The God Effect and it’s shocking danger to your financial health

I’m aware that I’m in a very vulnerable position with my day trading right now.

I’ve had five days with barely a losing trade … lots of winners … am hitting new highs …

And I’m dizzy with a wave of overconfidence.

So, what am I complaining about?

This is the ‘God effect’ that wipes out the cocky trader!

How winning can be more dangerous than losing

We often think of our most vulnerable times as a trader are when we’re in drawdown, suffering a run of losing trades. However, when we’re losing money, we’re generally already in ‘protection mode’ – battening down the hatches with reduced position sizes and getting more cautious about the trades we take.

In contrast, when we’re winning, we’re often increasing our position sizes (even if it’s still the same percentage of our growing pot size) … and we get more gung-ho about which trades we choose to take.

Winning is shockingly dangerous to your financial health.

There’s a statistic that 30% of lottery winners end up filing for bankruptcy (compared to around 1% of the general population). I couldn’t find good stats on this, but there’s a clear sign that winning money makes us extremely vulnerable to losing money!

So, what goes wrong?

The most dangerous behaviour of the overconfident trader is over-trading.

You’ve got a methodology that’s making money, so if you repeat it more often, you’ll have even more success … right?

Wrong!

This is most risky for day traders. There’s always something going on in shorter timeframes, and we can always find an ‘almost’ signal to try our ‘infallible’ trading skill at!

Stick rigidly to trading rules. Don’t be tempted to bend them because you’re feeling lucky or reckon you know better.

And watch your position sizing

How do you decide how much you’re going to risk on a trade?

1. Do you risk a fixed value? (If so, you aren’t tapping into the power of compound investing.)
   
2. Or a fixed percentage of your bank size? (This way, as that bank grows, your position sizing will also grow. And if your bank size decreases, your position size will also shrink, helping to protect capital.)
   
3. Or do you adjust risk according to how much you ‘like’ a position? How confident you’re feeling? (This emotional response to position sizing leaves you most vulnerable to overconfidence.)

The most sensible approach (I’d argue) is option ‘2’, which gives us direct access to the power of compound investing.

However, in periods when your bank is growing fast, beware of building to your position size too quickly. You may be increasing your risk beyond comfortable levels. Consider putting some of your profits aside to top up funds when you hit your next drawdown.

Warning signs that you’re suffering from the God Effect:

• Do you think you understand the driving forces behind price behaviour? Find yourself making comments like … ‘Prices have turned here because of this support line I drew in earlier’? Markets are highly complex – don’t fall into the trap of oversimplifying the causes of price behaviour.
• Do you beat yourself up because you missed a winning opportunity? FOMO can override natural caution in selecting the best opportunities.
• Are you worried about getting it wrong? It should never matter if we get a particular trade wrong … even a run of trades. What’s important is that you keep your long-term edge.

How to trade with confidence, not overconfidence

It’s fine to trade aggressively and with confidence – we don’t want to be hesitant and miss the best opportunities.

However, I recommend you match your aggressive profit-hunting with aggressive loss-planning. Plan for your losses with the same determination as you work towards your winners. It’s not a simple task … to trade with confidence, while also trading on the assumption that every trade you enter will end in a loss. But it’s exactly this kind of planning that leads to long-term success.

And finally, a little rule that’ll help prevent giving back your winnings: quit while you’re ahead.

I’ve talked a lot in the past about drawdown limits … but we can use the same theory on profitable days. When you’ve hit your profit goal for the day – JUST STOP TRADING.

With that in mind … I’m turning off my computer and heading to put my feet up!

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