Keeping Small Errors from Turning into Big Mistakes

09/23/2010 12:01 am EST

Focus: STRATEGIES

Michael Radkay

President and CEO, RDS Trader, LLC

If you are a golf fan, I'm sure you heard about Dustin Johnson grounding his club in what Whistling Straits officials deemed a bunker on the 72nd hole of the PGA Championship. Dustin didn't realize it was a bunker, and the penalty for grounding his club cost him a shot at winning the tournament. And, how about the recent story about a guy that drove a ball off the fairway into the rough? When he took his next shot, his club struck a rock and created a spark that set off a 25-acre fire. They needed 150 firemen to put it out. Expensive shots to say the least! You might be wondering why I am mentioning this, and what does this have to do with the financial markets?

At times I feel, in some respect, that the lessons learned in golf are very similar to the lessons learned in trading the markets. When you pull out the "big dog" (a.k.a. your driver) or try and put on that home run investment idea, most often, you land way off target with devastating results. Both of these golfers went for it despite their original poor shots and it cost them. I want to hit the big shot myself just as we all do, but what wasn't talked about in both of these stories was what you should do when things start out badly.

When the investment clearly gives you negative signs from the start, the results tend to get worse. As a society of competitors, we often times do not want to admit our mistakes. We get so cocky that we think we can play ourselves out of the bad idea. Big mistake! How about when Lehman Brothers decided not to take the offer that would have kept it in business today? It’s like they never existed. How about Nick Leeson, who didn't take his medicine, only to take down a 233-year old bank? The list goes on and on.

I learned a hard lesson early in my trading career. A couple of years before I went off on my own, I was trading part time and working for an order-filling firm full time. It was January 1995 (I recall it clearly) and I put on a short position with my own money in bonds (meaning I thought prices where going to fall). You guessed it; prices kept going higher—ouch! I said to myself, "Don't worry, it will come back." Sound familiar?

After three days of torture, I finally took my medicine and covered the trade for a $3,000 loss. I never risk the house anyway, but as a competitor, it pissed me off! I want to win! I missed the original big hint. The trade started out badly and immediately went $1000 against me. Thirty minutes later, it gave me false hope and I was only down $500. Instead of accepting the early clues and taking my medicine, I kept the trade, and 72 hours later, the loss had soared to $3000 and I had enough. In review, if I took my medicine, it would have saved me $2500 and 71.5 hours of my life.

The golfer who started the fire reminded me of that early lesson, which is simple: Take your medicine, admit your mistake, and move on to the next idea. It has helped me to survive and thrive today. Going a little further when thinking about that trading day, I started to laugh when I calculated the loss if I was still holding the bad idea today, 15 years later. It would be close to $250,000 and never even smelled a hint of profit over the years. I picked the bottom.

Instead of saying to myself, "You suck," I said, "Great lesson!" If you know something about the bond prices since 1995, they have climbed a bit higher since then! The point of this story is take notice of what you originally get yourself into. If things start out with bad results feeling like a hard gut punch right away, remember that you've been notified to wake up. If your bad habit doesn’t get you now, it will eventually.

By Michael Radkay of RDSTrader.com

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