It is our job as traders to find as many variables as possible to leverage in our favor. I’m not suggesting we do anything illegal, but what I am suggesting is the best way to make a trade NOT a gamble is to put the odds in your favor. At the core, trading is a game of probabilities and odds so our focus needs to be on educating ourselves as much as possible, including within the realm of science and psychology. In this particular case, by understanding a very basic concept in psychology, you can better understand a type of trading that is easier. Now just because the trading style/strategy may be easier does not make it guaranteed; however, it again goes back to the point of it allowing you to leverage probabilities in your favor. I don’t want to be a gambler. I don’t want to view the stock market as my casino. I want to view this all as a methodical plan of attack where I can find myself “most likely” outcomes. The topic I talk about in this episode perfectly illustrates why you need to understand and leverage this human emotion within your personal trading.
Clay: Hey, it’s Clay, real quick before I get to the episode, I want to just bring to your attention one of the most common questions I get and it’s a wise question. It’s something that makes sense to be asking it, “Clay, what is a good broker for a beginner? I want to trade stocks. What would you recommend?” Ideally, if it’s got zero commissions and that would be Webull. They’re a fantastic platform and what I like to apply is known as the platform HAT method, H-A-T.
Clay: First off, the H. Does the platform give you the ability to hunt for stocks, to find good stocks? Webull absolutely does. The A, the analysis. Does a platform give you the ability to analyze whatever stocks you have hunted and found and with Webull, it absolutely does and then the T, take action. You can hunt out stocks, you can grow an analysis on them but if you can’t actually take action and put everything into motion, well then a platform is not going to do you very much good. But once again, Webull is very, very beneficial for allowing you to take action with whatever sort of stocks and then strategies you are looking to take advantage of.
Clay: So are they the be-all-end-all? They’re not. There’s lots of good platforms out there but when it comes to the quality of charts they give, when it comes to the zero dollar commissions and the ease at which you can sign up, they have a great app for your phone, I would say at least give them a try. So go to claytrader.com/webull and you can learn more all about them. But let’s now get to the episode.
Clay: This is The Stock Trading Reality Podcast, episode 326.
Announcer: This is The Stock Trading Reality Podcast, where you get to see the realistic side of a trader’s journey. Get inspired and stay motivated by every day, normal people who are currently on their journey to trading success and this is your host, ClayTrader.
Clay: Yeah, I really would like your feedback. A little context here for those of you that are maybe not sure what I’m referring to or maybe you just want to check it out but I’ve had a separate YouTube channel for, I don’t know, the past let’s call it four years where all I did on it was video analysis of individual stocks. So I’d look at, for example just Apple, and then I would talk about just the Apple chart in that one video. It’d be a very short video and then I would do this for many different individual stocks.
Clay: But very, very recently, as of the release of this podcast here, I’ve tried a new format and a new video playlist where now I’m taking 10 stocks and I’m calling it the Top 10 Stocks and then I’m doing all the analysis within the very same video. So instead of having many, many two to three minute videos I’m just having one, basically 15 to 17ish minute video where I go over the 10 stocks in that video.
Clay: So I am curious for those people that maybe are used to and have seen both from the other channel and then this new format, what are your thoughts? I would love to hear thoughts, suggestions, feedback, any sort … criticisms, as long as it’s some sort of constructive criticism. That’s always good too. But I am very open to hearing everybody’s thoughts and feedback on that. So you can reach out to me through either any of my social media channels, contact us through the site.
Clay: But if you are willing to just chime in on that new format, like I said, would love to hear any bit of feedback, good or bad. And as long as the bad is a constructive type of criticism then I am definitely all open for it. But just saying, “Clay, you’re terrible. Clay, you’re pathetic.” Thanks, but I’m not quite sure I can really work with that in terms of the feedback in terms of that new format. So, yes, please let me know.
Clay: As I’m sure you saw by the title of this podcast I am flying solo once again and I think, as of now, I don’t know, maybe I’ll surprise myself but this should be pretty small. Obviously you know because you know the timestamp, you know how long this thing is going to go but as of right now the plan is to keep it short and sweet because … And these are my favorite topics or concepts are ones that are super, super powerful but they just make sense and yet, because they make sense you don’t have to sit there and elaborate on them and go down deep rabbit holes. It’s just, “Oh, okay, I can see that and because I can see that, oh well it makes sense in that application.”
