The danger of the overconfident trader

Yesterday I wrote about a trader struggling with added size and risk. In seeking a solution for this trader one possible area of focus was overconfidence. How does it happen? Why is it dangerous? What can we do to combat overconfidence?

You trade well. You are seeing screens well and the market is trading in a way that allows your strengths to produce outsized PnL. Your firm gives you a bump in size and risk. Everyone around you sees you slaying the market and comes over with the fist bumps and giggles. On a prop desk, you get followed around more by traders engaging you in your trading. You are the BMOD (Big Man on the Desk). You may start to believe you have “figured” this whole trading game out.

We all have systems that we run. I call it our PlayBook. You might call it something else. The truth is some markets just set up very well for us. And it is very possible that our hot streak as trader is because of market conditions. This can often be the case even for the best of traders. And market conditions change.

Take for instance the past few months, where there has been great opportunity in the Low Float space. That opportunity can come and go. Yet a good run by a Low Float trader, then given a size and risk bump, with a turning of good market conditions for Low Float trading and a trader overconfident can be dangerous. That trader can start to underperform and drawdown.

Most recently, the past week was optimal for Market Play traders. Futures traders in particular had a market to crush and outperform. Some of these traders are spending the weekend feeling like the BMOD. Give them added size and risk, add overconfidence because of most recent past results in optimal market conditions, then change those market conditions and danger can visit. Danger in the form of drawdowns and for the lesser experienced traders blow ups.

When we are trading well and our PnL hits levels higher than expected it is time to be cautious. You will want to take your temperature more often on potential overconfidence and double down on efforts to let your trades come to you. Do not sabotage those optimal market conditions and good runs, just check in more often and check to see if you are letting setups come to you that offer good risk/reward in the present environment,

Further, I love the 90/10 rule for traders. 90 percent of your effort is spent each day focusing on your existing trades with edge. 10 percent is spent on experimenting with new setups, with small risk. Record your results on these new setups and size up those working for you. A consistent effort to expand your trading PlayBook allows you to trade with edge in more market environments. This minimizes forcing trades when market conditions change. For example, if you have Market Play edge, you might have been less likely to force Low Float trades this past week, thus minimizes a negative effect of overconfidence.

As the old saying goes, we are not as good as we think when crushing markets and we are not as bad as we think in periods of drawdown. The key is to be actively on the lookout of present market conditions and our trader mental state, so we keep more of our gains during the good runs and give back less when market conditions change.

Nothing wrong with skipping a trade says this Options trader

*no relevant positions

Mike Bellafiore is the author of One Good Trade and The PlayBook. Bella is the Co-founder of SMB Capital and SMB Training. He welcomes feedback and your trading questions at [email protected].