The story about the failure that may set others out for success. This piece was originally published by me on HackerNoon and became a top story.
There is something fascinating about trading, especially cryptocurrency trading. Every time you open a position, you feel like you know something others don’t, something that puts you on a pedestal. When you are right, you feel like you’ve beaten the market, but this is the exact moment when the market starts to beat you.
In late 2016, after spending a great load of time studying the phenomenon of cryptocurrency, I’ve decided to pour all my investment-dedicated capital — around $11,000 — into it. I got so bought into the whole concept that every time I went to bed and closed my eyes, the coin ratios in the portfolio seemed to be flying around my head.
My main investment thesis was straightforward — to increase the amount of outstanding capital I could subsequently use to diversify my investment portfolio between other asset classes. In my mind, this should have produced my personal source of basic income that I could rely on to pursue other ventures of my interest, instead of having to work a day job. I wasn’t dreaming of a yellow Lamborghini or a seaside mansion, as some may think. Not because I follow the ascetic lifestyle or don’t want such things, but rather in a sense that such motivation doesn’t seem to drive me.
After all, the most genius things in life are simple. So was my trading strategy back then. I knew that any market at its inception is based purely on human emotions. In the case of money, we get easily manipulated by fear and greed. Even back then, Bitcoin seemed like a gone opportunity to a lot of folks who just got into the field. I know it because I was one of them. For this reason, I started buying coins that were cheap and able to make a fortune if their price would have risen. Quite a simple strategy, huh? I felt so as well and decided to add a bit of rational counterbalance. If the coin’s fundamental idea seemed flawed — I didn’t buy it.
Most of the time, this approach didn’t work the way I expected. I’ve seen times when the whole market was rising and the value of my holdings was decreasing. This was one of the harshest emotional rollercoasters I had experienced to date. I still don’t know what gave me the strength to pull this strategy off to the end, even when it seemed like the whole market was against me. To make an educated guess, I’d say that human emotions are irrational, so I supposed my strategy should’ve been the same. Finally, my plan has paid off and at the beginning of 2018, I enjoyed a 12x return on my investment peaking at $139,000. This is what Jared Vennet from Big Short would call “getting a sundae with a red cherry on the top”. During my prop trading times, I had this amount of capital on my account in the first week I’ve got to sit at the trading terminal — hence I was happy but not too happy.
Fast forward a year, my trading account balance has gone all the way down to zero. I have made a whole series of mistakes that a trader can make to go broke. Failing to translate my emotional state, I got on the hook of what behavioralists call a “hot hand fallacy”. This is a sort of a gambler’s mentality that prescribes the increased probability of a successive win after several previous ones. On top of that, I constantly had an overwhelming temptation to remain involved with a market that just provided a nice profit. The emotion of greed was just too powerful and I didn’t have a strategy in place to counteract it. It demanded from me an immediate re-entry into the trade to avoid leaving profit on the table. Though my case was a little trickier. In retrospect, I should have stopped trading crypto at all, not only switch between the markets. However, at the moment of decision-making, the desired potentiality of the outcome always seems to outweigh its high improbability.
Nevertheless, I’ve come to realize the importance of any experience in my life, despite how salty or painful it can be. As long as I haven’t been knocked out of the game completely, I gain the knowledge that can’t be acquired otherwise. Therefore, below are the learnings I distilled in the process of my crypto-trading failures. I think you may want to get some popcorn for that.
1. Trading is a numbers game.
In the beginning, I was obsessed with winning trades. I was in constant search of hacks and tricks for identifying profitable trades, making the win rate (% of winning trades) my worship metric. Each time I experienced a losing trade — I was devastated. It’s difficult to overestimate the negative impact these thoughts had on my trading performance. When markets were ripe for trading, I was gun shy. But when it was time to wait, I was full of unearned confidence to open new positions.
Successful speculation of any asset isn’t about how well you identify profitable trading opportunities. In fact, one can be a successful speculator even if 70% of his trades are losing. Take out of your head things, like high win/loss ratio, as it is just a vanity metric novice traders brag about, trying to impress people with millions under management. Most of us can’t stand losing — hence we all fall for systems promising high wins. If you are not comfortable with being wrong a lot, you probably don’t have the gut for this business. So you better address this or spend your money elsewhere.
This game’s secret is simple — make asymmetric bets. Play small with the potential reward being much bigger than your expected loss, ideally 3:1. When you’re wrong, you’ll be wrong small. And when you’re right, you’ll be right big time.
You may think that if you’re an investor, not a speculator, this stuff is not for you. In reality, any investment is speculation, no matter how you look at it. Any decision you make has an opportunity cost that produces trade-offs. At the end of the day, how well you manage risk determines your success in trading, and it’s the most undervalued skill of our lifetime.
