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This Trading ‘Bible’ Will Change The Way You See The Market
As a trader, you will come across tonnes of articles and books about trading psychology. But this wasn’t always the case and in many senses, it is a very modern concept.
Then Trading in the Zone: Master the Market with Confidence, Discipline and a Winning Attitude came along and that all changed.
Trading in the Zone by Mark Douglas is highly regarded by traders across the world for its insight and details on the subject of trading psychology . Some even refer to it as the “bible of trading psychology” .
Mark Douglas is famous within the world of trading and is currently the president of Trading Behavior Dynamics , which delivers training programmes to assist with trading psychology at financial institutions.
His unique insight into the psychology of trading makes this one of the most useful trading books available today and is arguably one of the most important trading books ever written .
The book’s importance, if anything, has only increased over the years as it has become apparent that the vast majority of retail traders lose money. Some argue that up to 95% lose money – the real number is actually debatable – and then quit altogether.
Mark Douglas believes these losses are due to poor trading psychology and the resulting lack of money management.
If you only read one book on trading psychology, make it this one.
Mark Douglas and why he matters to your trading strategy
Mark Douglas was an experienced author with a wide variety of books under his belt. During his career in finance, he worked with hedge funds , money managers and some of the largest floor traders .
Before that, Douglas was educated at Michigan State University, majoring in Interpersonal Communications and Political Science.
Douglas started coaching traders in 1982 and amassed a wealth of experience in teaching them how to develop the right mentality around it.
This experience was crucial to his books ; he knows exactly how to talk to traders, how they think and understands what concerns them.
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He wrote his book under the assumption that all traders want to create an income they can rely on . The book is also for traders who fully understand that trading is not a get-rich-scheme or just an alternative to a savings account – it can be a full-time job.
In 1990, Douglas wrote his first book The Disciplined Trader which gained him moderate success and attention. However, much of his success was gained with Trading in the Zone in 2000.
Following on from that, Douglas primarily wrote alongside co-author Paula T. Webb , who specialises in prosperity psychology . From 2020 onwards, the two gave seminars and workshops around the world on trading psychology.
Sadly, Douglas passed away at age 67 in 2020. You can find out more about Mark Douglas’s career in finance here .
Douglas’s work earned him many awards, particularly in finance-related publications.
The most prestigious of which is the Bull/Bear Award , which he won in 2006, 2008 and 2020, and again in 2020 and 2020.
Other books by Douglas
Douglas’s other books include:
- The Disciplined Trader . Douglas’s first book on trading, published in 1990.
- The Complete Trader . Written with co-author Paula T. Webb, published in 2020.
- Little Book of Trading Performance . Also co-authored by Paula T. Webb, 2020.
- Becoming “The Disciplined Trader” . Also co-authored by Paula T. Webb is an updated version of The Disciplined Trader, 2020.
- Simple Wisdom for Prosperous Trading . Also co-authored by Paula T. Webb, 2020.
Douglas has also written about how to become a successful author and a number of motivational books.
Many of his books have been translated into a variety of different languages, including German, Japanese, French, Chinese (Simplified and Traditional), Italian, Korean, Polish, Portuguese, Czech, and Spanish.
If English isn’t your first language, it’s worth taking a look to see if there is a translation available.
You can also check out other books reviewed by Trading Education here.
What does Trading in the Zone teach?
Trading in the Zone can teach traders a variety of lessons concerning risk management , consistency and finding new levels of fulfilment and enjoyment from successful trades.
The main lesson which traders can take away is learning how to understand the root cause of common trading mistakes .
Douglas highlights that many poor trades are often a result of deep-rooted emotional issues , which influence a trader’s interactions with the market.
During childhood, we all experience failure in different ways and we gradually learn to overcome these feels of hurt.
Our upbringing leads to patterns which are so deeply woven into our psyche that we are unaware of the impact they create .
An unsuccessful trade will inevitably feel like a failure and can quickly stir up negative feelings from our childhood. This book can teach the coping mechanisms needed to avoid these negative emotions .
Overcoming negative feelings related to failure can help traders become consistent in their trades as consistency is what is needed to be successful .
Psychology and successful trading strategies
In many cases, the feeling of failure can lead traders to chase their losses at which point they are no longer following a trading strategy but gambling and putting everything at risk.
As we mentioned earlier, before Trading in the Zone was published, trader psychology was rarely discussed. It was a completely new concept.
Successful trades were seen as strictly the outcome of exceptional market analysis , while unsuccessful trades were the opposite.
