Saturday, December 09, 2017

Trading Psychology Challenges - 8: Complacency and Overconfidence

Unless you as a trader operate with a consistently high hit rate on your trades--far and away the exception in directional trading--then you're likely to experience sequences of winning and losing periods simply as a chance occurrence.  The noisiness of markets, which means the presence of flows from different participants at different times, ensures that good ideas will sometimes not work.  A major problem for developing traders is that they fail to distinguish between periods of losing money and periods of trading poorly.  This leads them to continually change their trading and risk taking, eroding their probabilistic edges.

There is a flip side to this problem, however, and that is allowing strings of winning trades to skew forward risk taking.  Falling prey to the "hot hand" fallacy after a winning period, traders falsely assume that they now have a much larger edge and expand their risk taking.  They size positions unusually large and/or take many more positions.  As a result, when the inevitable losing trades occur, these wipe out large amounts of the prior gains.

It is not unusual to see traders oscillate between sloppy and complacent trading after winning periods and overcautious and risk averse trading after losses.  This means that they are most likely to lose when they take more risk and most likely to follow rules and trade carefully when they take less risk.  This recency bias ensures a downward skew to P/L over time.

Complacency after winning periods can show up in other ways as well.  Traders can become less focused in their research and preparation following profitable runs.  They can also let positions stay on their books without careful periodic review, allowing those "stale" positions to surprise them by reversing on unexpected news or flows.  

The key to avoiding overconfidence bias is to actively view winning periods as risks to future trading.  This is counterintuitive, as human nature is to feel good about succeeding.  If, however, you are actively reminding yourself that wins can lull you into carelessness, then you have an effective prod to double down on the essential elements of trading process.  An exercise I've found helpful in this regard is to visualize that the recent gains have instead been recent losses.  How would you be preparing for the day in that event?  Would the trades you're contemplating when you've made money also be ones that you would take if you had experienced losses?

A common mistake at trading firms is to allocate capital/buying power to traders after winning periods and reduce capital/risk after losses, when such stretches of losses and wins are entirely expectable given the trader's historical Sharpe ratio.  It is not at all unusual to see a trader wipe out prior gains by meaningfully bumping up risk taking after a profitable period.

Ultimately, traders become vulnerable when their feelings about themselves and their work are tied to short-term returns.  As I noted in the 2.0 book, one of the greatest strategies for avoiding recency bias is to have sources of happiness, fulfillment, and energy outside of markets and thereby ensure that trading fits into your life and not the reverse.  We become vulnerable when our recent returns dictate our current moods.

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Sunday, December 03, 2017

Three Key Ingredients of Trading Success

In a recent post, Mike Bellafiore explained why one of the traders at his firm has been experiencing career-best success lately.  What Mike modestly leaves out from his post is that quite a few of the traders on that floor have been experiencing their best ever returns.  That creates a wonderful database for studying the ingredients of trading success.

The first contributor to success is simply the market environment.  It is not a coincidence that November was a stellar month for the active day traders.  Many smaller cap stocks in the blockchain/crypto space have made huge moves intraday and over the course of a week.  It is very difficult for directional traders to achieve stellar returns in low volatility environments, something we're noticing among hedge fund returns lately.  What enables the active traders to achieve solid returns is their ability to direct their trading to what is "in play" at the time, thereby finding spheres of opportunity when VIX is still modest.  The principle here is that what you trade is as important as how you trade.  You can be the greatest gold miner in the world but go broke if you're digging in the wrong places.

On a parenthetical note, I might mention that the above principle is as important for longer time frame participants, not just the active day traders.  The directional macro investor typically benefits, not simply from volatility, but from trend.  If you look at the returns of hedge fund traders this past year, you'll find that the ones doing well have tended to be those who have been long stocks (or a combination of long stocks and long bonds in the risk parity trade); short volatility (which has trended lower most the year); and/or trading "mean reversion"/relative value strategies (in which stretched relative relationships tend to retrace in lower volatility environments).  Like any entrepreneur, the successful trader has to operate in a market that provides distinctive opportunity.

The second contributor to success for the traders who have had career best months and years has been the presence of an overarching visionary goal.  Several explicitly stated to me early in the year that they wanted to be million dollar earners this year.  It was a regular part of their thinking, and it framed how they thought about their performance.  The presence of a vision kept them energized and provided the motivational thrust for working on their trading.  Holding the vision kept them excited and energized through the year.  In many cases, that excitement and energy carried over to members of their team, fueling their performance.

The third success element for these traders was having small goals to accompany their large visionary goal.  The small goals were the things they needed to work on day to day and week to week to keep getting better.  Without the large, visionary goal, the smaller, process goals would have been mere drudgery.  But without those short-term process goals, the big vision would never have come to fruition.  As Bella explains in his post, it was the accumulation of trading improvements during the year that set the trader up for exploiting the trading environment.

