Apurva Sheth

As you read the following two conversations I had with one of my friends on different occasions...take note of anything unusual.

Conversation 1:

Me: Hey buddy, what's up? How are you? How's your trading been the last few days?

Him: Hey, Apurva. I'm good. My trading has been excellent. I closed four profitable trades in a row. And all of them delivered double digit returns exactly as per my expectation. I identified and entered these trades at the right time and booked solid gains. I really love this trading business and am thinking to increase my trading capital.

Conversation 2:

Me: Hey buddy, what's up? How are you? How's your trading been the last few days?

Him: Hey, Apurva. I'm okay. My trading has not been that great. It has been a terrible week for trading as markets have tanked. Three out of the six stocks I was holding delivered bad quarterly numbers. And you know this season 'they' are severely punishing the stocks with bad numbers. Seems like it's an operator driven market. And small traders like me do not have any chance against these big fish.

It is obvious that the first conversation took place when my friend's trading performance was good and the second when he was going through a losing streak. But if you read closely, his responses to the same question were very different...

He was happy in the first conversation about his trading and attributed his success to himself. But in the second conversation...he was sad and attributed his failure to others. In short, he attributed internal factors (himself) to his success and external factors (situations) to his failures.

He almost considered himself a trading genius when the performance was good. But he felt like a victim when the performance wasn't good. This is not the right way to measure trading performance.

Unfortunately, most of us look at our trading performance like this. Indeed, we look at all our decisions like this. If the outcome is in our favour, then it's all because of our skills and intelligence. But if it's against us, then it's all because of bad luck.

Heads was skill. Tails was bad luck.

This is because we humans have a fragile sense of self-esteem and a key mechanism to protect our self-image is self-attribution bias. We have a tendency to attribute good outcomes to skill and bad outcomes to luck. This is how human psychology works. The problem is it prevents us from recognising mistakes as mistakes, which prevents us from learning from our mistakes.

(You already know learning from mistakes is crucial for successful trading. That's how Ray Dalio built the world's largest hedge fund from scratch. Click here to read his story.)

So what is the solution to this? How can we avoid this bias?

Take a look at the decision matrix below.

Decision Matrix

	Good Outcome	Bad Outcome
Right Reason	Skill	Bad Luck
Wrong Reason	Good Luck	Mistake

If you want to combat self-attribution bias, then you first need to have a written record of your trades along with the reason you're taking them. Once you close the trades, you can map those trades in either of the four quadrants. That is, whether you were right for the right reasons. If so, then you can give full marks to yourself and place this trade in the skill quadrant. But if you were right for the wrong reasons, then it was just good luck and not skill.

On the other hand, if the trade didn't work out as expected, then was it because of the wrong reasons. That means it's a mistake and you should learn from it. But if you were wrong for all the right reasons, then it's just bad luck and you should move on.

The ultimate objective of all traders should be to have more and more trades with a good outcome for the right reasons. Obviously, one cannot completely eliminate the other three. But a trader should see to it that trades with a bad outcome because of wrong reasons be minimised as far as possible.

Trading performance can be improved only if we measure it correctly.

We can measure our performance correctly only if we refer to our decisions and the reasons for those decisions with outcomes. If we do this regularly, we will understand when we are lucky and when we have used genuine skill. This will help us measure trading performance correctly and improve performance substantially over time.

At Swing Trader, we have specially designed a trading portfolio tracker for all our subscribers. The tracker enables them to record their trades along with their reasons for entering and exiting. It can even be downloaded in an excel sheet for further study. This tool helps our subscribers to measure and improve their own trading performance.

How do you measure your trading performance? Share your views in the Club or share your comments here.

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