We now know that this is not the complete story.
In reality, the outcome of a trade is the result of the decisions we make . Decisions which can be influenced by the pressure that comes along with the risk of losing money and how we respond to such pressure.
These decisions are also influenced by personality traits such as fear and greed , for example. Those are characteristics which make up our personality, but we are not always aware of. They impact our trading plan, trading style and even the goals we set ourselves .
Moreover, Douglas explains how if you are winning a lot you will have a positive attitude. Likewise, if you are losing a lot you will have a negative attitude . This then affects how you perform your next trades.
Trading in the Zone seeks to assist readers in adjusting their attitudes towards trading, so that it is possible to trade without fear or greed, resulting in the elimination of reckless behaviour.
A game of probability
The book aims to help people trade in a way which is free of psychological constraints, where a loss is seen as a possible outcome rather than a failure .
Douglas explains that the right way to think about trading is a game of probability . There is no right or wrong, win or lose, only probability .
After all, financial trading should be seen as a business and with every business, owners need to put their emotions to the side and make appropriate decisions for their business’s survival.
Losses should be accepted and moved on from.
Mark Douglas comprehensively covers the processes required to help traders analyse the market with a clear, dispassionate viewpoint, which hopefully will lead readers to make a profit.
The famous five ‘truths’
One of the most useful sections Trading in the Zone covers is Douglas’s famous five ‘truths’ theory, which can be summarised as:
- Anything is possible .
- There is no need to know what will happen next to make a profit .
- Wins and losses do not follow a pattern, they are randomly distributed .
- An edge is an indication of a higher probability, it is never a certainty .
- The market is unique at every moment .
Douglas believes that once a trader accepts these truths, they are able to leave their psychological baggage behind.
The advice is to choose your edge, stick to it and trade so that over time the random distribution will at some point fall in your favour.
The four fears
In Trading in the Zone , Douglas also wrote about what he calls the four fears. They are:
- Fear of Missing Out (FOMO) . This is the fear that you are missing out on an opportunity while everyone else is gaining from it.
- Fear of Loss . This is the fear of losing what you already have.
- Fear of Being Wrong . This is the fear that your next trade won’t work out, a crisis of confidence.
- Fear of Letting a Win Turn into a Loss . This is the fear of losing all that you have gained.
Douglas teaches us the importance of trading with confidence. We must remove fear from our trades but must remain disciplined.
Are there any areas for improvement?
At Trading Education, we would advise every trader to read this book . At the time of writing, it has a rating of 4.2 out of 5 on Goodreads and 4.9 out of 5 on eBay.
Trading in the Zone has also stood the test of time well, too.
Published in 2000, many traders are still learning plenty from it despite how much trading has changed over the last (almost) two decades, particularly with the advent of the Internet and retail trading.
What do the critics say?
Trading in the Zone has plenty of critics, both in terms of how the book is written and the accuracy of its content.
You should be prepared for a number of long-winded metaphors which can be found throughout the book.
The book is also very repetitive . Some even say that if you cut out the repetition, it would be very short. So you may end up skim reading some parts if they feel too similar.
Many of the book’s critics question Mark Douglas’s authority on trading , saying he is not actually a trader. He is, instead, a coach of traders .
These critics feel that unless you are a successful trader, it is dangerous to coach or advise other traders because you haven’t been in their shoes.
If that’s not enough, Douglas has revealed that he lost a lot of money trading which has led many to be sceptical of his trading knowledge.
On top of that, there are many that say the book is diluted with too much psychobabble .
By that, we mean psychological terms, phrases and explanations that don’t actually mean much in the context of trading or are questionable in terms of scientific accuracy.
However, we urge readers to look past this and focus on the positive and practical things the book teaches.
In defence of the book, while some may call Douglas’s writing psychobabble and knock the fact that he devalues technical analysis, it should be pointed out that technical analysis is also sometimes called a pseudo-science as well, particularly by academics .
In the real world of trading though, both are vital.
Key chapters to read
If you are looking to take away the key points, without spending too much time reading the full book, we would recommend reading the first seven chapters:
- The Road to Success: Fundamental, Technical, or Mental Analysis
- The Lure (and Dangers) of Trading
- Taking Responsibility
- Consistency: A state of Mind
- The Dynamics of Perception
- The Market’s Perspective
- The Trader’s Edge: Thinking in Probabilities
Then finish off with the final chapter – chapter 11, Thinking Like A Trader – which pulls everything together. And at the very end, there is also an exercise that is highly recommended.