When you have an inspiring vision and a robust process for working toward that vision each day, you set yourself up for success when opportunity arises.  

How are you preparing for success in 2018?

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Saturday, December 02, 2017

Trading Psychology Challenges - 7: Overtrading

Sound trading lies at the intersection of rigorous thought and decisive action.  Without rigorous thought, we trade randomness and fall prey to impulse.  Without decisive action, we betray our best ideas.

Overtrading occurs when we take risk without a clear edge in our trade.  On the surface, this seems like madness.  Why would a rational human being risk their hard-earned capital on an idea without merit?  The answer is that even rational human beings can fall short of consistent rationality.  Under conditions of fear, greed, frustration, and overconfidence, we can act mindlessly--in ways we would never contemplate if we were in our normal, grounded state.

Peak performance requires full focusAny distraction impairs efforts that require concentration and pattern recognition.  Watch weightlifters before they snatch their weights; golfers before their putts; kickers before their field goal attempts; basketball players before taking a free throw:  all will compose themselves, get themselves in the right state of mind, and then perform.  Great performers summon focus at will.  They have stronger focus muscles, and they have superior control over those focus muscles.

Suppose a surgeon finds himself distracted immediately prior to a surgery.  Would he or she blindly go forward and make an incision?  Of course not.  The surgeon would first find their focus, make sure the team has made the necessary preparations, carefully review the surgical plan, and only then move forward.  Above all else, do no harm is the commitment of every physician.  Life is precious.

Every trade is an incision in your net worth.  The capital you're trading is precious.  When we find ourselves distracted or emotionally aroused during the trading day, we need to do what the surgeon, weightlifter, or golfer would do:  slow ourselves down and engage in a routine that reinstates focus.  Slowed and deepened breathing, accompanied by a review and/or visualization of what we want to be doing, can be very helpful in grounding ourselves.

I'm a big fan of keeping two lists at one's side during trading.  One is a to-do list that captures everything you look at and everything you do when you're trading at your best.  The other is a to-don't list, which captures all the wrong things you engage in when you trade poorly.  With those lists in front of you, it's easy to conduct a focused review before placing the trade to ensure that you're aligned with your best practices and not repeating your worst ones.

In recent posts, I've addressed steps we can take when our trading is impacted by performance pressures; anger or frustration; and negative, perfectionistic thinking.  All of these can lead us to act on impulse and overtrade.  I'm currently working with several traders who are having unusually successful years.  They have demonstrated an improved ability to catch themselves in the wrong states during the trading day and refocus their efforts.  Improved self-awareness has enabled them to work on their mindstates in real time.

Equally important, however, is to avoid overtrading that results from boredom.  Many times traders find themselves staring at screens even during times when they know they shouldn't be trading.  Sure enough, they notice something that looks meaningful and act upon it, without clearly thinking through a bigger picture and plan.  In such situations, it is not enough to simply count upon "discipline" to avoid the overtrading.  What is needed are positive, alternate activities that will move your trading forward, even when you're not trading.

Those alternate activities could include rejuvenating oneself through exercise, social interaction, or meditation.  They also could include getting away from the desk to work on research and generating the next set of ideas.  Many traders I work with identify--in advance and in their calendars--the hours in which they want to be trading and hours in which they want to be doing other things.  There is no time for boredom--every hour is moving you forward in some fashion.

The cure for overtrading is self-mastery.  When your head is in the game, you work on the game.  When your head is elsewhere, you work on your head.  Approaching trading the way surgeons approach their craft is a great way to avoid doing harm

Further Reading:  


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Sunday, November 26, 2017

Co-Trading: How Coworking Can Transform Our Trading

In this post, I would like to introduce the concept of co-trading.  Co-trading is the collaboration of independent, curated traders within a coworking environment.  

Let's unpack what that means:

First off, co-trading features true collaboration.  That means the sharing of ideas and resources, as well as coordinated work on personal and professional development.  Within a co-trading environment, collaboration can include mentoring, coaching, research, brainstorming, performance review--all of the functions that traditionally occur within a large trading firm, such as a hedge fund.

The members of co-trading teams, however, are independent traders.  They affiliate based upon shared values, interests, and experience.  Unlike a hedge fund, co-traders trade their own capital, retain their earnings, and bear the brunt of their losses.  What is shared is intellectual capital and the benefits of operating within a community.  This works best when the co-working community is curated:  carefully selected to ensure that the commitments and benefits are mutual.

All of this occurs within a coworking environment.  Coworking is well known among professionals involved in startups.  Sharing a work environment with others who are passionately committed to what they do creates and sustains a high level of energy.  Networking among talented professionals generates learning and growth.  Surveys find that people thrive in coworking settings: they are more engaged in what they do and happier in their workplaces.  For a single membership fee, coworkers enjoy everything from comfortable lounge, cafe, and meeting space to shared technology and the flexibility to work individually or within teams.

