Training your Brain for Big Gains
Do you ever wonder if people who make BIG money in trading have their brains wired differently? Do you ever wonder if it is something that can be learned? Before I go into how to “Train your Brain for Big Gains,” I want to share a story with you:
I was chatting with a friend who did very well in Crypto. He made something like 300% from his original investment. Even better, he luckily pulled out at the height, solidifying his gains. He’s currently taking it easy right now and taking care of his family. However, he still has the itch and wants to go back in to the markets to make even bigger gains.
However, he’s not sure if he can repeat the process.
When we were chatting, I made a point that really opened his eyes. I said, “Even if you have a sharpe ratio of 3:1, it suggests that in order for you to to make 300%, you need to have risked something like 100%”
His mind was blown and he needed a moment to absorb the information. It made him realize that he actually potentially took on more risk than he bargained for. Most people don’t think of big gains this way. This is super critical for long-term success.
Why is this statement so important?
Let’s get some definitions down.
Sharpe Ratio
A Sharpe Ratio essentially compares to the return of the investment with its risk.
[More specifically, it compares the return of an investment minus the risk free return and divides it by the standard deviation of how the investment performs. But the specifics are not too important for this article].
You can read more about Sharpe Ratio in this Investopedia article.
Compare these two investments:
Investment A
You make 40% but you risked 60% to make 40%
Investment B
You make 20% but you risked 10% to make 20%
Which is better?
I hope that intuitively, making 20% while only risking 10% is better than making 40% and risking 60%, everything else being equal.
Why is that?
Between Investment A and Investment B, only Investment B is actually consistently profitable. Let’s say the chances are 50/50 of a win and loss. Investment A has you make 40% half the time but lose 60% the other half. And investment B has you winning 20% half the time and losing 10% the other half. I hope that’s obvious.
What’s interesting is that if you take Investment B where you make 20% while risking 10%, you can leverage that investment by 2. Maybe you buy it on margin, maybe you take out a loan. But whatever it is, you now have twice as much with the same amount of money. If you do this, You’d make 40% while only risking 20%. This is far superior to Investment A that made 40% and risked 60%.
Again, I hope this is all intuitive because the next step is the big leap.
Sharpe ratios greater than 1 is good. It means that you make more than you risk. That’s the bare minimum to make trading worth while. As you can imagine, sharpe ratio of 2 is excellent. For every percent of return you make, you’re only risking half a percent. And finally, a sharpe ratio of 3 is world class. You can do a lot with a sharpe ratio of 3 or higher. But, as you can imagine, it is rare. As of the writing of this article, google tells me that the sharpe ratio of the S&P 500 is 1.25.
So how does this deal with BIG gains?
When I see people smile with their big 200% returns, 400% returns, I’m happy for them. However, I’m also wondering how much risk they took to get those big gains. For someone with 100% returns
- If they have a sharpe ratio of 1, they’re actually risking 100% or more to get that 100%. They might wipe out in the next investment cycle
- If they have a sharpe ratio of 2, they’re risking about 50% of their investment at any moment in time. If they become unlucky and lose that 50%, they’ll need 100% to get back to break even. But if they lose 50% twice (or if they have a 2 standard deviation move), that’s 75-100% loss. That’s a wipe out! Near impossible to come back.
- If they have a sharpe ratio of 3, they’re risking 30% of their investment at any moment in time. This is a bit better. But that still implies that a 2 standard deviation move is a 60% loss.
This is why all the crypto investing made me cringe. Having such high volatility allowing people to have BIG gains also came with a lot of risk. It’s clear that a lot of people in crypto were very unaware of the true risks. I’m not against trading crypto. I’m against trading without knowing the true risks.
Here is the psychological component to all of this:
Nearly every new investor looks at the possible gains. That’s understandable, expected, and normal. Why would you get into trading if you didn’t believe you could make big gains in the first place?
However, nearly every new investor does not look at the risk that is needed to achieve those gains. This is why these investors are called “new” or “naïve”. It’s a rookie mistake. As a result, many new investors and traders get swayed by charlatan stock trading programs of “make 1% a day for a year” or “make 400% return with XYZ asset”.
When I see those high numbers, I ask myself, “What is the sharpe ratio? How do they maintain it? How is the edge defined to be so high? And why does it only cost $500/$1000 or $100 a month if it can clearly make more money elsewhere?”
On a psychological level, we have a tendency to look at the upside without understanding the risk. But when you look at the risk for those big numbers, you realize it may not be worth it.
How much do you want to make? How do you make BIG gains? Here’s your psychological toolbox to achieve just that:
- How much do you want to make?
- How much risk are you willing to take to make those BIG gains?
- Are you skilled enough to achieve that ratio?
Answer those questions and you won’t be blind sighted on your path towards success!
How do you achieve the skill for a sharpe ratio above 1, and hopefully, 3 someday? You need the right education. You need to practice and you need to learn from people who have accomplished these things. This is where psychology ends and the development of your trading process begins:
- ✅ You will be taught how to trade like a professional trader
- ✅ It will be hard work. You need to put in the work.
- ✅ You will lose money along the way and that is okay
- ✅ If you are ready, you can sign up to be mentored by a professional trader
I’ve used the program to much success. When I started my ratios were absolute garbage (losing 75% of the time, winning 25% of the time with poor reward to risk ratios). But I improved. At my height, my wins were 66% of the time and 33% of the time with equal reward to risk ratios. These days, I find myself having less percentage winners vs losers but higher reward to risk ratios.
At the end of the day, I know what metrics to measure and improve. That’s the true value of ITPM. They got me on the right track and I want you to be on the right track as well. I can help with the psychological component but they are more qualified to teach you the right process for successful trading.
If you’d like to learn more about my thoughts on the programs, click the links below:
Your trading psychology might be the deciding factor for your next BIG win or your next BIG loss.
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