Every Trader Should Know This Story
When we refer to the best traders, there is always a sort of mystical atmosphere around them. We think of them as half-god who just know every little detail about the market, they’re in.
But we will see in this short post that this is not necessarily the case. In fact, too much information can be detrimental to a trader because it can make them miss the big picture.
I warn you; you might feel some deception at the end of this post… But also some relief and hope as you’ll realize that the very best traders don’t need more information than you to make a killing in the market.
When knowing and doing are not the same:
I hope you are ready for the story that follows. It comes from the book by Jim Paul: “What I learned losing a million dollars” and I highly recommend you read it.
In the passage below, the author is having a conversation with Joe Siegel, one of the most successful traders in a commodity called “Green Lumber”:
One morning Joe Siegel and I were on the trading floor when one of my accounts called in from vacation. “What’s lumber doing today?”
“It’s limit up.”
“The cash market is a lot stronger because storms in the Northwest are making it hard to get the lumber out from the mills.”
I told him prices for two-by-fours of white fir, western SPF, and green Douglas fir, and continued reading the news wire. The “green” in green Douglas fir refers to the fact that it has been newly cut (it has not been dried), just like someone who is new at something is referred to as green.
Siegel looked over at me and said, “I never have understood why they get such a premium price for lumber that they paint green.”
What can we learn from this story:
This passage highlights that our trader: Joe Siegel enjoyed a successful long-term career trading something he had no clue about. He confused fresh lumber with lumber painted in green.
In contrast, the author, Jim Paul, who knew everything (or think he knew everything) about this particular commodity, proposed some beautiful narratives, and had the best contact in the industry went bust trading it.
This is “the green lumber fallacy”.
But wait a second. How could that be?
Aren’t traders supposed to know just about everything about the market they are trading?
Well, it seems that not really.
The truth is that markets are chaotic and driven by factors beyond our understanding. A small change in one tiny and hidden variable can drastically change the movement of prices, and what you think is unimportant might in fact be really important.
On that note, trying to predict the future based on overanalyzing and overthinking about certain variables can blind you from the truth. Often, the more knowledgeable and cultured someone seems about a particular stock or commodity, the more they will be trapped in their own fallacies.
Why? Because they tend to confuse the variables “x” (weather, supply chain, future outlook,…) with “f(x)” (the price).
Remember, markets are chaotic. Forgetting about just one tiny variable can totally change the outcome. And you know what: no one knows what are all the variables affecting the price of an asset. Hence, no one can perfectly predict price movement. If you are in the game of shekels, you should be extremely cautious of making strong predictions. People who talk well, do not often do well, and this was the unfortunate case of Jim Paul.
Of course, I am not arguing that no knowledge at all is good.
Knowledge is good. But there is an important distinction between what Aristotle calls practical wisdom (phronesis) from scientific knowledge (episteme). This is the core idea of the green lumber fallacy.
How overthinking and overanalyzing can make you a worse trader
To illustrate this point, we will use the analogy of surfing:
Suppose you see two different guy in the water trying to surf.
-One is ultra-knowledgeable about the ocean, the tide, and the physics of how a wave breaks.
-The other is a super committed guy that never took any surfing lessons. Instead, he learned by himself through trial and error. He had no clue about how a wave is formed but he as good sense of observation. Hence he know intuitively where he should be on the lineup, and when he paddle for a wave.
Do you have any guesses on who would catch the best waves?
Well, in my view, the best surfer will be the one having the most practical knowledge, acquired by having skin in the game. He will take off on a wave with confidence, being in the flow and adjusting his surf based on the direct feedback from the waves.
On the other hand, the erudite might be prone to overanalyzing unimportant variables such as trying to predict the movement of the ocean with too much certainty. He would make predictions on when he should paddle and what he should do on the wave instead of surfing based on the direct feedback that the ocean gives him. Thus, if things go out of his predetermined plan, he will be hesitant and surf badly.
The same thing goes for trading. In our example, Jim Paul was full of theoretical wisdom while Joe Siegel was just devoting his energy to the right places, having the right discipline, the right money management, and being open-minded about his decision.
“Clearly, it is unrigorous to equate skills at doing with skills at talking..” — Nassim Nicholas Taleb
Here’s the truth: we, as men, are extremely uncomfortable with uncertainty. To deal with this discomfort, we tend to create scenarios in our minds by substituting the truth for what we want to see happen. But what works in the real world might not match the made-up stories in our heads. In the market, being overconfident about your bet can make you a gambler instead of a trader: confusing backward narratives with actual results.
The core idea of the green lumber fallacy is that it is better to focus on what is essential while accepting the limits of your knowledge rather than focusing on the intricacies that may not bring additional benefit (and make you miss the big picture).
I hope that this post made you realize that traders don’t have a crystal balls. Instead, they are human just like you.
What distinguish them is that they know how to approach uncertainty by exploiting a given anomaly with a clear strategy, and proper risk management. They accept the harsh truth of trading: they won’t be always right. They just adapt their plans, so that they have a lot of small losing bet, but when they win, they win big. This is the art of trading.
“Erudition as such as no value for traders. Trader’s trade. Prophet’s go bust.”
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Catch you later,