To be sure, co-trading has occurred in other settings.  Traders have affiliated in online chat rooms and groups for years.  So-called arcades have been trading firms that offer workspace and technology to traders who rent desk space.  Co-trading is different in that traders are physically located in their work areas with other traders, but also potentially connected via videoconferencing with other co-trading pods at other locations.  The co-trader has the opportunity to trade at multiple affiliated locations, while traveling across the country, for example.

Perhaps most important of all, however, is that co-traders operate within larger shared office spaces with professionals from other fields.  Across the aisle could be professionals starting up businesses and developing apps, as well as people engaged in fields as diverse as journalism and business consulting.  In a recent trip to a coworking space in New York, I met with an insightful professional mountain climber who conducts personal development hikes for his clients.  I would never encounter such a person in my normal daily, office-based routine.

These are people who can expand each others' horizons.  If I belong to the coworking space in Connecticut, I can choose to work in the affiliated New York or Chicago office.  I can connect with my team with high speed videoconferencing, and I can participate in a new team.  The coworking space is available 24/7, which means that I always have a home away from home, free of the distractions of home.  In my co-trading site, I can attend online education events with members of my team and collaborate on implementing what we've learned.  That turns trader education into true continuing education for professionals.

Of course, co-trading won't be for everyone.  Beginners in financial markets will benefit from joining firms that offer high quality training.  Experienced traders who rely on proprietary technology, teamwork, and capital will want to retain the benefits unique to a proprietary trading firm or hedge fund.  Co-trading will most benefit experienced traders looking to maximize their independence, while simultaneously maximizing their access to other experienced peers.

This coming week, I will be exploring coworking spaces for traders.  My sense is that this could be a dynamic way of blending the benefits of teamwork with the advantages of independence.


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Saturday, November 25, 2017

Trading Psychology Challenges - 6: Distraction

Traditional trading psychology has tended to focus on the emotional side of human nature as a source of performance success:  both controlling emotions and maintaining discipline and using our feelings as intuitive sources of information.  Both are essential; indeed, it is only by becoming observers to our emotions that we can learn from them.

Still, the research I've undertaken to identify the characteristics of successful traders has consistently shown that cognitive traits, and not just emotional ones, are essential to superior performance.  This is why, for example, I have emphasized the structure of the learning process as a source of mastery in the Enhancing Trader Performance book and why I devoted a large section of the Trading Psychology 2.0 book to the development of creativity and the cultivation of our cognitive strengths.  Show me a successful trader, and I'll show you someone who displays unusual talents in processing information.

The most basic of these cognitive strengths is focus.  Indeed, the ability to sustain focused attention is seen (albeit in different ways) among both successful daytraders and successful investors.  In the daytrader, we see the ability to sustain intense concentration on a number of variables simultaneously.  It is this parallel processing skill that enables the daytrader to act quickly on shifts in buying and selling flows.  Conversely, the skilled investor maintains a depth of concentration over time that allows for a deeper understanding of fundamentals and the supply/demand changes that result from monetary and geopolitical sources.

The challenge faced by these market participants is distraction.  Distraction interferes with focus and thus reduces the quality of our information processing.  Distractions can be emotional in nature, but can result from environmental sources as well.  Indeed, I've consistently found that both home environments and trading floor environments are poorly suited for the optimization of focus.  This is why many of the successful traders I've known have made it a practice to get away from their screens for periods of time during the day to both renew their concentration and to increase their focus on the bigger picture of what they are doing.

All of this is important because the quality of our focus mediates the quality of our access to intuition and prior learning.  When we have superior focus, we literally have greater access to a larger library of information.  In a highly distracted state, we lose any edge we might otherwise possess, because we simply cannot access the sources of that edge.  Indeed, it is only through focused immersion in information that we, over time, develop a keen capacity for intuitive pattern recognition.  Without that immersion, we never truly internalize our learning.

This is why so many successful traders value sleep and physical exercise as part of their daily routines.  They realize that fatigue and burnout increase our susceptibility to distraction: to optimize our focus, we have to keep ourselves in an energized and rested state, renewing our willpower.  

So what can we do to build our focus and reduce distraction?  Several steps stand out in my experience:

1)  Optimizing our physical environment - Surrounding ourselves with the people who contribute to our decision-making and tuning out others.  Creating a trading station that is comfortable and well laid out, with the right lighting, temperature, and sound level.  

2)  Optimizing our cognitive environment - Making sure we have ready access to the information essential to our decision making, but not more than that.  Laying out screens for ready comprehension and action and avoiding a cluttering of our information environment.  Controlling when and how we access chat, email, and phone calls to minimize external noise.

3)  Optimizing our capacity for focus - I've written extensively on the topic of biofeedback as a tool for improving focus.  Indeed, biofeedback is a major treatment modality for children who suffer from attention deficits.  In biofeedback, we learn to sustain frontal brain activation over time, literally training ourselves to build our attention muscles.  This helps us filter out distractions and maintain focus for longer period of time.

