In a book I am reading I came across a story that reminded me of a research paper I had read some time ago and I immediately saw a connection with the studies results and my own trading.
Dan Ariely is one of the leading academics in the field of behavioural psychology. He did 2 Ph.D’s one in psychology and the other in finance, as we say in Yiddish, so much nachas. However, Dan has not had an easy life as a young teenager he suffered major burns to 70% of his body keeping him in and out of hospital for 3yrs undergoing excruciating treatments which plague him to this day.
Dan is naturally an inquisitive person and his research probes some of the most fascinating choices we make on a daily basis. Through his torturous skin graft treatments he encountered face to face the well known dilemma of whether to rip a plaster off a wound quickly or slowly.
Nurses in a burns unit have been trained to do it quickly to get the pain over as quickly as possible. Dan wanted to know from proper research if that was indeed the best way for the patient. There were many factors to take into account but I will cut to the chase. It turns out that after all things considered the patients found that ripping slower than fast was their preference. It is easy to understand from a nurses perspective; they want to get the pain over with as quickly as possible, but the problem is their is bias from the nurses perspective as they want to get their pain over as quickly as possible not necessarily taking the patients best interests into account.
Mike’s Freestyle Drawdown Chart
I noticed how I can apply the insights on ripping fast or slow to my own trading experience around drawdown. Losing money (drawdown) is painful so there is a natural inclination to want to get it over with as quickly as possible to remove the pain. The problem with this approach is that it actually leads to more pain. I wrote a blog post, “Drawdown Leads to Triple Penance” a few years ago, about a natural mathematical relationship to drawdown recovery taking 3x longer than the drawdown from its MaxDD point.
The takeaway I am trying to leave you with is that following common wisdom is not always the most rational approach. While nurses believe ripping plasters faster than slower is better for the patient, they are actually acting with a bias and putting their own emotions before their patients.
The same applies with trading and encountering drawdowns. We encounter this pain that we want to make go away for ourselves and our investors. As investors we put additional pressure on our managers to perform when they are in drawdown and as traders we put extra pressure on ourselves to get out of the uncomfortable/painful experience of losing money. However the best approach to handle drawdown is to embrace it. There is only one way to make money and that is to risk money, so accept it is part of the journey to be in pain. By trying to get out too quickly you are probably going to add to your pain.
So in conclusion, learn to “embrace the burn”!