That said, the book is only 240 pages at the longest and can easily be read in a short amount of time .
There are also a number of traders who would recommend reading this book at least once a year to remind themselves of what it teaches.
Who would benefit most from this book?
Trading in the Zone would best suit three types of traders:
1. Beginners who are still trying to find their place in the world of trading.
Trading in the Zone can help mentally prepare beginners for what they are about to undertake and make them understand how important trader psychology is to avoid mistakes and make successful trades.
2. Traders who are not confident in their trades . There are a lot of risks involved in trading and without confidence, traders may never make the dive.
Sometimes people just need to trust their instincts, which is what Trading in the Zone can teach.
Traders may find that when they make a mistake if they had followed their initial instincts they may have avoided it. Instead, they felt anxious and decided against their original instincts, which lost them money.
3. Traders who are losing more than they are earning . This book can help them evaluate the potential reasons why this is happening.
With it, they can think about their own mentality and, hopefully, identify psychological reasons that are causing them to make mistakes. More importantly, attempt to find solutions to these problems.
Where does Trading in the Zone fall short?
A key thing to remember about Trading in the Zone is that it focuses on trader psychology, which is one part of learning how to trade.
You still need to learn the technical basics and how the market actually functions. Without them, you will not know what you are doing. Confidence in your trades compliments a trader, it doesn’t make you a trader .
In a sense then, while this is definitely a book you must read, it should not be your first read. Ideally, you should focus on reading something more technical first .
That said, the technical side rarely changes. Once you learn it, you can be sure you know it.
Our personality, however, can be more complicated to understand as everyone is different. A lot of us don’t really know ourselves that well, or at least, not as well as we think we do.
It can be hard to isolate destructive behaviours that may be negatively affecting your trades. Often we need someone to help point us in the right direction.
Then it can get even more complicated when you start trying to change your behaviour, which for some can take years or even a lifetime.
To find out more about trading strategies and techniques, please take a look at our articles or contact our knowledgeable team.
If you enjoyed reading this article from Trading Education, please give it a like and share it with anyone else you think it may be of interest too.
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4 Fears That Are Stopping You From Achieving Your Best Life (And How To Overcome It)
Fear is a powerful force. It helps us stay alive and prevents us from doing stupid stuff. However, it’s also a very limiting mental blockade that can prevent you from achieving the life you want. Fear has the power to literally kill your ambitions, goals and dreams. Fear creates excuses that seem legitimate enough so that you’ll stop taking action and go back to your comfort zone.
The problem is that most of these fears are subconscious and therefore it isn’t always easy to identify what type of fears are holding you back. Without consciously being aware of it myself, fear had quite a strong grip on my life. Fear was the main reason I was procrastinating. It was the main reason why I wasn’t working on the highest value activities that would actually help me achieve my goals. Fear was sabotaging my success. But fortunately, I’ve learned to use fear as a compass for action — and it now helps me navigate what I should be doing and where I should be going with my life and business.
First, I’m going to discuss the 4 types of fears in detail so you can start thinking about which ones are limiting you. Then, at the end of this article, I’ll talk about how to overcome your fears in 7 steps, so you can start to tap into your full potential.
Fear #1: Fear of Rejection
The fear of rejection is probably the biggest fear out there. It’s where almost all of the other fears we’ll be discussing lead to. We’ve all been rejected in our lives. Whether it was the rejection from a university, job interview or by someone from the opposite sex. And rejection hurts. It makes us feel inadequate. It lowers our self-esteem and confidence. In some cases it can hurt so bad that people might even slip into depression.
As human beings, we are true social creatures. Even the biggest introvert on the planet needs other people in order to survive and thrive. Essentially almost all of us are dependent on other people for food, water, shelter and many of the positive emotions such as love and joy. Therefore, we’d do anything to be accepted by others, and we’ll avoid everything that could possibly mean rejection.
Think about it, even as little as hundreds of years ago, rejection equalled physical death. If you were rejected from your tribe, you wouldn’t survive for long. Nowadays, rejection equals psychological death.
One way people avoid all of this pain is by avoiding to stand out. In Australia, they call this the ‘tall-poppy’ syndrome. Famous Australian actress Margot Robbie explains this principle well by saying:
“There’s a thing in Australia called tall poppy syndrome. Have you heard of it? It’s a pretty prevalent thing — they even teach it in school. Poppies are tall flowers, but they don’t grow taller than the rest of the flowers , so there’s a mentality in Australia where people are really happy for you to do well; you just can’t do better than everyone else or they will cut you down to size .”