4)  Optimizing our personal lives - In addition to maintaining a high quality of sleep and exercise, many people find that how they eat and take in caffeine and sugar impacts their level of focus.  Quite a few traders I've known have made use of coaching, not to work on their trading per se, but to sort out challenges in their personal lives (relationship issues, family matters, financial challenges) that can be distracting to their trading.  It is generally a mistake to try to put such issues out of your mind.  Finding time and a proper forum for addressing the issues directly helps prevent them from intruding on trading time.

As the quote at the head of the post suggests, it is very difficult to achieve great things if we're distracting by little things.  Building our focus from day to day is helpful in sustaining a greater life focus, where we're not only doing things right, but doing the right things.

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Sunday, November 19, 2017

Trading Psychology Challenges - 5: Performance Anxiety

Real time stress is one of the most common psychological challenges faced by competitors in performance activities.  Even very experienced golfers have been known to get the "yips".  Most public speakers have had the experience of going blank during a major talk.  The student who has studied all night for the exam can "freeze" during the test and forget what he or she has learned.  Traders who have laid out promising plans for trades can find themselves exiting on a small move against them or--worse still--struggling to "pull the trigger" to enter the trade.

What causes this stress--or performance anxiety--and what can we do about it?

First, note that not all stress is a bad thing.  As I pointed out in a recent post, anxious feelings can point the way toward our growth.  In such cases, tackling the nervousness that occurs when we push our boundaries is very constructive.  The last thing we want to do is try to bury the feelings that point the way toward our growth!

Conversely, not all anxiety is performance anxiety.  Some people experience anxiety across a range of life situations, not just during periods of performance demands.  Broader anxiety problems, such as generalized anxiety disorder, panic disorder, and various phobias, require professional assistance, usually with behavioral methods and medication assistance.  True performance anxiety is specific to performance situations.  It occurs when we become so worried or concerned about the outcomes of our performance that our nervousness interferes with the performance itself.

Fear of loss is the most common reasons traders experience performance anxiety.  Instead of accepting loss as a natural part of playing a probabilistic game, such traders view loss as a threat.  This is important to understand.  It's not simply losing money that creates anxiety, but the interpretation of loss itself.  When we view losses as threatening, we naturally respond with the fight or flight stress response--and this colors our subsequent decision making.  Very often, we choose flight over fight and fail to enter good positions or bail out of existing positions at poor levels.

Sometimes this performance anxiety is the result of having taken large--too large--losses in previous trading.  The emotional upset associated with those outsized losses return when positions move against us, so that even normal noise is experienced as threatening.  In a previous post, I noted that drama in P/L can create trauma in our emotional responses.  Sound risk management is essential so that we ensure that losses cannot become truly catastrophic to our accounts--and to our psyches.

A rule that I have long advocated for active traders is to make sure you do not lose so much in a trade that you cannot finish the day in the green.  Similarly, you don't want to lose so much in a week or month that you cannot finish the month or year positively.  This is helpful psychologically, as no losses become undue threats to our success.

Should you find yourself overreacting to past losses, it is very helpful to return to modest risk taking, regain consistency in trading, and gradually rebuild size as the sense of security and confidence return.  This is how people recover from all traumas:  repeated experiences of mastery and safety eventually reduce the sense of threat.

The behavioral techniques described in The Daily Trading Coach are particularly effective in dealing with performance-related stress.  Visualizing hitting one's stop and taking planned losses while mentally rehearsing constructive self-talk and keeping yourself calm and focused with deep, slow breathing is a way of reprogramming catastrophic self-talk and the upsetting impacts of past losses.  If those visualizations are performed repeatedly before trading hours, they create what psychologist Donald Meichenbaum referred to as "stress inoculation".  We expose ourselves to manageable threats and this exposure provides us with a sense of mastery and perspective that helps us deal with drawdowns in real time.

I have worked with many successful traders.  The great majority lose money on a substantial number of their trades.  Where they succeed is that they keep the size of the losers small and profit more meaningfully on the winning trades.  If we cut our winning trades short because of performance anxiety, we create a situation where it would take an unrealistically high hit rate on our trades to ensure profitability.  Ironically, it's when we can accept and even embrace losses--ensuring that we learn from losers and thus take away something of value from our setbacks--that we can make the most of our trading strengths.

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Saturday, November 18, 2017

Two Things Successful Traders Are Doing

Two factors stand out among the successful traders I've been working with:

1)  They collaborate:  They find like-minded colleagues and reach out to discuss ideas, research, and performance.  That collaboration allows for a richer processing of information, as traders not only see something on a screen, but actively work with that information.  Many traders fall short of their potential because they aren't processing information in the ways best for them.  Active processing is great, but many traders excel at interactive processing.  

