Running A Pre-Mortem On A Trade

Most pre-trade review asks a forward-looking question: does this trade make sense, what's the thesis, what's the plan? A pre-mortem flips the question around and asks it from the future: imagine it's six months from now and this trade has lost money, what happened? Answering that question, before the trade is even on, tends to surface specific failure modes that a purely hopeful "here's why this should work" review skips over, because it's much easier to generate reasons for a story you're told is already true than reasons for a hypothetical you have to imagine yourself.

Why imagining failure works better than asking about it

Asking "what could go wrong with this trade" invites vague, generic answers, the market could move against me, I could be wrong, because the question is open-ended and the failure hasn't happened yet in the trader's mind. Asking "the trade has already failed, why" is a small framing change that produces much more specific answers, because the mind treats the failure as a fact to be explained rather than a possibility to be brainstormed. This is the same mechanism decision researchers use in other high-stakes fields: assuming the bad outcome already occurred and working backward pulls out concrete mechanisms that forward-looking optimism naturally suppresses.

A trader planning a pairs trade between two historically correlated names ran a quick pre-mortem before sizing it: "it's three months later and this trade lost badly, why?" The answers that came out fast were specific and useful, one name got acquired and the pair relationship broke permanently, or one company's earnings diverged from a sector-wide factor both names shared. Neither had shown up in the original thesis, which had focused on the historical correlation holding. Sizing the position smaller and adding a specific check for pending M&A rumors in either name came directly out of the exercise, protections that a standard "why should this trade work" review, framed entirely around the case for the trade, hadn't produced.

A pre-mortem takes a few minutes and doesn't require new information, just a change in framing, which is exactly why it's easy to skip under time pressure and easy to add back once it's become habit.