The poppies grow together and they’re supposed to be uniform. If one grows up too high, it means it’s got to be slashed and cut back down to size. Some people don’t like it if you succeed too much. It makes them feel bad. Therefore, they’ll start to lash out and maybe even reject you. Let them. It says a lot about their ambition and what they’ll achieve in life (not much).
Unfortunately, the fear of rejection causes many people to give up on their dreams and ambitions. They abandon self-development because their friends aren’t doing it. They won’t develop their talents because they don’t want to stand out. They don’t grab every opportunity that comes their way. They don’t start a business because they’re afraid they won’t get the support of their friends and family. They adopt the same bad habits as their friends do in order not to get rejected.
All in all, the drive to avoid the pain of rejection can make us do things that aren’t in line with our purpose and mission. Maybe you’re suffering from this type of fear. This is nothing to be ashamed about, it’s human nature. Only when you identify and accept your fears, you can start to overcome them.
Fear #2: Fear of Failure
The fear of failure is another big reason why many people don’t achieve their best life possible. In fact, the fear of failure can be so paralyzing that people simply decide to procrastinate over and over again, even though they continue talking about their goals.
The payoff for procrastinating is that we protect ourselves from ‘real’ failure. Because as long as you don’t put in the necessary effort for success, you’re at least not confronted by ‘real’ failure. You can still refer back to the excuse that you haven’t given it your all and that you potentially can do so much better. But make no mistake. Not taking action is a bigger failure than ‘failing’ at your goals.
When you really fail at your goal, despite taking action, you’d still learn valuable lessons and therefore grow. But if you simply procrastinate, you won’t learn. You’ll only waste your time. Remember, on your journey to success it’s necessary for you to fail and make mistakes. It’s an essential part of the process. At those moments, you’ll learn new valuable lessons that’ll help you get closer to your endgoal.
For example, when I started my first business, GetGo Investing (a financial education business), I made a ton of mistakes. I spend so many hours working on content that would never see daylight. I made products no one really wanted. I’ve switched from strategy to strategy, all without the results I hoped for. For 1.5 years, I didn’t earn a single dollar in revenue… And yes, it was painful and embarrassing. But I learned so many valuable lessons that would eventually help me earn a full-time income online and grow my other businesses (Elevation and Personal Growth Lab) much faster and more profitable than before. It was during that process where I realized that every failure brought me closer to success and that every mistake serves a purpose — which is to learn and to grow.
One last thing that I want to say about the fear of failure is that you should let go of perfectionism. When you believe that things should be done perfectly, the result is that nothing gets done at all. When faced with a task, you become overwhelmed and frustrated by impossible standards. 80% is good enough. When you continue to aim for ‘perfect’, you won’t get a lot done — and the fear of failure creeps in time and time again. When perfect is your standard, anything below that is considered failure. Don’t forget that perfectionism is usually just a form of insecurity and procrastination that has managed to dress up in a seemingly positive character trait.
Fear #3: Fear of Success
The fear of success is a type of fear that most people don’t expect to see on this list. Probably, as a Personal Growth Lab member, you’re all about creating a successful life and you’re already putting in the effort to make this happen. Yet, subconsciously, it’s possible to fear the success you are actually striving for.
Because success is scary. Fulfilling your true potential is scary. Why? Because it’s unknown territory. And we’re practically hardwired to label anything unknown as scary. Like those who procrastinate because they fear failure, you can keep yourself safe from facing your true limits by avoiding opportunities and putting things off.
Maybe you’re afraid of success because you fear your friends or family will reject you if you have a totally different lifestyle compared to them.
Maybe you fear success because you know you’ll have to drop some old behaviours and habits, which can lead to rejection by certain people in your social circle.
Maybe you fear success because you’re afraid of getting more responsibilities and expectations.
Maybe you fear success because you don’t actually feel worthy or capable of handling success.
Once again, you don’t have to feel ashamed if you can relate to any of these type of fears. The important thing is that you identify and accept them. Because only then you’ll be able to overcome them.
Fear #4: Fear of Ridicule
This is a more subtle form of the fear of rejection, but it’s still a massive limiting factor for many people around the world.