2)  They find multiple ways to make money:  They aren't limited to one strategy or pattern to trade.  That allows them to succeed when markets become slower or when trends are not dominant.  Many times, the discovery of new ways to succeed comes from the collaboration mentioned above.  Seeing how other traders are succeeding sparks ideas for a trader.  Imagine how successful you could be if you cultivated a fresh source of edge each year.  Over time, you would have quite a portfolio of methods for succeeding, and you could reap the benefits of diversification:  always having some methods working while others are not.

A great way to not succeed is to be isolated and locked into a single style of trading.  To go far in trading, as the proverb above suggests, it helps to go together.

So what makes collaboration successful?  What do you look for in a trading colleague?  This recent Forbes article highlights the research pertinent to teamwork and the factors that will help you effectively collaborate with others:

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Saturday, November 11, 2017

Trading Psychology Challenges - 4: Frustration

Of all the psychology problems I observe among highly competitive traders, frustration is the most common.  Indeed, as I recently noted in a presentation to fund managers, frustration is a great example of the principle that strengths, taken to an extreme, can become vulnerabilities.  When we are achievement oriented and demanding of ourselves, having something get in our way breeds a natural frustration.  That frustration, in turn, triggers a fight/flight state and suddenly we are no longer nicely grounded in our brain's prefrontal cortex.  Instead, we activate motor areas to cope with the situation and act in ways that we would never entertain if we were calm and focused at the start of the trading day.

As the above quote suggests, frustration comes from expectation.  When we have a goal and the achievement of that goal becomes blocked, we are wired to take action to remove that block.  That can be helpful if, say, our path out the driveway is blocked by high, wind-blown snow.  The frustration of the situation can energize us to take out the shovel and remove the block.  But what if we cannot take remedial action?  If a car suddenly pulls in front of us without signaling and nearly causes an accident, there is no ready, constructive action we can take.  So we blow off steam and curse, hit our horn, etc.

Suppose, however, that we are in a *rush* to get to our destination.  We need to be on time, and the car suddenly pulls in front of us and causes us to get stuck at a red light.  That's when frustration is likely to be channeled as anger.  The inconvenience is now processed as a threat and our fight/flight mechanism goes into overdrive.  It's not just having a blocked goal that creates frustration; it's the *need* to reach that goal that sets us up for a performance-destroying response.  Should we react to the traffic situation by running the red light or suddenly switching lanes ourselves, we could create a real accident.  Those are actions we would never take under normal driving conditions.

As I point out in The Psychology of Trading, many times frustration and anger are responses to current situations that bring up the feelings from prior challenges and conflicts.  In such cases, our frustration seems out of proportion to the immediate situation.  That is because we are responding to past situations, not just the (similar) current one.  For example, if we experienced considerable difficulty learning in school, perhaps because of a learning disability, normal setbacks in trading can feel like past failures, eliciting self-criticism, negativity, and frustration.  In such cases, our frustration problems will not be limited to trading contexts.  When the past intrudes into the present, that typically affects a broad swath of life domains, including relationships and work.  If those patterns are interfering with many life areas, it can be very helpful to seek professional help.

When frustration is more situational and shows up dominantly in the trading context, the techniques described in The Daily Trading Coach, such as building positive associations and exposure methods, can be quite helpful.  (Another way to access resources relevant to frustration is to Google "Traderfeed frustration" and you'll see quite a few posts pertinent to the topic).  One particularly powerful approach is directly addressing the perceived *need* that fuels the shift from frustration to anger.  It is natural--and not necessarily problematic--to be frustrated when we don't reach a desired end.  When we tell ourselves that we *must* achieve that goal *now*, we set ourselves up for overreaction.

In such cases, training ourselves to embrace losses and learn from them is very helpful to our trading psychology.  Quite a few times, I have entered a good trade with a positive expected return and it hasn't worked out.  When that has occurred, I will say to myself, "That should have worked!"  That leads me to entertain the hypothesis that the market cannot sustain the expected direction and may indeed trade the other way.  That can be very useful when a breakout trade suddenly stalls and returns to a prior trading range.  Embracing the loss and now looking for a possible retracement of that range, given that others are similarly trapped, can turn the losing trade into a tuition for an even more profitable winning trade.

Other times, we may extract useful information about our trading mistakes from losing trades.  Perhaps our entry execution was sloppy, triggering us to work on firmer rules for entries.  That channels the frustration constructively, away from anger.  Many traders I work with become very alert to the cues of mind and body to recognize frustration as it's brewing.  They are able to recognize that as an emotional pattern that has cost them money in the past, and that triggers them to step back from screens and regain emotional equilibrium.  We are best able to change an emotionally driven pattern if we're aware of that pattern.  Mindfulness is a great antidote to reactive trading in the heat of battle.

