Greed, Chasing Trades, Risky Bubbles & Pay Caps

Traders chase trends. All traders almost all of the time.

Everyone, including the US gov't  likes to blame this phenomenon on greed. In fact the topic du' jour on CNBC is pay caps being instituted by Washington D.C. which are intended in effect to cap greed. Aside from unintended consequences, it won't work. It won't work for capitalism but even beyond that, there is a more fundamental reason that also applies to all traders all the time. 

See it doesn't matter if you are an independent trader sitting in your private office or if you ran a mortgage desk at Bear Stearns, the more powerful motivator in trading is the fear of missing out. Research in neuroeconomics shows that regret over what could have been is more compelling than money that might be made (or lost).

In other words, the feeling of "I missed that trade" or "those guys are making money" is much more powerful than "I will make money if I follow a reasonable trading strategy and manage my risk."

Today's New York Times business section even has an article about hedge fund managers which says and I quote - "The sharp rebound in world markets that started in mid-March has prompted many hedge fund managers to shift gears sharply, INCREASING RISK TO AVOID BEING LEFT BEHIND .... (caps are mine, no pun intended).

No one is going to convince this adminstration that the pay caps won't work but for those of us who have control over how much we take out of the markets, it pays to remember that we will indeed be compelled to take the trade we knew about even if we are late or are only half paying attention. We will also be compelled to fade a momentum move because we just missed this huge run and where else can we make money now?

If we stop blaming greed and start understanding the root cause of chasing trades, buying the last rally in a bubble or taking the other side of a steam-rolling trend, we will indeed puncture the fear - not the greed - that gets all of us into trouble sometimes. 

In short, it ain't greed. It is just different flavors of fear.