Maybe you want to start a YouTube channel or record a course, but you’re afraid of how you’ll look in front of the camera. Maybe you want to start a business that some of your friends or family don’t understand. Or maybe you have certain interests that some of the people around you make fun of. In many cases, we fear that the things we do, say or like will be ridiculed and made fun of by other people. This fear will be even bigger if it concerns the opinions of our friends and family.
The fear of ridicule has certainly been a massive subconscious fear for me. When I just started making content about self-development, I didn’t have that many followers on YouTube or Instagram. Some of my videos only had 2 views.. That’s some embarrassing stuff. I feared that some of my friends and family members would see it and that they would think I looked like a fool. When you have a YouTube channel with 37 subscribers and a bunch of videos that aren’t that good, it’s hard to stay motivated and not let the fear of ridicule kick in. Especially when some of your friends don’t give you any positive feedback at all.
But (as I learned from books like The 10X Rule and The Subtle Art of Not Giving a F*ck) if you want to achieve great things in life, you have to be willing to look stupid for a while. You have to embrace the fact that you aren’t yet at the level you want to be. Only with this acceptance, you can come up with the consistency and authenticity to grow and improve until you eventually don’t ‘look stupid’ anymore.
Everyone who’s ever made it in life or business looked like a fool in the opinion of some people. Those who stand out because they are willing to take the initiative, try out new ideas, follow unexplored paths or create a better life for themselves, will always be ridiculed by some. Your ambition confronts them with their own lack of ambition — and in order to protect their own ego, they’ll lash out by trying to ridicule you. Realizing this will make it 10x easier to overcome and bash through the fear of ridicule.
How To Overcome Your Fears In 7 Steps
Step 1: Realize Everyone Has Fears
It’s human nature. Many people are afraid of something, but they simply don’t show it (and therefore you don’t know about). Realize you are not alone.
Step 2: Identify and Write Down Your Fears
Write down exactly everything you are afraid of. Be as specific as possible. Also, label to which of the 4 categories your fear belongs. Sometimes, a fear can also belong to multiple categories. For example:
I’m afraid that my friends will think my new YouTube channel is stupid — Fear of Ridicule
I’m afraid that my business idea won’t work out and I have to go back to my 9–5 job — Fear of Failure and Fear of Ridicule
I’m afraid to share my new insights about spirituality with my spouse, because I’m afraid he/she won’t agree or understand and therefore reject me (even if it’s just a minor rejection) — Fear of Rejection
Step 3: Identify and Write Down The (Realistic) Worst Case Scenario
Whenever we feel fear, our mind will greatly overestimate the worst case scenario. Therefore, we need to identify our realistic worst-case scenario beforehand, and write it down. This way, we can refer back to rationality in moments of irrationality. You’ll very likely see that the rational, realistic worst case scenario is not as bad as your mind has made it in moments of irrationality.
Step 4: Identify Your Fears In The Moment And Focus On Gratitude
Whenever you feel fearful, become truly aware of what type of fear it is. Identify if it’s a familiar fear and place it in one of the 4 categories we talked about. This awareness alone will disarm fear to such a degree that it will no longer have such a strong grip on you.
Furthermore, try to replace your fear with gratefulness. This is a trick I learned from Tony Robbins, who says that ‘fear disappears whenever you are grateful’. You can’t feel fearful and grateful at the same time. It’s always one or the other.
So, let’s say that you’re afraid of starting a new business. Instead of focussing on the fear, focus on being grateful for the fact that you have this awesome idea in the first place. Or focus on being grateful for your entrepreneurial mindset. This way, fear will disappear a lot quicker!
Step 5: Do The Rocking Chair Test
This is another technique I learned from Tony Robbins, and it’s highly effective in order to put certain decisions into perspective. See yourself at the age of 80 or 90, sitting in a rocking chair. How would you feel at that moment if you know you didn’t do certain things you wanted to do, because you let fear control you? How would you feel if you let short-term fear lead to long-term regret? Use this feeling as fuel to bash through your fears and do it anyway.
Becoming fearless is not about fearing nothing — it’s about feeling the fear and doing it anyway.
Step 6: Make A ‘Screw You, Fear’ Affirmation
Write down an affirmation of a few sentences that combines steps 2, 3 and 5. Read this whenever you feel your fears coming up. You can also read this daily as part of your morning routine in order to start your day fearless (fearing less).
I’m afraid that my friends will think my new YouTube channel is stupid and that they’ll ridicule me for it. But I know this says more about them than about me. I know this YouTube channel is going to be important for the success of my business. With the right consistency and practice I’ll get better — which leads to more viewers and subscribers.