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Tuesday, November 07, 2017

Trading Psychology Challenges - 3: Inconsistency

Most traders have dealt with runs of winning and losing trades.  We can expect those to occur simply as a function of chance.  A greater problem occurs when we have runs of sound and unsound trading processes.  In other words, we become inconsistent in our preparation for trading; inconsistent in our research; inconsistent in our sizing and risk management; etc.  This inconsistency threatens any possible edge that we can have in markets.

One of the reasons I encourage traders to keep regular report cards to grade their performance is so that they can catch inconsistency as early as possible, before it can sabotage their trading and their mindset.  A trader I recently met with scored himself unusually low on his ability to anticipate risk.  He simply failed to engage in scenario planning should his position fall out of bed on adverse news.  Because he had been trading well, he became comfortable and complacent.  We used that lapse to help him make the scenario planning part of his daily checklist.  The goal was to review the "what if" contingencies--and mentally/emotionally prepare for them--*before* putting the trade on.

So what causes us to become inconsistent?  There are three important possibilities:

1)  The market has changed.  Our trading can become inconsistent when markets themselves exit one regime and enter another.  As trends change, correlations among markets change, and volatility changes, what had been working may no longer bear fruit.  If you find that your trading processes have remained relatively constant but your results are noticeably worse, you want to take a deeper look into what you're trading and whether it has become a different market.  If so, you want to make sense of that new regime and develop fresh trading ideas based on new understandings.  Be especially attentive to alterations you have made in your trading processes in reaction to changed markets.  One trader I recently spoke with found himself trading more frequently as markets became less volatile, in essence pressuring himself to make money by taking more trades since each trade was yielding less.  That overtrading led to poor results. 

2)  Our state has changed.  In the example from the second paragraph above, the trader became overconfident and overeager after a period of winning.  In other situations, we lose consistency when we become frustrated or fearful.  The state change into fight or flight mode causes us to act in a reactive, unplanned fashion.  At such times, we place trades as much to manage our states as to optimize our profitability. If we find that critical portions of our planning have been overlooked in the heat of battle, then our goal is to work on staying calm, focused, and mindful in real time.  In my Trading Psychology 2.0 book I discuss self-hypnosis as a way of replacing negative states with positive ones.  The Daily Trading Coach covers a number of methods for state-shifting, including the use of trance and behavioral exposure techniques.  When we can recognize problem states in real time, we can then use meditation and guided imagery methods to switch into a calm, focused mode before the agitated state can hijack our trading.

3)  We have become fatigued.  Fatigue is a special kind of state change, as it relates to energy level more than emotionality.  Very often traders spend long hours in front of screens and overtax their willpower.  This is a short-term equivalent of the burnout described in the recent post.  In that situation, we need to renew ourselves, typically by getting away from screens and entering a different mode and state that is stimulating and renewing.  Taking an exercise break midday, getting off the desk and talking with colleagues--these are ways of shifting gears that can be renewing.  Getting the right amount and quality of sleep at night is also an important consideration, as the lack of restorative sleep can lead to diminished concentration and susceptibility to inconsistent trading.  The positive impact of healthy eating, healthy exercise, healthy sleep patterns cannot be when it comes to optimizing one's energy level.  Building positive, stimulating activities into non-trading time can also be highly renewing.

In short, there is no single answer for inconsistent trading, as there are many potential causes.  As a rule, if your process is inconsistent, then state changes could well be the trigger and culprit.  If your processes have remained rigorous but results have gone downhill, it could be a sign of changing market regimes--important information in itself.  Inconsistency in trading generally means that you have fruitful work to do, either on yourself or on markets.


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Sunday, November 05, 2017

Resources: Learning Technical Analysis

It's no secret that I'm a skeptic regarding traditional technical analysis, per the recent blog post.  Still, I respect objective reality and acknowledge that I've been honored to know a number of successful traders who make active use of technical ways of understanding markets.  My sense is that they are skilled in identifying stable market regimes and the patterns that characterize those regimes.  Peter Brandt's newsletter stands out as a technical resource that covers a wide range of assets, with a track record documented in real time.  The newsletter also shares the accumulated wisdom and experience of a seasoned trader, an equally valuable contribution.  It's hard to dismiss technical analysis entirely when an experienced hand is garnering real time returns that beat the pants off most money managers.

So how can a trader learn the best of technical analysis and avoid the hype and mumbo-jumbo?  My favorite text is Cliff Sherry's classic, The Mathematics of Technical Analysis.  Another phenomenal resource is the cycle work of John Ehlers, which forms the basis of another service with an outstanding track record: StockSpotter.  Both take a quant approach to the analysis of price behavior, adding an important element of rigor to the common use of charts and indicators.  Brandt's newsletter stands out as a real time resource that not only makes market calls, but explains these in technical terms.