Clay: So, yeah, psychology has said quite a bit about this topic and I’ll give a couple different resources but yeah, psychology says that this certain type of trading is easier and before I just reveal the type of trading I just want to set up a little bit more context here and just throw out a question and see if you have any experience with it, maybe not experiencing it yourself but maybe observing it, but you’re in a stock, a crypto, a forex pairing, a futures contract, whatever, and this thing is just going higher, going higher, going higher, slow and steady, slow and steady, slow and steady, just grinding upwards. “Oh, it went up again. Oh, okay, it went up again.”
Clay: And then, whether it be in a couple of hours, a couple of days but in a very small amount of time, poof, all that progress is wiped away or maybe not all of it but a significant portion of it is just wiped away, in a very small amount of time. So maybe a stock price, for example, is just grinding higher and higher and higher for basically a few weeks straight and then just like that, two days, boom, wipes away all those days of gains. Have you ever seen anything like that in the market? I mean, we all have in the sense of assuming you were around for … I mean, there’s been several instances. The dot com bubble, the financial crisis of 2008 and more recently the … not any big one since 2008 but any time there’s any sort of news.
Clay: Who remembers Greece? Remember the Greece bailout? If you remember that, that was one of those temporary things where markets were going up and up and up and then everybody starts talking about Greece and I mean, it was just boom, down. How about, I don’t know, have you ever heard of the Coronavirus? I don’t know if many people have heard of that. Remember what happens to the markets there? Markets were going up and up and up and up and then in a matter of, what was that, just a week? A couple of weeks, two weeks knocked out multiple years worth of gains, just like that.
Clay: So market crashes, right, have you seen, again maybe not necessarily experienced it yourself but at least observed a market crash? So what is the point of all this? Well, there’s a good, very well researched, very well established track record of, like I said, just good old fashioned research. I’m emphasizing research because, especially when it’s done at institutions and universities, that’s not free. So there has been a lot of money put into this sort of research and it makes perfect sense when you see what all the data suggests and in fact, let me just get to it.
Clay: So, the article that I’m … I’m not going to tell you what it is right now but just the article that I’ll use for the definition because it’s a great definition but within that article where they talk about this topic they cited 14 sources and these sources are all various research papers from universities, big scientific studies and when I was doing my research on it for this and then also just for a YouTube video I did on it, I don’t remember the exact paper but I came across one paper that was over 100 pages long on this topic here.
Clay: Now I only read the abstract of it, so it was a couple of paragraphs but point being what I’m really trying to hammer home is, I don’t want to come across and proclaim any of this like, well, this is what I think about it or this is just my opinion or this is my anecdotal evidence because well, this is how my experience has been so therefore … none of this word like, “Oh well the world revolves me so because I’ve experienced it that must just make it a universal truth”. That’s not what I’m getting at here.
Clay: There is a ton of stuff and all this stuff is, let me, again, let’s see, all right that’s not a good example. That research paper’s from 2018, that’s not that long ago. There we go, 1977, 1998, 1997, in terms of when these research papers were done. 2000, is that 21 years ago? 2000, I’m getting old. Goodness. Let’s see, 1992. So again, this is not some sort of well, Clay … because I’m trying to … I could understand, Clay, well yeah, I get there maybe is a bunch of research but all this research just happened in the past two years.
Clay: So I mean, it’s cutting edge. Maybe this is all stuff is just going to get blown up and proven to be false. Which is a very good rebuttal on your part but I’m just trying to be proactive against that rebuttal and just let you know that this research is, like I said, the oldest one I saw there, 1977 up to … not only is it old but it continues to basically come up as being true because there are still studies that have been done in 2018, 2019. There’s one from 2020. So, yes, it’s been established in the past and it’s continuing to be established.
Clay: And what this is known as and what this topic, very well researched and explains market crashes perfectly and explains why a certain type of trading is much easier, is called loss aversion. I’ll say that again, loss aversion and you are more than welcome to do more research on it if you would like but again, my goal here is to just get … like I said, I’m not going to read much of this article. I’m going to read the opening paragraph because I think it does a fantastic job of just summarizing everything and then it makes it very easy to then translate that to the world of trading and why.