In the worst case scenario, my YouTube channel won’t get off the ground. But even then I would have learned a great deal. I’d learn to be more comfortable in front of the camera and do better public speaking for example.
Also, I know I would regret it later on in my life if I didn’t try for (at least 6 months) to grow my YouTube channel. I won’t let this short-term fear lead to long-term regret.
If you’d read a text like this every single day, I guarantee you’ll overcome your fears a lot faster and easier. And imagine what’s possible when you become more and more fearless. When there are little to no mental blockades on your path of success..
Step 7: Take Massive Action
Action kills fear. Inaction and procrastination feed fear. Take massive action and your mental blockades will start to become weaker.
Now Do It
Nowadays I view fear as a compass for action. Direct, massive action. It helps me navigate what I actually should be doing and where I should be going with my life and business. That whatever I fear is most likely what I should be doing.
So, as an action point for this article, identify 1–3 fears that you’d like to get out of the way and follow the 7 steps as described above.
How Much Will a Trade War Hurt Your Company?
By Christian Ketels and Martin Reeves
The trade dispute between the US and China continues to escalate. Tariffs of 25% have been imposed or announced on $50 billion of imports from China, and tariffs on a further $200 billion are now being reviewed. China has retaliated against the first round of US tariffs and has vowed to continue to do so in response to any further US action. A number of other trade relationships, from steel and aluminum to NAFTA and the US-EU automotive trade, are seeing tensions as well. With some of the world’s largest trading relationships embroiled in an escalating trade conflict, how high might the cost to the global economy and to your firm be?
Business leaders get divergent signals on how worried they should be. On the lower end are assessments like those from Goldman Sachs, which sees the tariffs announced so far shaving off only about one to two basis points from US GDP. The World Bank found that even a widespread increase of tariffs would reduce global GDP by less than 1%, even though global trade would drop by close to 10%. On the higher end is the Bank of England, which sees escalating trade protectionism and its repercussions reducing US GDP by 5% and global GDP by around 2.5%. Financial markets are clearly concerned but alternate between short-term dips when new policy actions are announced and quick recoveries once quieter conditions (but not lower tariffs) are restored.
How should business leaders make sense of these conflicting views? We argue that the differences in predictions are mostly a sign of differences in the scope of impact assessed, not of fundamentally different views on how tariffs affect trade. But where they all fall short is in their lack of focus on those metrics that matter most to individual firms. We offer nine observations on trade policy impact analysis for firms and then lay out four implications on how executives can respond.
We argue that the differences in predictions are mostly a sign of differences in the scope of impact assessed, not of fundamentally different views on how tariffs affect trade.
Observations About Trade Impact Analysis
A small welfare loss overall could mean a huge profit or loss for your firm.
Trade policy impact analyses tend to focus on welfare losses as the result of a higher tariff. They talk much less about individual winners and losers. If a tariff is imposed, the net welfare losses tend to be modest—they are measured by the reduction in consumption times half of the tariff. But individual gains and losses can be substantial. Government and domestic producers gain while consumers and the firms subject to the tariff suffer. And this redistribution of value can be very significant—measured by the tariff times all remaining trade and by the consumer price times the change in market share.
Take as an example US steel tariffs. The Department of Commerce reported in its Section 232 investigation on steel a current market share of imports of about 33% of US demand (by volume) and suggested a 25% tariff to reduce this market share to 22% while dampening US final demand by about 4%. The welfare loss is given by half the tariff rate (25% / 2 = 12.5%) times the reduction in consumption (4%) = 0.5% of market revenue. The amount of value shifted around, however, is a multiple of this amount. Foreign producers lose one-third of their sales, equivalent to about 10% of market revenue. Some of this shifts to US producers, some of it manifests itself in lower market activity. Foreign producers also lose profits to the US treasury given the lower prices they have to accept net of tariffs for their remaining sales, equivalent to 22% of the market. If their margin drops by, say, 2 percentage points, that alone would be similar in absolute terms to the total loss of welfare. Local producers earn market share. And they benefit from a higher margin on their entire sales, equivalent to 80% of the market, as consumers have to pay higher prices.
The shift in market shares and profits is much larger than the net welfare loss. And for individual firms it is these changes in market share and profit that matter.
A more exact analysis would look at the granular data on market dynamics, prices, margins, and the like. But while the specific numbers will change, the broader point holds: the shift in market shares and profits is much larger than the net welfare loss. And for individual firms it is these changes in market share and profit that matter.
