Monday, May 19, 2014

Don't Overanalyze

If you're not making mistakes, then you're not doing anything. I'm positive that a doer makes mistakes.
John Wooden
When your hard earned money is on the line, there's a strong urge to be extremely careful. Why? If you should make a mistake, you could end up taking a big loss, or worse yet, you could find yourself in a major drawdown situation.

It's a natural human tendency to be averse to risk, but if you're not careful, you may be afflicted with a severe form of analysis-paralysis. Although it is often the case that an analysis of all possible alternatives and all possible consequences of one's decisions is the hallmark of good decision-making, too much analysis can be and often is a distraction.

The question becomes; why are we consumed with making a mistake? Throughout our lives, we have been taught to make prudent decisions rather than acting on impulse. Great thinkers, such as Benjamin Franklin, advocated evaluating the pros and cons carefully before making a decision. Research studies have shown, for example, that cultivating a deliberative mindset helps people focus on and consider incoming information and decrease the influence of self-serving decision-making biases.

A study by psychologists Dr. David Armor and Dr. Shelly Taylor suggests that in some cases, it may be wise to just quickly choose an alternative and focus all your energy on achieving an objective. In a well-controlled experiment, participants were randomly assigned to one of two conditions. In the deliberative condition, participants were asked to decide between two equally effective strategies to obtain a reward, before using one of the strategies to reach an objective. In a second condition, participants were not given a choice, so they would immediately focus all their energy on using a single strategy to achieve the desired goal. There were clear advantages to focusing on a specific strategy, rather than deciding between two options. Participants who did not have to choose, and did not deliberate, showed greater determination, commitment, curiosity, and confidence than those who did. They also viewed the task as less difficult and performed better.

Many trading decisions must be made quickly before market conditions change. Through experience with the markets, you can analyze information quickly and reach a decision. While trading, it does not help to deliberate too much. It just doesn't pay off. You may not always be right, and you may have a few losing trades, but that's the nature of the game. Through a carefully devised trading plan and risk management, however, you can minimize the impact of a single losing trade, and make enough winning trades to come out ahead. So when you start to see yourself over-analyzing and becoming paralyzed, stop! Just put on the trade already. You'll trade more profitably in the long run.

Enjoy Your Weekend!