October 5, 2014

The secret to who is a good trader or investor is meditation

Two of my favorite books that are related to the stock market are Market Wizards and The New Market Wizards by Jack Schwager. What distinct these books from most other books related to the stock market is that they include chapters about psychology. If you didn't know it, it's very important to be aware of your own psychological limits if you are traveling the ups and down of the stock market. 

One of the traders interviewed in the book Market Wizards is Richard Dennis. He understood the importance of psychology if you want to become a better trader or investor. According to another book about Richard Dennis, The Complete TurtleTrader by Michael Covel, Richard Dennis never read any stock market news, such as crop reports or the latest unemployment numbers. What he read was the magazine Psychology Today to keep his emotions in check and to remind him how overrated intuition is in trading. While other traders woke up as early as possible so they had the time to read the latest news, Richard Dennis stayed in bed until the last minute before arriving to the exchange just as trading started. 

One common psychological mistake most novice traders and investors make is that they are buying stocks and other assets when "everyone" else is buying, like during the so-called tech bubble at the turn of the century. When the stock market began to fall, after the burst of the tech bubble, they who had earlier bought expensive stocks were now afraid of buying cheap stocks because everyone else was as afraid of losing more money as they were. 

Another common mistake is called confirmation bias (Wikipedia has the full list if cognitive biases). Let's say you've invested in gold. It's common that you will read information saying gold is a good investment and you confirm what you already know, but you also tend to reject all articles saying gold is a bad investment. 

So how can you control your emotions? It's super-easy to read about psychology, but it's much harder to remember and apply what you've read when you are losing all the money you've saved throughout your life. One solution to this problem can be meditation. 

According to the podcast The Tim Ferriss Show, where Tim Ferriss interviewed Joshua Waitzkin, the secret to who is a good trader or investor and who is not is actually meditation. Joshua Waitzkin is coaching the top hedge fund managers. When Tim Ferriss asked him the question "What are some habits that you've observed that you find interesting?" Joshua Waitzkin answer was: 
"First of all, meditation. Meditation is as deep and as powerful tool as I can possible describe. Maybe six or seven years ago when I was first talking about meditation with guys in the finance world it seemed like some strange thing for them to take on. But as more and more people are integrating it into the process, you wouldn't believe how many of the most powerful players in the world are meditating very deeply."

According to this Bloomberg article, hedge fund managers like Ray Dalio, Paul Tudor Jones, and Michael Novogratz, are fine-tuning their brains with meditation. But what's meditation? Meditation used to have this reputation as a hippie thing, but Samurai practiced meditation to become killers that are more effective. You've probably seen those Buddhist monks who are sitting with their legs crossed and their eyes closed. They are not praying and meditation is not a religion – what they are doing is they are trying to focus on the present. Focusing on the present is actually very difficult. Next time you are brushing your teeth, try to focus on brushing your teeth. But you will probably notice that your mind will wander away and you will think thoughts unrelated to brushing your teeth. 

If you can focus on the present, you will be able to move away from your other thoughts and make better decisions. If the stock you've bought is falling through the floor, you have to ignore your bad thoughts to not panic and try to remember the cognitive biases to not sell the stock just because it's falling.

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