Tariffs matter because they shift value around; in fact, that is their very purpose. Firms should not get confused by the small aggregate numbers of trade impact assessments.
Trade analysis (often) assumes one-step trade; companies live in a world of global value chains.
Trade impact analysis tends to model trade as a good produced in country A being sold for consumption in country B. A tariff creates a price wedge between what consumers pay and what producers earn, reducing trade and shifting economic activity to where the market is.
However, an increasing share of global trade follows a different dynamic. The many different steps through which goods are produced are often fragmented across different locations, creating so-called global value chains or nets. The development of these global value chains has been a key driver for world trade to grow much faster than world GDP—the same goods are moved across borders (and counted as trade) many times before they reach the final consumer.
In a global value chain, tariffs play out somewhat differently from the traditional model. A tariff makes a location less attractive because it raises import costs. Both imports and exports will fall. This can shift production away from the country that is “protecting” its producers, in particular when other countries retaliate and impose tariffs of their own on the final product. Global value chains also provide opportunities for firms to avoid tariffs by relocating individual activities. Tariffs then fail to “protect” the entire value chain and benefit only the small set of activities that need to be in a located in the market concerned for the tariff to apply.
The global automotive industry is a poster child for global value chains and shows how these dynamics play out. Many European producers have US factories from which they serve Asian markets, drawing on European parts and components. A US tariff could easily undermine this model, even more so when China reacts by imposing further tariffs of its own. This would make the US less attractive as a production site, not more. The global automotive industry has a long tradition in managing tariffs: producers sometimes export ready-to-assemble kits to markets with high tariff protection for finished cars, creating minimal value-added in these markets themselves.
Firms should assess their exposure along the value chain and review their options to respond as trade policies change. They will be affected by tariffs in many supplier industries, not just their end-product market. Global value chains create more exposure but also more flexibility. Firms with a larger global footprint will be advantaged through their broader ability to respond to changes in trade policy conditions.
It is not the tariff rate that matters most, but the market elasticities.
It is the tariff rates and the value of the trade affected that make the headlines on trade policy. But how they affect firms in the markets in which they are applied depends significantly on the demand and supply elasticities. How much of the tariff can be pushed over to customers? How easily can domestic producers step in and take market share? Are there third-country producers that are not covered by the tariffs and might be able to step in?
This affects the overall welfare gains but, more important, has dramatic implications for how economic value is redistributed among consumers, domestic and foreign producers, and the government. A high tariff in a market with low elasticities matters little to firms; it just taxes local consumers. A low tariff in a market with high elasticities, however, can dramatically change market shares.
This bias also affects the metric often used to measure protectionism: trade-weighted average tariffs. Here the level of protection is assessed by the level of trade that still occurs, not by the level of trade that has not taken place because of the tariff.
Firms should deploy their deep understanding of the market dynamics that they are exposed to and not get distracted by the nominal tariff rates. Firms with attractive (that is, differentiated) positions in attractive markets (with high entry barriers, high switching costs, products critical for consumers, and the like) will suffer the least.
Tariffs are a visible sign of protection, but non-tariff barriers have an increasingly more powerful impact on competition.
Tariff rates are transparently laid down in official rules and regulations, setting rates for very narrow product categories. The reduction in tariff rates over the past couple of decades has been very visible and has symbolized the reduction of trade barriers that has been achieved.
While tariffs have become less of a burden, the role of so-called non-tariff barriers that arise because of different rules and regulations across countries has grown. These non-tariff barriers include a wide range of policies, from local content requirements to health and safety standards. In a world of global value chains, investment regulations, including dispute settlement mechanisms that give foreign investors recourse against home country policy decisions, are part of this set of rules that matter. They are called barriers, but unlike tariffs they cannot be simply eliminated; they reflect issues that governments have a fundamental responsibility to organize in some way irrespective of trade.
Firms need to be aware of the impact that these rules and regulations have on their costs as well as on their competitive position relative to rivals. Contrary to tariffs, there is no profit shifting to governments, but there are costs from meeting specific national requirements. The complexity of these rules is in itself a cost, and often one that larger firms are better positioned to manage.
Adjustment can be costly but is usually not included in assessments.
Economic models tend to compare equilibrium situations: what does the world look like now, and how will it look like with the tariff(s) in place? This is a reasonable approach, especially when looking at aggregate changes in welfare. But it can miss significant adjustment costs as value (and production) is shifted around. It can understate short-term implications, for example the temporary over- and under-shooting of investment across different locations as companies adjust their production footprint to a new trade policy environment. And if decisions about costly adjustments have to be made in an environment where the long-term trade policy context is uncertain, it might lead to a backlog of postponed investments with consumers paying higher prices in the meantime.
