The Illusion of Control

In 1975 a study was carried out at Yale by Ellen Langer on the ‘Illusion of control’.  Ellen demonstrated that we have a tendency to assume we are more in control more than in realistically possible.  Her work focused on gambling studies, but has relevance in the trading and investing world.

In one of the studies participants were given lottery tickets, with the lottery numbers pre-chosen. They were then given the opportunity to pay for the right to choose their own numbers.

Many did this despite it having no effect on the odds of winning.  Langer explained this in terms of the greater perceived control when you choose your own numbers.  (Maybe next time you are placing your lottery numbers at the kiosk you might want to think about just letting the machine pick them for you!)

The illusions of control for traders

Illusions of control can especially problematic for traders. Trading is learned skill, but good traders often lose money and poor traders can get lucky.  This can be a source of enormous performance anxiety for traders.  For example the trader who gets lucky early on and feels invincible may find it difficult to maintain their performance in the long term and be distraught that their method is no longer working and give up.  While the skilled trader that goes through a period of drawdowns will see their confidence suffer and it will ultimately diminish his/her ability to make the same bets even with a trusted system that has delivered in the past.

Using Langer’s findings, in 2003 a study of 107 traders in four City of London investment banks was carried out.  In the study the traders were asked to press keys on a computer wherever they expected something to happen on a particular index.  The findings were striking. Traders with high illusions of control were paid significantly less, contributed less on average to desk profits and were rated by managers as poorer at analysis and risk management.

So if we agree that we have little control over what the market will do and according to the study, its better that way, how do we let go of control and trade profitably?

Well, first let’s be honest here, we are all loss adverse, we know there are risks involved in trading, but we risk to win not lose.  So how do we deal with our flawed nature as human beings when it comes to needing to be in control?

The only way I know how to deal with this, and I learned this the hard way, is to trade a tested system with strict money management, a relatively simple system in concept that can allow for losses to come, but for those losses to ultimately be outstripped by the gains that follow.  There is a reason the term “cut your losses short and lets your winners run” is well known and accepted Wall Street wisdom!

So give up your need for control, focus on money management and let a system tell you what to do.

May today be a profitable day…for all of us!