Hindsight Capital – Second Guessing Your Own Trades

As I sat down to write this post, I worried that the message would be hard to convey.  Anyone who has traded real money has probably toiled with the pain of second guessing (and third guessing) his own trading decisions, even when you’re not having your decisions second guessed by someone else  – which is another problem alltogether.   I had such a clear case of this double-triple-quadruple-regret yesterday as I was managing a long position in $AMRN that I figured I’d try to explain it.

In short, $AMRN was expecting a reply from the FDA on an issue no later than yesterday.  The stock opened up small, and then took off – up almost 30% at one point.   Here’s an annotated chart, with a not-entirely sarcastic view of what was going through my head:

amrn_01_15_14

Now:  I knew news was coming yesterday.  I didn’t know when, and I didn’t know if the company would halt the stock.    Regular readers know that my rule number 1 is: Know What You Don’t Know.   In this case, as the stock ripped higher, I assumed there was something that I didn’t know.   It doesn’t mean that the FDA had made their announcement publicly, but it seemed that the Market knew something.   My biggest trading flaw* is that I almost NEVER assume I’m smarter than the market.    With $AMRN, yesterday, there are two approaches that I was pondering:  1) the stock is up 30% on no news – I should obviously sell some  or 2) markets are efficient enough – someone knows something (even if I don’t know what it is yet) – I should hold my position.

I chose to sell a tiny bit – less than 15% of my position – at $2.52 right after the annotation “stock is ripping, I should sell some” on the above chart.  In a matter of minutes, the stock was trading $2.62 and then $2.72.    Now, instead of thinking “this is even crazier, I should sell some more,”  I was thinking “jeezus – the market ripped through my level so quickly I must be wrong.”   So instead of selling more, I sat on my position.   The stock came back in, and stabilized slightly below the level of my initial sale.   At this point, I had ample opportunity to further lighten my position, and the “market is telling me I’m wrong” logic was out the window – the stock had stabilized BELOW my initial sale trigger.   But I didn’t sell more.   I was now onto my third-guessing of myself:  why didn’t I sell more up at $2.70 ???   At 4pm, the announcement came that there would be no announcement, and the stock quickly traded down to $2.05, which I tried to annotate on the right hand side of the chart with the black line down.

Now we’re on to 4th-guessing myself:  dammit – I KNEW I should have sold more.   Thus, the roller coaster of questioning one’s own trading decisions continues.

This is a hard concept to explain, and one that I certainly don’t have a solution for in terms of “how not to do this,” but it’s essential for traders to limit their rear-view mirror.   Forget about what you did or what you could have done: make your trading decisions in the best possible manner given the price of the underlying and your risk as of right now.  It doesn’t matter that I sold some stock “too soon” at $2.52 when the stock continues to go higher.   What’dya wanna do at $2.70?    And then it doesn’t matter that I failed to sell any more stock as the price dropped back to the $2.40 range:  what now?  Forget about the past.

It’s almost impossible to avoid Hindsight Capital second guessing of yourself – after all, if I’d liquidated my position at $2.50 and $AMRN saw positive news from the FDA last night, ripping the stock to near the $4 range, I’d be complaining that I sold to soon.

My point in this post is that it’s somewhat unusual to have such a roller-coaster of second-guessing one’s own positions in a single day.  I went from being made that I sold some, to thinking I should have sold more, to passing up the opportunity to sell more, to REALLY thinking I should have sold more.

Hindsight Capital.

-KD

disclosure: long $AMRN

* We could argue if it’s a flaw or not – I’d like to say it’s a strength too, but I think it becomes a hindrance because I take it too far.

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