Subscriber Only - Mindful Trading: The High-Water Mark

This is the first in a series dedicated to exploring the concept of mindful trading.

Growing up in Southern California, where drought cycles are as much a part of the culture as In-N-Out burgers and a “sick day” at the beach, it’s easy to forget that despite all the swimming pools and lush front lawns, you still live in a desert.

Every few years, a dirty line appears around the edges of lakes, ponds, and rivers as we transition from abundance to shortage, which reminds us of this reality.

Known as a “high-water mark,” by nature’s design it signals that something that was once there is now missing. That at one time there was more. And more significantly, prompts us to question if that which was lost will ever return?

Found in the guts of a prospectus, the term guarantees investors some sense of fair play, ensuring that they will only be charged a performance fee if the fund’s value for the quarter – or year – is at or above its peak.

Found unknowingly lodged in the psyche of a market participant, the concept leads to anxiety, frustration, and self-sabotage.

A typical manifestation occurs when a day trader finds himself up early in the session, then gives a chunk back by midday courtesy of a few losing trades.

It’s then that the stain of the high-water mark sparks a kind of distorted thinking.

The type which twists Gordon Lightfoot’s famous line “Sometimes I think it’s a sin, when I feel like I’m winning when I’m losing again,” into the equally depressing analog, “Sometimes I think it’s a sin, when I feel like I’m losing but I’m winning again.”

For the trader who has seen their $2500 gain reduced by 20% no longer believes they are profitable on the day, but that instead, they are down $500.

And often, in a quest to regain their losses - and with time running out - the trader will force trades into the close that end up producing the opposite result.

However, this delusion is not only limited to the active trader but is common amongst even the most conservative of investors.

Take for example the long-term investor, wisely avoiding the Quixotic quest for short-term gains and diligently indexing and dollar-cost averaging.

For years at a time, things go fine, until the market hits a patch of increased volatility, and a ring appears on their statement in the form of an outsized drawdown.

Even though they hadn’t planned on touching their funds for decades, the revelation that they’ve “lost” money causes them to go to cash, usually right as the market is about to rebound, taking their account balance with it to new highs.

One reason the high-water mark phenomenon impacts us so much is that once we’ve been shown the money, we believe that rightfully it’s ours. And when we believe it’s ours, we start to do things with it.

In some cases, it’s as straightforward as mentally spending on something we want.

In others, it satisfies a subconscious need, like making up for the trading losses incurred yesterday, or proving that despite what that ex who dumped us in high school thinks, we’re not a loser.

So when the money gets taken away, we not only suffer from its loss, but the loss of all the things it was going to do for us.

As with all aspects of the mental game, there’s no easy way to combat the belief in a high-water mark, but recognizing when you’re succumbing to its effects is half the battle.

And under the category of “fighting fire with fire,” a mental trick you can try is to acknowledge when you’ve made money, but until it’s a closed profit, tell yourself, really convince yourself, that it’s discounted twenty or thirty percent.

That the $100K in your 401k is only $70K, or that the $2500 in day trading profits is actually just $2000.

It may not be the perfect answer to the problem, but perfection is not what we’re aiming for.

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