Let’s Make A Deal: Trader’s Edition

Learning to control your emotions can be one of the hardest challenges for many traders. These tests are often brought on by downturns in the market and/or drops in positions. Trading with full emotion is like driving with your eyes closed. You may make it a short distance but the chances of you safely getting to your destination unharmed are extremely unlikely.

A couple of weeks ago I was watching the movie 21, in which there’s a discussion of the Monty Hall Problem. It’s based on the game show Let’s Make a Deal, hosted by Monty Hall in the 1960’s in which there are three doors with a prize behind just one of the doors. You are the game show contestant and are given the choice of one of the three doors. After making your selection the host opens one of the doors and then gives you the choice of changing your selection. This is where emotion begins to leak into our thought process. No one wants to be wrong and the less action taken is often believed to minimize the ability of a wrong choice. So you stick with your first pick and two-thirds of the time you go home with nothing but a gift basket.

As traders each week, each day, each tick of the bid-ask spread we are presented with the choice of buy or sell. Each decision offers a zero-sum outcome. You either made money or not. Not making money does not equate to failure and many new traders have a hard time coming to that realization. Without a game plan when a position begins to go against you emotion can start to seep into your thought process.

This is what happens to contestants on Let’s Make a Deal. They are presented with the option to change their choice of doors after one door as been opened and reveal the prize is not there. This slight change in the variables, going from three doors to choose from two doors has a significant impact to the odds of you winning the prize. Since Monty Hall knows which door the prize is behind he knows which set of doors to choose from to open. The odds increase to two-thirds if you change your selection while they remain just one-third if you keep your original pick. The math and the odds are in favor of changing doors but many contestants let their emotion take over and they chose to keep their first choice. It’s as if they are frozen of fear of being wrong that their brain doesn’t allow them to act rationally.

As traders we perform our duties and we execute our trades not for entertainment but to follow a plan that should led to a profit. Allowing emotion to leak into that process can keep us from thinking clearly and choosing the wrong door. And unlike a game show, the market doesn’t give you a consolation gift basket.

So which door would you chose?

Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer. Connect with Andrew on Google+, Twitter, and StockTwits.