Are you looking for Nirvana when you invest? Forget about it. It doesn't exist.
Let's start with two big losers that relied on financial data and ended up on the trash heap. First we have Long Term Capital. Founded by John Meriwether, Robert C. Merton, and Myron Scholes. They formed the largest hedge fund in the U.S. in the 1990s with an estimated 4.6 billion in capital. Merton and Scholes had won the Nobel Prize in economics for developing a pricing model for options called the "Black Scholes Model." Since both men had won the Nobel Prize, this should have been Nirvana. Now comes along the Russian financial crisis and Long Term Capital was on the wrong side of history. They took such a beating that the Federal Reserve had to help bail them out for a time until they went bust in 2000.
Next we have a Chinese peasant named David X. Li. Mr. Li earned advanced degree in mathematics and eventually ended up working for JPMorgan Chase & Company (NYSE: JPM) He too had found Nirvana in a formula using Gaussian copulas which produced a correlation of several numbers based on Credit Default Swaps (CDSs). A correlation produces a single number. So now Wall Street had found Nirvana, a single number, on which to bet the farm. Traders didn't even know what the number was all about but they traded like maniacs using Li's correlation. Now comes the sub prime crisis and Li's number doesn't work anymore. Wall Street trading houses lose billions of dollars and the Federal Reserve bails them out. Li fled back to China.
Then we have the more ridiculous correlations. Money manager David Leinweber, in a spoof exercise, correlated butter production in Bangladesh with US stock prices and found it to be 75% accurate in predicting what the stock market would do.Other crazy sayings include: "go away in May and come back in the fall." If you did that this year you missed one of the biggest bull moves in market history.
What can you do to protect yourself from falling into one of these trading traps. Here a few common sense rules.
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Know yourself. What kind of risks are you willing to take? What kind of emotional boundaries do you set for yourself? Many traders get caught up in letting their emotions rule their trading. Do you trade long term or short term? Do you use a trading system? Do you analyze your mistakes? How accurate are your trades?
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How accurate is your overall system? Some systems work well for a year or so, then some unknown factor enters in your trading that throws your system out the window.
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Trading systems look at the past and can never predict the future.
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Be willing to adapt to a new and better system.
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Don't fight the market. When you're wrong get out. Don't let your ego control your trading.
And finally, believe in yourself. You will only be successful to the extent that you believe that you are successful. Above all, use your common sense.
Please add any other suggestions you may have to improve your trading.
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