"The race is not to the swift or the battle to the strong, nor does food come to the wise or wealth to the brilliant or favor to the learned; but time and chance happen to them all."
- Ecclesiastes 9:11
Traders and investors like to believe that the harder and smarter they work the more likely they will be rewarded with exceptional returns. There clearly is a correlation between effort and results but it is dangerous to believe that hard work will protect you from bad luck. The swift do tend to win the race and the strong do tend to prevail in battle, but most market players grossly underestimate the role of luck in their endeavors.
It is an understandable conceit as we'd like to believe that we can influence outcomes with careful preparation but no matter how hard we might try, we will experience soul crushing bad luck at times as well as glorious good luck.
Luck is our constant companion in the stock market and we are fools if we ignore that fact. Our job is to manage luck. We can't let the inevitable bad luck hurt us and we have to seize it and prosper from it when good lucks smiles upon us.
Some market players will argue that luck and risk are essentially the same thing but it is helpful to draw a distinction. Risk is more easily quantifiable. It is the acknowledgement that there is no sure thing but luck is the thing that blindsides you. It is the unexpected news that hits out of the blue and it is impossible to anticipate it.
In his book "The Black Swan: The Impact of the Highly Improbably", Nassim Taleb discusses how we are programmed to look for predictable patterns and tend to underestimate the potential of outlier events. In other words we think luck is a far less frequent occurrence in our trading than it actually is.
The most obvious forms of luck in the market occur when we bet on earnings reports, FDA decisions, economic reports and other news events. We don't know what will happen and we don't know how the market will react. If you read some of the details of cases about insider trading it is amazing how often the perpetrators still lost money even when they had inside information.
The luck associated with single events is easier to deal with because we know what the catalyst for it is going to be. We can prepare in advance for the event and decide whether we like the odds or not. We can deal with it is by making sure we don't place a bet so big that it will cause pain. Even if we believe the likelihood of a positive outcome is high there still is no sure thing and we can make a judgment as to what to risk.
Quite often the best move is to trade after such an event occurs rather than bet on the outcome. This is the case quite often with earnings but other events also offer this situation. For example, this past week Sarepta Therapeutics (SRPT) had much anticipated FDA news. I decided to not bet on it and cut my positions substantially before the news. The stock gapped up nicely on positive news, but for a number of reasons, it is now much lower. Not betting on that high risk situation gave me the ability to trade it with lower risk after the fact. Rather than count on good luck, it was less risky to just stand aside.
The other form of luck is the 'surprise'. A headline about political events or a takeover or an announcement of a big contract are things that we don't know are coming and can catch us unprepared. Even if you avoid obvious news events this sort of luck will still have a dramatic impact on your trading at times.
There are a number of ways to deal with the good and bad luck that will impact your trading. The best thing you can do is to acknowledge and embrace it. We have a tendency to underestimate luck in our trading and are not mentally or emotionally prepared to deal with it very well when it does occur. If we keep in mind that it can hit at any time it allows us to deal with it more effectively when necessary. Luck is going to happen so don't pretend otherwise. If you are always ready for bad luck, you will be pleasantly surprised at times when the gods bless you with good luck.
The most important issue when it comes to dealing with luck is to make sure you never put yourself in a position where it can put you out of business. The best way to do that is to make sure you use sufficient diversification by both position and time frame.
I almost always use an incremental approach to my trading which gives me far greater flexibility to deal with luck when it hits. Rather than simply panic when caught by surprise I can work on developing a strategy to better deal with the situation.
Often the best thing to do when you are blindsided by bad luck is to dump the position and move on quickly. Bad luck can use up a tremendous amount of emotional and psychological energy. Rather than wallow in misery it can be better to get it off the screen and move on.
Luck in the market is inevitable but if you acknowledge its role and are prepared for it, then you can deal with it effectively and find ways to profit from it.