Being Right or Making Money

In technical trading, the concept of “Being Right or Making Money” highlights a crucial mindset shift for traders. While “being right” involves predicting market movements accurately to validate one’s analysis, “making money” focuses on profit and risk management, emphasizing adaptability over rigid accuracy. Traders driven by profit prioritize capital preservation and respond dynamically to market signals, reducing emotional biases. This approach promotes consistent returns by focusing on flexible strategies and disciplined exits, ultimately underscoring profitability over ego in successful trading.

Learning Objectives

In studying “Being Right or Making Money” for the CMT exam, you should learn to differentiate between the desire to be correct in market predictions and the objective of consistently making profits. Examine how ego-driven trading can lead to holding onto losing positions, while profit-focused strategies emphasize flexibility and risk management. Evaluate methods that prioritize capital preservation, including stop-loss orders and trend-following, to enhance profitability. Additionally, understand the psychological impact of trading mindsets, such as confirmation bias, and explore techniques to avoid emotional attachment to trades. Apply this knowledge to identify effective, profit-centric trading strategies in practice scenarios.

In technical analysis, a central debate exists: should a trader aim to be “right” in their predictions about market direction, or should they focus primarily on generating consistent profits? This philosophical and practical dilemma highlights the difference between ego-driven trading (proving one’s market calls correct) and profit-driven trading (focusing on sustainable trading practices).

Concept of “Being Right” in Trading

The concept of “Being Right” in trading often refers to the mindset or approach where traders seek to make correct predictions about market direction or price movement. However, in professional trading, being “right” about the market is less about individual wins and more about overall profitability and consistency. Here are some key aspects of this concept:

Definition and Common Mindset:

• Being “right” in trading refers to the desire to predict market movements accurately, often as a matter of personal satisfaction or ego.
• Traders with this mindset may hold a firm conviction about market direction, staying in trades to validate their views, regardless of changing market signals.

Risks and Challenges:

• Bias Reinforcement: A focus on being right can reinforce cognitive biases, such as confirmation bias, where traders selectively focus on information that supports their view.
• Missed Signals: The market constantly shifts due to new information, and ignoring these signals to hold onto an opinion can be costly.
• Emotional Attachment: Traders who prioritize being right may become emotionally attached to their positions, making it difficult to cut losses.

Impact on Trading Decisions:

• Leads to “holding and hoping” behavior, where traders maintain positions longer than advisable.
• May result in missed opportunities as traders resist market movements that contradict their predictions.

The Profit-Centric Approach

The Profit-Centric Approach in trading focuses on overall profitability and long-term financial gains rather than the accuracy or frequency of correct predictions. This approach emphasizes maximizing profit potential while managing risks effectively, often prioritizing strategies and practices that consistently yield positive returns over time.

Definition and Mindset Shift:

• Focusing on making money involves flexibility and adaptability. Profit-focused traders prioritize capital preservation and risk management over being right.
• These traders make decisions based on market conditions, recognizing that markets can behave irrationally or unpredictably in the short term.

Strategies for Profit Focus:

• Trend Following: Rather than attempting to predict exact market tops and bottoms, trend-following strategies focus on capturing the bulk of a market move.
• Risk Management: Prioritizing stop-loss orders and other risk control methods to prevent large losses, even if it means closing a position at a loss.
• Letting Go of Ego: Successful traders often adopt a mindset where they see losses as part of the process, focusing on the overall profitability of their trading system rather than the outcome of individual trades.

Techniques for Adopting a Profit-Centric Mindset

• Developing a Trading Plan: Craft a well-structured plan that outlines entry and exit points based on market signals rather than personal bias. Include specific risk management strategies.
• Learning to Accept Losses: Losses are part of trading. Recognizing that not every trade will be profitable helps reduce emotional responses to losses and promotes a focus on long-term success.
• Process Orientation: Process orientation is the focus on following a systematic trading strategy with discipline and consistency rather than reacting emotionally to individual trade outcomes. By emphasizing process, traders improve their chances of long-term success.
• Continuous Education: The market evolves, and so must the trader. Staying updated on technical analysis tools, market trends, and psychology can help traders avoid becoming too attached to their original predictions.
• Risk Management: This technique involves setting predefined limits on potential losses for each trade and using tools like stop-loss orders to control downside risk. By prioritizing risk management, traders protect their capital, enabling sustained profitability over time.

Practical Comparison of the Two Approaches

Examples

Example 1: Sticking to a Bearish View in a Bull Market

A trader might have a strong bearish outlook, convinced that the market is overvalued and due for a correction. Despite the market’s upward trend, they hold short positions, believing the market will soon align with their view. However, by focusing on being right about the market’s valuation rather than following the prevailing trend, they miss out on potential gains from the bull market. This attachment to a viewpoint highlights the importance of flexibility and adjusting to market conditions to prioritize profitability.

