to past price behavior, the more impressive the historical simulations will appear and the better the trader will feel about using the system. Yet, ironically, beyond a very limited point, the more effort expended to make a system fit past price behavior more closely, the worse actual future performance is likely to be. The desire to design a system that looks great also leads people to accept favorable simulated results without sufficient scrutiny. Very often, great results are simply the consequence of error or naive methodology. Eckhardt’s advice is that system designers should believe their results only after they have done everything to prove them wrong.

Eckhardt proposes that the tendency to do what is comfortable will actually lead most people to experience even worse than random results in the markets. In effect, he is saying that most people don’t lose simply because they lack the skill to do better than random but also because natural human traits entice them into behavioral patterns that will actually lead to worse than random results – a particularly compelling observation. If Eckhardt is right and I believe he is the critical implication is that our natural instincts will mislead us in trading. Therefore, the first step in succeeding as a trader is reprogramming behavior to do what is correct than what it feels comfortable.