Clay: And maybe you already know where I’m headed with the type of trading that I’m getting at here but and if anything hopefully, I can just offer up some additional context because I can see people sitting there saying, “Well, I don’t know, I feel like this trading is easier. I feel like things just seem to go a little smoother. Is that true or is that just my imagination?” No, I would argue that it’s not your imagination. It is smoother and it is easier in the sense of you just have more things weighing in your favor from a psychology and scientific point of view.
Clay: So what actually is loss aversion? Well, I’m just going to read this definition from the article and like I said, I’m guessing most of you know right where this is all headed. But as the article starts off, and this is from The Decision Lab and this is also the article that cites those 14 sources. But what is loss aversion?
Clay: “Loss aversion is a cognitive bias that describes why for individuals the pain of losing …” and get this here, “… the pain of losing is psychologically twice as powerful as the pleasure of gaining. The loss felt from money or any other valued object can feel worse than gaining the same thing. Loss aversion refers to an individual’s tendency to prefer avoiding losses to acquiring equivalent gains.” Simply put, it’s better not to lose $20 than to find $20. So that’s what loss aversion is and I want to go back to the part of psychology.
Clay: I mean, that is crazy to think that the pain of losing is psychologically twice as powerful as the pleasure of gaining. So it’s not, we’re not talking at the margin, here. We’re not talking, Ah, well it’s in the ballpark. It’s basically a wash. No, no, no, it’s 100% more, twice as painful to be losing. So in other words, as humans we don’t like to lose and because it’s so powerful and because it’s so painful a natural human tendency that would be what?
Clay: Well, let me just stop the pain, right? If you put your hand on the stove and you start to get burned you’re very wise, your mind, the way it’s wired is, “Well, let’s make this pain stop”. So, of course, you’re going to remove your hand from the stove. Nothing complicated there at all. But let’s now move that into the financial markets and the question becomes, okay, well, we’ll go with the stove example. If people feel pain by seeing losses and in the markets you can definitely lose money and if that pain is double as much as the pleasure part of things, well what is the human tendency going to be?
Clay: Well, they’re going to want to stop that pain. They’re going to want, “This pain needs to end. This pain, I don’t like it. I’m scared of it. It’s not pleasant. I just want it to end.” So knowing that, what would that … how would you end the pain in the financial markets? Well, if you’re losing money then, “Well, I don’t want to lose any more. I’m already losing it and it’s already painful and I could lose even more than what I have so I’m just going to get out. I’m going to end the trade.” So they’re going to what?
Clay: Sell, and then of course, that creates more downwards pressure. So somebody else, maybe the next door neighbor, now they’re feeling pain. “Oh, it went down even more. Well, I don’t like this at all. I want this pain to stop.” So they’re going to sell. Well, now the neighbor on the next street over, well they’re, “Oh, my, oh, I mean I was holding okay but oh, this pain is just, it’s getting to much. I can’t stand it. I’m out.” Right. And then it’s just the domino effect and there’s a market crash because people want to stop the pain and the pain shows up relatively quickly when you think about that again, to quote that, “The pain of losing is psychologically twice as powerful as the pleasure of gaining.”
Clay: Can you gain in the stock market? Yes, that’s known as going long. So there is pleasure from making money, don’t get me wrong but when you look at the downside of, well, yeah, but losing money, I mean, that emotion is twice as powerful. That’s crazy. So let’s go full circle. Is there anything you can do out there? And this will sound cutthroat. This will sound brutal but you know what? My job as a trader, your job as a trader is to find things that we can leverage in our favor.
Clay: If you’re not doing that as a trader then you are a gambler. I’m not a gambler. I’m not here to gamble. I value my money. I believe that you want to be as wise as possible with your money and being wise, if you’re going to be a trader is let’s not gamble and how do you not gamble? Well, you need to find and line up and put into place as many probabilities as possible that makes the trade a very, very likely guess. It is still a guess at the end of the day, absolutely. There’s no perfect system. There’s no perfect way to go about it where you can sit there and be like, “I’m never going to lose money again.”
