A lot of successful traders, investors, and hedge fund managers say that they’ve made money by trading on a “gut feeling”. They say that some of their best trades were made because they just “felt” that the market would move one way, and it did. They couldn’t fully explain why they were bullish/bearish. Some even claim “I had a dream that the market would go up. I went long, and the market did go up”.
But here’s the simple reality: you should never trade on a hunch or gut feeling. You should always follow your trading strategy. Here’s why.
What these successful traders and investors aren’t telling you
Big name speculators will always tell you their success stories, such as “I made 20% in silver in one week because my gut told me that it would go up”. These stories add to the mysterious allure of these traders. These stories also help media organizations sell copy because everyone wants to know about the “genius who just knew it would happen”.
But interviews and stories always leave out the failures. How many times have these hotshots LOST money when trading on their gut feeling?
In my experience, the probability of success when trading purely on a gut feeling is barely greater than 50%. History remembers George Soros’ great 1992 Pound short. But how many historians will tell you about the loss he suffered from shorting the Hong Kong Dollar? (Answer: few).
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So while media organizations will tell you about how successful these traders were by trading on a hunch, they leave out the failures from trading on a hunch.
What “a hunch” really is
There are 2 kinds of “gut feelings”.
- Completely unsubstantiated gut feelings.
- Gut feelings that represent your subconscious thought process.
Unsubstantiated gut feelings are extremely dangerous. They are basically just irrational human emotion. Traders tend to become bullish AFTER the market goes up and bearish AFTER the market goes down. You are basically gambling if you trade on unsubstantiated gut feelings. “I feel like the market will go up/down” is not a trading or investment strategy. It is rolling the dice.
Successful traders and investors are successful because they follow their time-proven methodologies. Unsuccessful traders and investors blow up their portfolios in the long run by treating the market like a casino. Trading and investing is all about probability. It isn’t blind luck.
Renown traders and investors who have successfully traded on a “gut feeling” fall into the second category of gut feelings. When these market players say that they’ve traded on a “gut feeling”, they are essentially trading on their subconscious thought process.
These traders and investors have well-defined strategies. They don’t just roll the dice. And because these market players have been trading for so many years, their thought process has become second nature to them. They go through their trading process without being consciously aware of the fact that they are going through the process.
For example, a new trader will consciously go through Steps 1, 2, 3, 4, and 5 before making a trade. A seasoned trader might subconsciously fly through these steps and possibly even skip an unimportant step or two. He might fly through a mental checklist instead of going through a physical checklist. Hence, it’ll seem as if he isn’t using a predetermined strategy when in reality, the strategy is already in his head!
When seasoned traders are “trading on a gut feeling”, their subconscious mind is actually rationally sizing up a trade/investment in a matter of seconds.
Also note that some seasoned traders are tape readers or chartists. They’ve been doing this for long enough that they don’t need to actually draw trendlines to know if the market is bullish or bearish.
Why even successful traders and investors should always follow the process
Quantitative traders should never trade on a gut feeling. They should always follow their trading models. You might make a little money right now by deviating from your model, but your return will suffer over the long run if you consistently deviate from it.
Discretionary traders and investors should never trade on a “gut feeling”. They should never fly through the trading process without consciously thinking about each and every step.
Humans make mistakes, no matter how successful you are. You might forget a step or two if you don’t go through an actual checklist before placing a trade. The step that you missed might be the deciding factor as to whether your trade will succeed or not. You should always go through each and every step in order to avoid mistakes.
Going through every step will also help you clarify your market outlook. Rarely will the market be 100% bullish or 100% bearish. Most of the time you will have a mixture of bullish and bearish factors.
Your thought process and analysis will be clarified when you go through all the steps and list the bullish/bearish factors. The key to trading is deciding which factors override the others. Your trading process should predetermine which factors are more important than the others.