Another recent set of learning resources has been offered by Adam Grimes.  He has recently supplemented his book on technical analysis with a free course and a hands-on workbook.  The workbook is a compendium of resources Adam has offered over the years, spanning trading psychology, the psychology of learning, chart reading, and basic statistical methods for assessing the validity of technical patterns.  Adam makes the excellent point that technical formulations are really ways of identifying patterns that capture two factors:  value (mean reversion) and momentum (price continuation).  He stresses the importance of understanding the "stories" behind charts and price action, not simply following preset indicators and chart formations.    

There is a lot of lazy technical analysis out there.  One thing stressed by all the above resources is analytical rigor.  Technical analysis can provide valuable market insights, but not shortcuts.

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Saturday, November 04, 2017

Trading Psychology Challenges - 2: Perfectionism

In the Enhancing Trader Performance book, I identify a powerful obstacle to developing successful trading strategies: perfectionism.  "Perfectionism clearly plays a role in preventing us from cultivating superior strategies," I wrote.  "In a very important sense, perfectionistic traders are not seeking to make money.  They are trying to not lose money.  Their intolerance of loss keeps them moving from method to method in search of a certainty that markets cannot provide." (p.157).

The phrase here is apt: *intolerance* of loss.  The perfectionist is not seeking self-improvement.  The perfectionist is intolerant of anything that falls short of ideal.  This sets the stage for self-blame and frustration.  While it might look like a shield of high standards that protects us, in fact that shield burdens us, weighing down our performance.

A review of one's trading journal often reveals when perfectionism is a problem.  A trader might have identified a good idea, placed a trade at a good level, and taken profits at a target, only to see the trade go further in his or her direction.  The journal entry will focus on what the trader *should* have done (holding the trade longer) rather than what the trader did well.  The "should" is not grounded in any tested rule; that same trader will be equally self-blaming over a trade that is initially profitable but reverses when he or she holds for a further target!  Such perfectionism is hindsight bias at its worst.  

Note how such perfectionism turns a winning trade into a psychological loss by exclusively focusing on shortcomings.  It is not constructive, because it does not create concrete learning lessons.  It is frustration channeled as self-blame.  As such, it robs us of the fulfillment we otherwise would feel after a good trade and leaves us feeling diminished.  Over time, such self-blame takes a toll on our energy and outlook, contributing to the problem of burnout.

How many of your journal entries and how much of your review time are spent on what you did wrong?  To what degree do you learn from your successes and reinforce your best practices?  If you are parenting a young child, you would use positive reinforcement, not just punishment, to teach the right behaviors.  As a trader, you are always a young child, always developing, always learning.  You want to be as constructive with yourself as you would be for a daughter or son you love.

Perfectionism wears people down.  Perfectionism tears people down.  We want to channel frustration toward learning and improvement, not toward self-blame.  We want to direct our anger toward our problem patterns, not toward ourselves.  That is a very important distinction.

So what can we do about perfectionism?  Three strategies stand out:

1Restructuring Our Reviews:  By giving ourselves realistic report cards, grading each area of our trading process, we can readily identify what we're doing well and what we're doing that needs improvement.  We want to go forward with positive goals--building on our successes--as well as remediation goals, correcting our weaknesses.  Every review should identify strengths and improvements and should lead to goals of continuing to do what is working.  Every review should also focus on constructive steps we plan to take to improve our shortcomings.  The focus of the review is on improvement, not blame.  We focus on getting better, not being perfect.

2)  Cognitive Strategies - The cognitive strategies described in The Daily Trading Coach enable us to identify negative thought patterns as they occur, so that we can redirect our processing in real time.  Very often, perfectionistic ways of thinking are ones we have inherited from parents, teachers, and other early life role models.  When we can separate their voices from our own--a great application of cognitive journals--we allow ourselves to stand outside our perfectionistic patterns.  In short, when we adopt a cognitive perspective, we turn rigid, negative thinking into the enemy.  That allows us to coach ourselves in an empowering way, not in a way that demoralizes us.

3)  Behavioral Strategies - Very often, perfectionism is triggered by frustration.  Of course it's frustrating to take off a trade only to see it go much further in our direction.  That frustration shows up as physiological tension, which in turn cues the negative thought patterns.  One of the greatest insights I came to as a trader was the recognition that my poor trading was entirely state-dependent.  When in the fight-or-flight mode, I was much more likely to miss what was happening right in front of me and impose my own needs onto markets.  Behavioral strategies allow us to pull back from trading screens and change the state we're in, becoming more calm and focused--and much more able to recruit solid coping skills.

Sometimes negative, perfectionistic thinking is pervasive, occurring across life domains, not just during trading.  If that is the case, it's worth consulting with a psychologist and developing a structured plan for changing those patterns.  It's also worth ruling out depression as an underlying problem, as the depressed state can lead to chronically negative thought patterns.  As I emphasized in the post on diagnosing our trading problems, it's always a warning sign when patterns disrupting our trading are also disrupting other areas of life.  That's when we want to move beyond coaching and get concerted professional help for overlearned patterns.

