The market is risky. There is nothing about it that isn’t risky. Risk never changes, your understanding and ability to make decisions based on what you are likely to achieve does change.
One of the most important things about risk is liquidity. Agoraphobia is a “Panic disorder with agoraphobia is an anxiety disorder in which a person has attacks of intense fear and anxiety. There is also a fear of being in places where it is hard to escape, or where help might not be available.” – A.D.A.M Medical Encyclopedia
This plays out in two ways:
- Physical limitations: The ability to get out of a position because there are ample orders on the other side of your trade. We have seen many positions get too big to win. Amaranth Nat Gas trade, CDS, and most recently the London Whale Trade. For most of us we will never have the ability to get into a position that size but if you trade penny stocks you might find yourself in trouble and with some serious momentum trades.
- Mental limitations: As it is often said “second trade first”, meaning have your exit in mind before you get into a position. We have all been there before. Not getting out of a trade where we should have. Now we are down money or gave back open profits. We are essentially trapped. The trade begins to own us. We have created an extra branch on the decision tree that does not need to be there. The last thing a trader who makes a mistake needs is more options. It is like giving a junkie the keys to the pharmacy, nothing good happens. You are now forced to pick from two bad choices and form two bad habits. If you get out right away, usually the best decision if you can make it, you will watch the trade and it might go your way. Now you are going to think twice the next time. Or even worse you stay in the trade and make money. This will make it nearly impossible to make the right decision next time. But it only takes one time for the market to not come back and we lose months, years, or a life time of work. Risk will always catch up with you, ALWAYS.
The physical liquidity issues are easier to avoid, do not trade illiquid markets or have a position so big to make the market illiquid. Mental liquidity is risk that all traders take when they do not have a plan for an exit or the discipline to stick with it. Do not trap yourself and avoid the anxiety of the agoraphobic trader.
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