Asking The Right Question 

Mistakes in Trading .Com

Asking The Right Question

One thing that is very important is to ask the "right" question. This is an extremely simple concept but some traders are doomed to failure because they only look at things one way and therefore don't examine all of the possible outcomes in a given situation. When you are considering entering a given trade there are two primary questions to be asked and answered. The first question is "what is the likelihood that the market will move in the right direction?" The second question is "what will I do if the market moves against me?" The problem is that traders often focus too much attention on the first question and not enough on the second.

Your answer to the first question represents your theory regarding what you think is likely to happen next in the market. Your answer to the second question represents your failsafe plan should disaster strike. In the long run what will make the biggest difference in your success or failure is not your prediction about what is going to happen in each situation, but how you react when things don't go the way you expect them to. This is a case of theory versus reality. In theory, you may feel, based upon your analysis, that your risk on a given trade is low. That's all well and good, but what if the reality of the situation turns out to be different? Are you prepared to deal with that situation? This is what asking the right question is all about.

When a trader considers buying a contract of Soybeans he asks the question "will it go down?" If he enters the trade then obviously he believes the answer is "no" or he wouldn't put the trade on in the first place. However, answering this question provides a trader with nothing more than the rationalization for entering into and holding onto the trade. No matter how certain he is that his analysis is correct, statistically the odds remain 50/50 that the market will rise after he buys. Once he puts the trade on all the brilliant analysis in the world isn't going to help him one bit. The only thing that matters from that point forward is "does he make money or does he lose money?" Regardless of what a trader thinks is going to happen and why, the market will move however it sees fit.

By putting all of their focus on the first question traders can fall into the trap of false confidence, which can cause them to not bother answering the "right" question which is "what will I do if the market goes the wrong way?" A trader may reassure himself by saying "I'm so sure the market is going up that I'm not worried about the downside" (which is tantamount to whistling past the graveyard). Try to argue with this trader by asking him "but what will you do if the market does go down?" and he will likely counter with a list of reasons why he doesn't think it will, as if any of them really matter.

To borrow a stock market example, a trader takes a huge position in Wal-Mart stock. When asked what he perceives his downside risk to be he replies "Nil." His reasoning? "Wal-Mart's practically got a monopoly" (whatever that means). One thing it does mean is that this trader has not asked the right question. He has answered the question "will it go down" with a reason why he believes it will not. He is also using this answer as a rationalization to not bother answering the more important question "what will I do if it does go down?" This trader could be standing on the edge of a canyon but he refuses to even acknowledge the risk in front of him.

The purpose of asking the right question is simple. In order to survive long-term, in each situation you must be prepared ahead of time to deal with the potential risks involved. Be sure to constantly ask yourself, "what is the worst case scenario and what will I do if it unfolds?" If you always have an answer to this question you have the potential to be a highly successful futures trader. On the other side of the coin, if you find yourself reassuring yourself that, based on your analysis, you have nothing to worry about, then you DO have something to worry about. If you have no real contingency plan for protecting yourself if you turn out to be wrong, be afraid, be very afraid. Remember, it only takes one bad trade to wipe out a lot of hard earned money. If you don't believe me, ask Victor Neiderhoffer.

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