Patience is a virtue, and the best results come to people willing to wait. As tick follows tock follows tick follows tock, so too do the benefits of patience and the ability to choose your moment to shine follow greater success.
Whilst it might not always benefit you to wait as long as you can, having the capacity to wait without the temptation to seek out sources of instant gratification is often very beneficial for your health, your personal life and your career, especially for those seeking a career in financial trading.
However, whilst it is extremely easy to tell others to be patient, it is exceptionally difficult to do so in practice for a variety of different reasons.
The biggest of these is a psychological concept known as temporal discounting, where a reward feels less valuable the further away it is, which makes more immediate rewards feel more tempting.
This is an important concept to understand in order to see how it might be already affecting your trading decisions, as well as how it more directly pertains to financial trading decisions and what you can do to understand and overcome its effects and succeed in prop trading.
What Is Temporal Discounting?
A slice of cake now instead of focusing on a diet, giving in to the temptation to smoke whilst trying to quit, or spending money rather than setting it aside for a rainy day are all examples of temporal discounting, specifically choosing a small benefit now rather than a large reward later.
Aside from zen masters or people with perfect control over their impulses and urges, every single person has given in to instant gratification at some point in their life, and temporal discounting theory works under the assumption that people naturally gravitate towards shorter options.
It is a form of present bias, where people tend to make decisions based on the present, irrespective of their effects on the future.
Temporal discounting is a framework that attempts to quantify how much value time has, or how large the reward for patience has to be before someone chooses to wait instead of taking the immediate reward.
The general way in which temporal discounting is explained is through the choice between a Smaller Sooner Reward (SSR) and a Larger Later Reward (LLR).
For example, if a person is given the choice between getting £20 now or £20 in a month’s time, people will seldom choose to wait. This is true even if the amount for waiting a month changes by an insignificant amount. Getting £22 for waiting a month instead of £20 will not change the decision much.
However, if a person had the choice between £20 now or £200 if they chose to wait a month, people would be far more likely to wait. The difference between the LLR and SSR is so great that people are willing to forego the immediate reward in favour of a larger reward later.
This could change depending on the time frame. If the choice became £20 now or £200 in a year, someone who chose to wait a month may not wait 12 months, valuing that £200 in a year as less valuable than £20 in their pocket now.
The amount of time at which someone values the LLR and the SSR as the same is known as the “indifference point”, and it can be a useful tool for evaluating an individual’s patience in the face of different sums of money and different amounts of time to wait.
In reality, temporal discounting is not that simple, and there are a lot of variables that go into the choice to wait for an LLR rather than take an SSR.
For example, if the example above was not simply hypothetical but was an offer for money given to you by a person, your decision to take the money now or wait for the LLR will depend on your trust in their ability to give you the rest of the money, or whether there would be some kind of deterrent for choosing the SSR.
Temporal discounting is rarely a consistent, solid process, but is dependent on the situation, dependent on the individual, and dependent on the mood and well-being of the person in question. People are less patient if they are tired, angry, upset or fearful, and that may influence their decision to take the SSR.
As well as this, people who tend towards impulsive behaviour, who are risk averse, are susceptible to social norms or peer pressure, and those who have had negative experiences waiting in the past are all more likely to take the SSR.
There are some other, rather unusual psychological biases that affect our ability to ascertain time. For example, if both the SSR and LLR are far enough in the future, people are more likely to be patient.
To return to the earlier example, if the choice is £20 in a month, or £22 in two months, people will likely wait the extra time, likely because they are going to have to wait regardless.
As well as this, this future value decreases the closer it comes to the present, so if you have the choice between waiting six months for £20 or a year for £200, most people would choose the £200.
However, if after six months they are given the ability to change their mind and take the £20 now, the temporal discount arithmetic changes drastically and more people are likely to grab the money now. A reward now is almost always worth more than a larger reward later.
How Does Temporal Discounting Affect Trading?
One of the biggest reasons why short-term trading plays such as day trading, short selling and opting into short-term investments are so popular is because of this temporal discounting principle.
Rather than focus on careful planning and building a portfolio using a robust trading plan that is barely touched once it has been set up except to check if anything has changed, temporal discounting opts towards a short-term future that is easily visible.
Whilst this can most visibly be seen with investments in highly volatile and speculative markets with a recklessness that borders on casino capitalism, temporal discounting can cause investors of all experience levels to fall for somewhat shortsighted decisions.
There are plenty of examples of exceptionally skilled investors who get spooked out of their position or those who see an asset bubble, correctly identify it as such but then invest anyway because they feel they can get in or get out.
In general, the random noise of the market can hide potential trends, and focusing on how an asset is valued right now is not terribly important compared to its overall trend in the medium and long term.
Most stocks have a down day, but that could be a small valley as part of a larger surge or a sign of choppy waters ahead. Focusing on the moment cannot really allow a trader to see how an asset is trending and whether to keep hold of it or sell it.
Temporal discounting is also a common reason for overtrading, a phenomenon where some traders make so many trades either due to inexperience, impatience, insecurity or a combination of all three that they offset their financial benefits or potentially risk wrecking their portfolio.
What Can Be Done To Stop Temporal Discounting?
Knowing that temporal discounting is a bias that can affect your trading is the first step to solving it. Practically everyone is affected by it to a certain degree, and there is no shame to have taken the short-sighted option in the past.
Most of us have picked an instant gratification option, and the worst action you can take afterwards is to be harshly self-critical. This will hurt you emotionally and make it more likely that you will take a short-term option in the future.
Instead, focus on strategies that can help you target long-term goals instead of being affected by factors in the here and now.
Automating as many decisions as possible, by using trading plans, software algorithms, stop-loss orders and a very regimented approach to trading decisions can help reduce the sway of temporal discounting.
Similarly, visualising your overall targets and goals will avoid the trap of focusing on day-to-day gains and losses, and the dangerous pitfall of equivocating those two with success and failure.
Following a rule of trying to visualise the impact of a decision 12 minutes from now and 12 months from now can help the future not feel so far away.
Patience is a skill, and it can be learned. You can train yourself in delayed gratification in small ways, and each time you succeed you will continue to get better and better at being patient.
Finally, know that you are not alone and take advantage of that. Every trader feels the temptation to be impulsive to network, make friends and act as an accountability buddy.
This concept, often used to great success in addiction, ensures that you have someone on your side who can keep everything in perspective.
Ultimately, having the flexibility to be patient allows you to make much better trading decisions, and temporal discounting is a universal feeling that can be overcome as part of that.