Clay: So I’m not saying that, but there are ways and that’s why you’ve heard of professional trading and consistent trading is while nothing’s perfect there are ways where you can go and say, “All right, that seems to be in my favor. Okay, that seems to be in my favor. Wow, that seems to be in my favor.” So anything, anything that you can find to put in the column of, hey, it’s in your favor, I believe it’s a responsible thing to do. I believe it’s responsible for me, as a husband and father and I’m not trying to get self righteous here. I’m just saying that because a lot of times people are like, “Well, what you’re proposing to do, Clay, is evil. That’s mean.”
Clay: And okay, if it’s mean for me to try to find probabilities that science says I should be using, that psychology says I should be using in order to better the well-being of my family. If that’s what makes me evil, then so be it. I mean, it’s not evil anyway the way this whole all works, which I’ve talked about many times before but my point here is that I’m not trying to come across like, “Oh, see, Clay, look at you …” I’m not trying to be self-righteous at all. All I’m saying is that it’s my job and it’s your job, as a trader, to leverage probabilities and in order to leverage probabilities, well, I mean, you’ve got to find that probability in the first place, right.
Clay: So if I know that there’s something out there that exists with emotions that are doubly as powerful as another set of emotions, you know what? I’m going to go with the set of emotions that’s doubly as powerful because logic would dictate, well if something’s doubly as powerful then that’s going to help, not guarantee anything, but it’s certainly going to help tip things in your favor and what it … it’ll leverage those probabilities.
Clay: So you know where I’m headed with this. Going short, shorting, being a short. If you’re brand new, all that means is in the markets you can make money when prices go down. I remember the first time I heard it, I was like, “What? I thought it’s buy low, sell high.” It is, it is known as going long but there are situations where if you go short then in those situations if a value goes down, so if a stock price goes down, you’re going to be making money and what did we just learn about? What did I just ramble on about?
Clay: In terms of human psychology, how the mind’s wired, yeah, we as humans we don’t like to see things go down and because we don’t like to see things go down, because it causes so much pain, of course we’re going to want to end the pain and ending the pain means, well we end the trade, which means we have to sell, which then is a self-fulfilling prophecy because it can create more selling. Okay, well but if I want to see that happen, if that would actually be good for me, well then why would you not short?
Clay: I mean, that seems like a logical process to take and when you just stop and think about it from a human emotion, how our brains are wired, well, yes, shorting is going to be easier. Now you can definitely get crushed. You can definitely just lose it all because if you’re not disciplined, well it’s not going to end well. But you know what? If you’re not disciplined crossing a busy street it’s not going to end well there too. So like anything in life, if you’re not disciplined, if you don’t have a strategy, if you don’t know what you’re doing, then you better be careful.
Clay: So you’re not wrong to say, “Yeah, Clay, but shorting is really risky because the price can go up and up and up, which is bad,” and that is absolutely true. You’re not wrong at all but you can also get hit by a semi truck crossing a busy street if you don’t have a strategy in place. So yeah, shorting is risky but so is buying if you don’t have a plan. That’s also risky.
Clay: So moral of the story here, obviously, have a plan, which for those of you long time listeners you may or may not have heard that quite a few times here and before we … I’m not going to go deep down this rabbit hole but the whole almost moral argument … “Oh, yeah, but then you’re betting companies are going down. That’s evil. That’s bad.” And the counter to that is, “Well, no, no. Yeah, I think the price may go down and yes, I want the price to go down but if I’m wrong, guess what I got to do? I got to go and buy.” So shorts, in order to exit the trade, have to buy.
Clay: So in other words, shorts are willing to turn themselves into guaranteed buyers. So when you look at it from there it’s like, “Okay, I get it.” They do think it’s going to go down. They are hoping it goes down but I mean, they did just put themselves in a position of buying a guaranteed buyer. They have to buy no matter what, which also makes it very risky, as I talked about because if they’re wrong and the stock goes up and up and up and up and keeps on going up, they’re losses are theoretically unlimited because the stock can go up forever.
Clay: A stock can only go down to zero. So from that sense you can only lose what you’ve put into the stock itself because it’s just going to go down. There are no negative number trading stocks. If a stock goes to zero, zero means worthless but a stock and go up and up and up forever. So yes, it may seem like, oh, well that’s just immoral but it’s not because if the company, if whatever causes the prices to go up, well I mean you’ve heard of short squeezes right? Been going on around quite a bit. Short squeezes and I have no problem with it.