2. Emotional management trumps everything.
To say that emotions are profit killers is an understatement. My hall-of-fame trade was long XRP (bought @ $0.22, sold @ $3.32). This was a trade that produced the most profit — 10x ROI. However, in this case, I bet against a strong consensus and this is what made it so profitable. It would have stayed the same if I hadn’t got too greedy when I should have been temperate, and too fearful when I should’ve been bold. I knew that target was reached and the market was about to suffocate, but something still prevented me from closing that position in full. When I finally sold it, I was afraid to open positions with other coins. It still makes a little sense to me.
Paradoxically, being emotional creatures, we underestimate the importance of emotional intelligence (EQ), especially in trading and business. But this is the reason why there are a lot of successful traders who don’t have any formal education for it. To trade profitably, you don’t need a high IQ, but you better have a high EQ. If you got both, you’re unstoppable.
Having a strategy in place on how to manage the worst of human emotions — fear and greed — and finding a way to make investment decisions with a cold mind — is crucial in wealth accumulation. Emotional management requires laborious practice. But if you don’t do it, it will cost you everything.
3. There’s no good or bad trading strategy. There’s an undisciplined execution.
Markets don’t really care what tools or strategies you use to analyze them, as long as you do it diligently. Profitable trading is a process of doing certain things over and over again with military discipline and religious patience.
When I used to work at a trading firm, I had a mentor who helped me a lot in studying markets and their psychology. At some point, he asked me to pass a test, so he could better understand my personality and offer grounded advice on how I could improve as a day trader. The test was somewhat similar to FEAST — an exam that air traffic controllers should pass in order to get the job. In essence, trading is a lot like controlling air traffic. You always have a bunch of information coming in, requiring several cognitive processes to run at once. It turned out I was pretty good at this stuff. However, I was terrible at handling structured routine processes. It seemed like I just didn’t have that kind of patient diligence in me. I guess it’s something Steve Ballmer calls “being hardcore”. For the same reason, I struggle to adopt habits, and all these “21-day rules” bullshit doesn’t work for me. Soon I realized that day trading wasn’t for me either and switched to more passive trading styles.
“Active valor may often be the present of nature, but such patient diligence can be the fruit only of habit and discipline.” —Edward Gibbon, Decline and Fall of the Roman Empire
No matter what I knew about my temperament and personality, I still gave myself the benefit of a doubt with crypto. Even when it was high time for me not to. From January-September 2018, being blinded by my emotional state, I’ve failed to realize that the whole cryptocurrency market has changed. My strategy was no longer in sync with the market and I had to do something about it. When I finally did, I personally was no longer in sync with my strategy. Those two concepts seem similar but they are the exact opposites. The former has to do with the market and the latter with the execution. Yet I behaved like a pendulum blade, swinging above my deposit.
My loss of discipline produced foolish mistakes that turned into an endless cycle. One losing trade produced the next one, and on and on it went. What happened after — you already know. If you are to take only one idea out of it, be it that patience and discipline for trading and investing are like water for human beings. You don’t die immediately but definitely suffer.
4. Trading is an evolutionary endeavor. Play iterated games.
As most people are more emotional than logical, they tend to get carried away by short-term results. Making 100 decisions to earn a million isn’t sexy, we want to make 1 decision that will produce a million right away.
I also fell for this trap by overestimating the potential profit the market could bring me in one shot. I thought that my main problem with trading was the small amount of capital I had to achieve my goal of building a source of basic income. At that moment, I foolishly believed that if I had a lump sum of money, I would be capable of using it wisely from an investment standpoint. In reality, I had no idea what to do with it because I haven’t gone along the way of accumulating it.
As Albert Einstein famously put it: “Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it”. I experienced the latter by assuming that it was some sort of all-or-nothing game. I imagined having the only chance to attain my goal when, in fact, it was an iterated play. Wealth has a tendency to compound over time, there’re no get-rich-quick schemes in its creation. If it seems like you found one, it’s probably someone else getting rich of you.
This was a hell of a year for me. Preserving capital turned out to be even harder than accumulating it. Although it may sound cliché, I still believe that trial and error will always outperform theory. Learning something by fighting in the trenches is far better than observing textbook examples.
Striving for something big almost always leads to painful failures. As it is, we must resort to self-analysis from time to time. We can’t change the past, however, we are capable of adjusting to the future. If you want to really get to know yourself, just become a speculator for some time. Even if you are not able to overcome your character deficiencies to become successful in it, you’ll definitely understand yourself better. And always remind yourself of what Charles Bukowski has famously said: