The psychology of risk

The

Psychology

of Risk

Mastering Market

Uncertainty

ARI KIEV

John Wiley & Sons, Inc.

The

Psychology

of Risk

Mastering Market

Uncertainty

ARI KIEV

John Wiley & Sons, Inc.

Copyright © 2002 by Ari Kiev. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey.

Published simultaneously in Canada.

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Library of Congress Cataloging-in-Publication Data:

Kiev, Ari.

The psychology of risk : mastering market uncertainty / Ari Kiev.

p. cm.

ISBN 0-471-40387-3

1. Investments—Psychological aspects. 2. Portfolio

management. 3. Risk management. I. Title.

HG4529.5 .K54 2001

332.6′01′9—dc21 20001007197

Printed in the United States of America.

10 9 8 7 6 5 4 3 2 1

For Phyllis,

with all my love

PREFACE PREFACE

Since 1990, I have been helping Wall Street traders master psy￾chological obstacles to trading success and develop strategies for

winning that would sustain them in the face of the uncertainty and

unpredictability of the markets. My first book on this subject, Trading

to Win: The Psychology of Mastering the Markets (Wiley, 1998), presented

a step-by-step goal-oriented program for building the mental and

emotional stamina not only to win but to win on an unprecedented

level. A second book, Trading in the Zone: Maximizing Performance with

Focus and Discipline (Wiley, 2001), examined specific techniques for

achieving and sustaining peak performance levels by entering into the

zone—a focused state of concentration and goal-directedness.

The present book provides further explorations into the psychology

of trading to win, focusing in particular on the appetite for risk taking,

on ways of modulating and managing risk, and dealing with some of the

pathological patterns of risk taking that often incapacitate traders. What

is it that allows some traders to assume risk with considerable impunity

and translate their analyses into action, whereas others with equally

good understanding of the companies they are analyzing and the stocks

they are trading are inhibited from trading as effectively as they can?

A willingness to take risks, set goals, persevere, and not be influ￾enced by the opinions of others is critical for success. What distin￾guishes the best traders is their willingness to acknowledge their

feelings, to ask for help, and to keep monitoring and adjusting their

performance in light of specific trading objectives. Traders who

“trade not to lose” don’t take enough risk or trade recklessly and

v

emotionally when in drawdown and jeopardize their capital. Trading

success requires you to manage your risk objectively to be able to cut

losing trades and stay longer in winners. To do all of these things well

requires an appetite for risk and risk management and the ability to

handle such distinct tendencies as perfectionism, decision paralysis,

hoarding, and impulsiveness.

I explore these and other psychological obstacles to trading suc￾cess in this book. I also examine a variety of psychological techniques

or principles that may help you to trade independently of your emo￾tional responses to the stress of trading. To convey a sense of the kind

of communication that transpires in my coaching sessions, I have in￾cluded a few dialogues with traders. Traders who have reviewed

them have found them useful in exploring some of their own trades.

My hope is that the examples and recommended solutions I describe

will give you a glimpse into the trading world from my perspective

and enhance your ability to take risk and master market uncertainty.

You will notice that I have deliberately avoided naming specific

companies traded because I have been more interested in illuminat￾ing useful trading strategies than in specifics about particular compa￾nies. Finally, as in my previous books, I have disguised the identities

of traders because my purpose is more to draw out generic principles

that might be applicable to other traders than to talk about their own

unique personal experiences.

It is my hope that, as with my previous two books, you will

profit from your reading and periodic perusal of the concepts in this

book, and that it will provide you with a new and stimulating per￾spective that will enhance your trading success.

ARI KIEV

New York, New York

March 2002

Preface

vi

ACKNOWLEDGMENTS ACKNOWLEDGMENTS

As with my previous books on trading, Trading to Win and Trad￾ing in the Zone, many people have helped me to develop the

concepts explored in this book.

First and foremost, I want to thank the various firms with whom

I have consulted over the past several years. They have provided me

with the chance to help traders develop their potential and produce

amazing results despite the difficult markets we have experienced

during this time.

I am most grateful to the various traders who have shared their

perspectives with me and taught me so much about risk taking in all

its dimensions. I also want to thank the traders who read and com￾mented on portions of the manuscript and helped me to clarify some

of the concepts that I have explored in this book.

I especially want to thank Tricia Brown, who has helped me to

organize thousands of pages of transcripts and notes into a workman￾like manuscript, integrating a mass of trading material with the psy￾chological and philosophical premises that I believe undergird the

task of taking risk. I also want to thank Grace Lichtenstein, who was

so helpful in reviewing the book in its final stages.

In addition, I want to thank my editor Pamela van Giessen for

being a committed listener who has helped keep me on track, espe￾cially during the final stages of preparation of this manuscript.

Last, but not least, I want to thank my wife, Phyllis, for her sup￾port and encouragement throughout all stages of this project, from

inception to completion. Her practical coaching helped me to stay on

task during the entire course of this project. A.K.

vii

CONTENTS CONTENTS

Introduction 1

PART ONE

THE ESSENTIALS OF RISK TAKING

Chapter One: Defining Risk 13

Considering a New Approach 17

Understanding the Psychology 23

Identifying the Problems 27

Chapter Two: Understanding the Approach 37

Making the Commitment 38

Setting a Target 44

PART TWO

THE PROBLEMS OF RISK

Chapter Three: Handling Your Emotions 57

Defining the Life Principle 58

Examining the Emotions of Trading 60

Understanding the Stress Response 67

Creating a New Life Principle 69

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Owning Your Responses 74

Dealing with Anger 80

Maintaining Your Concentration 85

Chapter Four: Learning to Let Go 95

Battling Perfectionism 98

Overcoming Mental Accounting 103

Combating Paralysis 107

Learning to Become Flexible 109

Hoarding Stub Ends 114

Considering the Herd 116

Releasing the Rationalizations 121

Acting Now 123

PART THREE

THE PERSONALITIES OF RISK

Chapter Five: Profiling Passive Traders 127

Cautious Traders 127

Fearful Traders 131

Insecure Traders 135

Committing to a Result 139

Choosing What You Have 142

Discovering What Is Missing 143

Chapter Six: Profiling the High-Risk Trader 147

The Solutions 162

Chapter Seven: Recognizing the Master Trader 167

Defining the Master Trader 168

Developing Mastery 176

Assessing Your Progress 183

Contents

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PART FOUR

THE PRACTICE OF RISK TAKING

Chapter Eight: Increasing Your Risk 189

Understanding the Value of Statistics 190

Using Specialized Techniques 195

Chapter Nine: Handling Failure . . . and Success 205

Recognizing a Breakdown 206

Managing the Emotions of Breakdown 207

Turning Breakdowns into Breakthroughs 213

Recreating the Wins 217

Remembering the Plan 224

Chapter Ten: Doing the Work 227

Discerning the Importance of Data Analysis 228

Determining What Is Relevant 230

Understanding the Business Model 232

Paying Attention to the Catalysts 235

Interpreting the Silent Data 237

Using Technical Analysis 239

Chapter Eleven: Coping with Risk: Coaching,

Teamwork, Systems 251

Consult a Coach 251

Take Advantage of Teamwork 262

See About a System 272

Conclusion 281

Index 289

Contents

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