Clay: This is a situation where groups of people have identified, “Hey, look, in that stock there’s a bunch of guaranteed buyers,” because remember that’s what a short is. “Look at all those guaranteed buyers over there. Yeah, let’s go make them pay the price,” and “Hey, all is fair in love and war”. So those shorts, they’re going to be paying the price right now. But I’m not really talking about it from that sense because in that sense those are hedge funds that were taken on massive positions and they can’t just hop in and out. From my personal perspective I am more so talking about it from a small scale retail trader, day trading perspective.
Clay: So I’m not saying, “Oh, well, you just go out there and short and you wait with the hedge fund.” No, that’s a little different but from a day trading standpoint it just makes sense and why those down movements seem to always be so much more violent than the up movements. Now of course, it’s not a universal fact but just from a general premise perspective that’s just why market crashes happen, that’s why stocks can seemingly go down easier and quicker than what they ever go up because well, people are just going to, “Oh, this is not good. This is painful. All right, I’m out. I want the pain to stop.” And when the pain stops, well that’s good for other people because they’re selling in shorts and come in and make money.
Clay: So loss aversion, very interesting topic, a lot of … so much research out there on it. I’m not saying you do need to go in short. I’m just saying that in my personal opinion, what I believe to be my responsibility as a trader is my job is to not gamble and one way to not gamble is to find as many probabilities as possible so that you can leverage those probabilities in your favor.
Clay: And I’m not saying you go do anything illegal. Shorting is 100% legal. It makes the markets balanced and I can see it now, “Yeah, but the shorts manipulate.” I know. The longs manipulate too, okay. Have you ever heard of Enron? That was one big upside manipulation. Analysts on TV, I won’t name her, but a certain fund manager out there with a bunch of ETFs, isn’t her thing on Tesla 3500 or something? Have you ever seen these analysts that give all these massive upside price targets? That is a form of manipulation. You are trying to get people to believe that a stock is going to go up way higher so people keep on buying, causing the price to go up.
Clay: So it happens all over the place. Shorts is a manipulation. Yes, absolutely. People manipulate things, try to manipulate things so prices go down. But they also manipulate things on the opposite side. Longs try to manipulate things to get prices to go up. So, I mean, it’s both sides. Now, yes, it’s easier to try to vilify one side compared to the other but as far as exclusively only the shorts doing it, that’s just not the case. I’ve heard all the arguments so I can see whenever I say something and I’m like, “Okay, I know somebody’s going to be thinking that or saying that.” So I’ll try to be a little bit more proactive against it.
Clay: But like I said, I’m all about probabilities. I’m not here to gamble. The stock market is not my casino. I’m trying to treat the stock market as my ATM machine but in order to make that ATM machine work as best as possible you’ve got to find those probabilities, figure out how you can think you can best leverage those probabilities and put them all on the side of your favor. That way you can try to tip the scale to make it a winning trade and that’s why I short. That’s why I short way more often than I go long. I still do go long so don’t get me wrong but that’s one of those questions, “Clay, how come you only go short? Clay, why does it seem like you only go short? Clay, all I ever see you do is go short.”
Clay: Well, this is why, loss aversion. Science says I should be more short biased. Maybe that’s what I’ll do. I’m just going to start to blame science. That’ll be good. That’ll be, no, I’m not immoral. Science is immoral because science says I should do it. Maybe that’s what I’ll do going forward.
Clay: But, hopefully this helps. Hopefully, this at least gets you to open your mind a little bit and make you aware of some things or if anything, just build confidence that no, you’re not crazy. No, you’re not seeing things. It’s not an illusion that prices seem to go down easier, that prices seem to go down faster than they go up. It’s just, it’s science. So science says you should short. So whether or not you want to take that advice from science that’s up to you but if you want to learn more about it, like I said, there’s all sorts of research out there on the topic.
Clay: Thanks for listening and hopefully this helps.
Announcer: This has been The Stock Trading Reality Podcast. Thanks for taking the time to hang out. To learn more about Clay and the ClayTrader community, including the trading team, premium training and more, visit claytrader.com.