As an example, think about the highly integrated US-Canadian automotive industry in the Great Lakes region. Building new plants in the US and training a new workforce will take time and resources. It will also lead to economic fluctuations: Assume that the current capital stock across the US and Canada is divided 80:20. With higher trade costs, that optimal division might now shift to 85:15. This implies not only that Canadian automotive investment drops by a quarter from now on. It also means that in the intermediate period investments in Canada will drop by even more until the lower new capital stock ratio is reached. And if US producers are unsure about the level of capital stock they should have in the US longer term, their investment in the US might not fill the gap with higher prices and lower output as the result.
Firms need to analyze the relevant adjustment path of the economy and what it means for them, and not just look at the potential new end state. Long-term market elasticities tend to be higher than short-term elasticities. Short-term movements in prices and investments might overshoot their long-term levels. And any adjustment requires investments to be made. Firms need to ensure that they have the resilience to manage these fluctuations.
Benefits from tariff protection are not a windfall—they come with expectations attached.
Tariffs are generally imposed with the purpose of increasing domestic production and employment, not to generate tariff revenues or create profits for domestic firms. But in most economic models, the tariff revenues do play a significant role in making protection a potentially welfare-enhancing policy intervention. Beyond that, policy makers hope that protection will encourage domestic producers to shape up and become more competitive.
The evidence on whether this actually happens seems to depend on local market conditions as well as the performance gap between domestic and foreign producers. The critical view of traditional industrial policy was the result of many cases in which the benefits from protection or government support were not invested in creating more competitive firms. Concerns about Chinese industrial policy are conversely driven by the view that government subsidies and a protected home market have enabled Chinese firms to build a war chest that they are investing in market positions and technological leadership.
Firms benefiting from tariff protection thus need to embrace a two-step task: First, exploit the change in market context to enhance current profits through a combination of gaining volume and raising margins. Second, decide whether to invest in strengthening capacity and capabilities with a view to compete more successfully in the future, with or without protection. The expectations from policy makers will be that firms raise volumes and invest. This might not always be the profit-optimizing choice. Firms need to be aware of the political repercussions of their choices.
Protectionism alone will not trigger a global recession, but its macroeconomic repercussions could.
The overall loss in global GDP predicted by traditional models from even a substantial increase in tariff rates is meaningful but far from dramatic. Studies to model a breakdown of the WTO system with all countries moving to non-cooperative tariffs predict average tariffs to rise to between 35% and 60%. Global trade would suffer, but global GDP would drop by only 3%. Countries with higher trade exposure would be hit harder—this was also true during the global financial crisis—but these also tend to be economies with higher competitiveness that are able to recover more quickly.
So is the fear unfounded that protectionism could trigger global growth to stumble? Not entirely. It will depend on how protectionism shapes the broader view investors and financial markets take about the future, and what repercussions their actions might have. Investment reluctance due to higher uncertainty could reduce momentum. Expectations of rising inflation due to higher import prices could lead to a tightening of monetary policy that slows growth. And a higher pricing of risk could lead to substantial redirection of financial flows, for example out of emerging economies that are more reliant on trade and generally more volatile. These macroeconomic repercussions are the reasons central banks and international organizations come to more pessimistic assessments of the impact that a trade war could have. In fact, the Bank of England assessment views such secondary effects to weigh much more on the UK economy than the direct effect of higher tariffs.
Firms should be aware of these risks to the global economic climate that the trade policy disputes have created, despite the seemingly moderate direct effects on global GDP predicted. Being resilient, and having plans for how to manage a changing economic climate, has therefore become more important.
When deviating from free trade promises gains, firms cannot take open markets for granted.
The economic assessment of tariffs spells out a little secret on tariffs that economists usually like to push under the carpet: countries have market power as importers, and their optimal tariffs are thus higher than zero. This might be surprising given that global welfare is the highest for free trade, and there is a lot of rhetoric that imposing tariffs is like hurting yourself. But it relates to the point on value shifting made earlier—importing countries can capture some value from exporters by imposing tariffs, and this can be higher than the value lost by local consumers. In fact, empirical assessments suggest that countries tend to impose tariffs that are significantly below the level that would be their “optimal” one to shift value.
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