Example 2: Refusing to Exit a Losing Trade

In this example, a trader enters a long position, expecting a stock’s price to increase. As the stock declines, they hold on, convinced that the price will eventually rebound. Instead of exiting and taking a small loss, the trader accumulates more losses by holding on too long. This “holding and hoping” behavior exemplifies the pitfalls of prioritizing the desire to be right over sound risk management practices that would minimize losses and preserve capital for future trades.

Example 3: Ignoring Market Signals to Prove a Theory

Suppose a trader has developed a technical system based on cyclical patterns and believes a reversal is imminent. As market indicators signal a continuation of the trend, the trader disregards them, sticking with their original theory. This decision reflects the desire to validate their technical system rather than adapting to real-time data. By ignoring signals that contradict their view, the trader jeopardizes their profitability, potentially leading to significant losses.

Example 4: Overtrading to “Recover” Losses

After a series of losing trades, a trader may feel compelled to take more aggressive positions in an attempt to validate their skill or recover losses. This approach can lead to overtrading, where the trader enters poorly thought-out trades without considering risk management. The focus shifts from profitability to proving their ability, often resulting in further losses. This example underscores the importance of emotional discipline and staying focused on a well-defined trading plan.

Example 5: Entering Trades Based on Prediction Rather Than Confirmation

A trader might enter a trade based on an anticipated trend without waiting for confirmation signals. For instance, expecting a breakout from a range, they position themselves early to capture what they believe is the start of a trend. However, if the breakout fails and the price remains within the range, the trader incurs losses by acting on an unconfirmed prediction. This example highlights the risk of trying to be right by predicting moves, rather than following profitable practices like waiting for confirmation before entering trades.

Practice Questions

Question 1

What is the primary risk associated with a trading mindset that prioritizes “being right” over “making money”?

A. It can lead to excessive flexibility in trading strategy.
B. It often results in greater adherence to stop-loss orders.
C. It may cause traders to ignore market signals and hold losing positions too long.
D. It increases the frequency of trades, leading to overtrading.

Answer: C. It may cause traders to ignore market signals and hold losing positions too long.

Explanation: When traders focus on being “right,” they often become attached to their initial market predictions. This attachment can create cognitive biases, such as confirmation bias, where they selectively pay attention to information that supports their viewpoint and disregard evidence that contradicts it. As a result, traders may ignore market signals, resist adjusting their positions, and hold onto losing trades longer than advisable, hoping the market will eventually validate their prediction. This behavior is risky because it can lead to significant losses rather than cutting them early in favor of maintaining capital. Answer C is correct because it directly addresses this common pitfall of prioritizing ego over profit.

Question 2

In the context of technical trading systems, what is a key characteristic of a trader who focuses on “making money” rather than being right?

A. They prioritize proving their market predictions.
B. They maintain flexible strategies and adapt to market signals.
C. They avoid using stop-loss orders to maximize profit potential.
D. They always trade based on fundamental analysis rather than technical analysis.

Answer: B. They maintain flexible strategies and adapt to market signals.

Explanation: A trader focused on “making money” is primarily concerned with the profitability and sustainability of their trading strategy, rather than being correct about specific predictions. Such traders are more flexible in their approach, willing to adapt to new market information and exit positions that do not perform as expected. They prioritize risk management techniques, like stop-loss orders, to minimize losses and protect capital, recognizing that not every trade will be profitable. Answer B is correct because it reflects the adaptable and pragmatic approach that profit-focused traders take, responding to actual market conditions rather than adhering strictly to their initial analysis.

Question 3

Which of the following best describes the difference between “being right” and “making money” in technical trading?

A. Being right focuses on long-term profits, while making money focuses on short-term accuracy.
B. Being right is about predicting market moves accurately, while making money emphasizes risk management and capital preservation.
C. Being right emphasizes quick trades, while making money requires holding positions for longer.
D. Being right is about focusing on market news, while making money is based purely on technical indicators.

Answer: B. Being right is about predicting market moves accurately, while making money emphasizes risk management and capital preservation.

Explanation: The key distinction between “being right” and “making money” lies in the underlying priorities of the trader. Traders focused on being right are often preoccupied with predicting the market’s direction accurately, which can lead to an ego-driven approach and excessive confidence in their analysis. This mindset may result in a lack of flexibility, causing them to disregard stop-losses or hold onto losing positions. On the other hand, traders focused on “making money” prioritize capital preservation and risk management over prediction accuracy. They are more likely to cut losses quickly and adjust to changing market conditions to protect their capital and ensure consistent profits. Answer B captures this core difference, highlighting the emphasis on risk management that is crucial for profit-focused trading.