*****One blogger/trader/educator who does a wonderful job of sharing research on elite performance and how it relates to trading is David Blair, The Crosshairs Trader. Below is his latest post for the SMB Trading Community. We hope you enjoy!***** — Editor’s Note
Do traders manage risk or uncertainty? Is there a distinction between the two? Does it matter? When we hear the Wall Street maxim that “the markets hate uncertainty” or the trader’s maxim “manage the risks and profits will take care of themselves” what do they mean? Should we passively accept such long held maxims at face value?
Traders do manage risk. We do so when we put on a trade risking X amount of money to make or lose X amount of money in X amount of time, much like an entrepreneur risks X amount of money and X amount of time to see his venture succeed or fail. Managing risks means accepting any number of possible outcomes associated with that risk. For the entrepreneur the business either succeeds or fails. The success can be phenomenal or a grand failure or break even with nothing gained or loss but the time expended. Oftentimes, the entrepreneur will sell his failed business venture only to see it succeed without him. For the trader, the outcomes can range from a small percentage winner to a big one, break even, a small percentage loser to a big loser (due to unforeseen news). As in the case with the entrepreneur the trader oftentimes will exit a losing position only to see it turn and run without him. The uncertainty is in not knowing which outcome will unfold. The risk is in accepting any number of uncertain outcomes.
The trader can enhance his or her performance not only by managing risks (X amount + X time) but by managing (i.e., accepting) the uncertain outcomes (all of which are known) associated with those risks. The trader, therefore, should embrace uncertainty and the risks associated with it, for this is where traders begin to hone their craft on the way to greatness.
The following articles can provide greater insight into risk versus uncertainty.
“While anything is possible (which is the essence of uncertainty) everything is not equally probably (which is the essence of risk).” (AmosWeb)
“The practical difference between the two categories, risk and uncertainty, is that in the former the distribution of the outcome in a group of instances is known (either through calculation a priori or from statistics of past experience), while in the case of uncertainty this is not true, the reason being in general that it is impossible to form a group of instances, because the situation dealt with is in a high degree unique.” (Frank Knight via Library of Economics)
“We never know what the roll of the dice will be, but we do know its one of six choices.” (Barry Ritholtz via The Big Picture)
“For investors, not being able to distinguish between risk and uncertainty is hazardous to their financial health.” (Frank A. Schmid via St. Louis Fed)
“The uncertainty of the future is a truth that applies equally well across the broadest range of human experience.” (Nick Werle via N+1)
David Blair
THE CROSSHAIRS TRADER
www.thecrosshairstrader.com
http://www.
Related blog posts:
Confirmation Bias and Trading
The Eight Principles of Elite Traders
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