We will never be perfect as traders.  That's what keeps us ever-learning, ever-growing.  Our challenge is to use our shortcomings as inspirations, fueling continued improvement.

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Sunday, October 29, 2017

Trading Psychology Challenges - 1: Burnout

Author's NoteThe extensive posting on how to diagnose your trading problems is helpful background to this series on challenges in trading psychology.  Before seeking solutions to issues that impact trading, it's important to figure out whether those issues are trading problems impacting psychology or psychological challenges interfering with trading.  The above linked post can help you make that important distinction--as well as a few other, key ones.

It's not unusual to hear young traders declare their passion for trading and their complete focus on developing themselves as traders.  When I hear that, I worry.

Very often those same traders are ones that burn out when they hit inevitable stumbling periods in their trading.  They pour themselves into markets and when markets don't give them anything back, they have nothing more to give.  Quite simply, they're burned out.

There are a few tell-tale signs of emotional burnout among traders, including loss of motivation and energy; negative, hopeless, and/or resigned thinking; and a loss of interest in life activities.  When I have been in a burnout state, I have felt overwhelmed.  I can't find the mental or physical energy to take on another task or responsibility.  It's a complete sense of overload.

In that state of overload, it's impossible to focus fully, further contributing to missed opportunities and poor decisions.  Equally crucially, in the burnout state, we cannot engage in high quality learning.  We're merely coping with our experience, not actively processing and learning from it.  For these reasons, burnout can take the form of a downward spiral, as lower energy and focus contribute to further performance problems, which in turn drain us of energy.

Lack of productivity--working many hours, but accomplishing little--is often an early sign of burnout.  Negative attitudes are also an early sign.  Many times, burnout in trading leaves people with little energy for the rest of their lives:  relationships, family, exercise, etc.  This, too, becomes a downward spiral.  When we lack energy, it's easy to avoid activities that initially take effort, but that could ultimately renew us.

Here are three things we can do to address burnout when it appears and also prevent it from occurring in the first place:

1)  Take Breaks - We can exhaust ourselves simply by sustaining concentration for long periods without any form of renewal.  Taking breaks during the trading day can help us review performance and make corrections.  It can also help us relax, clear the head, and renew our energy.  The key to effective breaks is that they keep you active, but not in the way you're active in front of trading screens.  Physical activity, social activity:  These are stimulating, but in different ways than trading.  Changing gears helps you restore those willpower muscles.  This principle applies to weekends and vacation periods as well: those are longer periods of renewal.  When you are truly burned out, trying something different at work is the wrong answer.  Any "trying" will simply further exhaust you.  Taking a complete break from work allows you to return with energy and focus, attacking your situation with a fresh perspective.

2)  Build In Rewards Even When Trading Is Not Rewarding - I am consistently impressed with how the most successful traders find work-related rewards outside of P/L.  Many of them work in teams and thus reap the psychological rewards of developing junior talent and contributing to others.  Many of them conduct their own research efforts and thus find fulfillment via intellectual curiosity.  During a period of flat to down performance, those research efforts may target new edges in markets, providing a sense of opportunity.  In all of these cases, traders evaluate their performance on multiple dimensions, not just P/L.  They find intrinsic rewards in managing money and are thus less likely to burn out during frustrating times.

3)  Build In Rewards In Life Outside Of Trading - As I emphasized in a recent post, using free time as down time is often a mistake.  You want your time outside of trading to be "up" time.  That is, you want your time outside of work to be energizing and stimulating--giving you energy at times when you're feeling sapped.  It is this positive use of time that prevents temporary overload from becoming a downward spiral of burnout.  Romantic relationships, friendships, physical exercise, personal interests, travel--all of these are potentially energy-giving.  

If you find yourself unable to enjoy non-trading related rewards and unable to benefit from the breaks you take, consider the possibility that your situation is more than a burnout.  Depression takes many forms and affects a significant portion of the population on a 12-month basis.  Especially if you have a family history of depression, consider seeing a qualified professional for a diagnostic screening.  There are many evidence-based therapies and medications for depression that are worth looking into if burnout seems chronic.

The key is that true burnout is situational.  Once we re-establish an equilibrium in lifestyle, we quickly regain our psychological equilibrium.  Balance in daily activities--and in life overall--ensures that no one setback in life will overwhelm us.  A great formula for well-being is a diversified and full life portfolio.

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Saturday, October 28, 2017

How Individual Traders Can Benefit From Teamwork

An interesting post from Adam Grimes explores the limitations of modeling successful people in trading.  There is much more to success than merely copying what others are doing.  And yet I find consistently that the greatest success among developing traders comes from working within teams.  For the last couple of days I've been working at a firm where all traders operate in teams and the teams operate within larger trading groups.  Every two weeks the traders meet in their groups to review performance, set goals, and learn from the experience of others.  The team leaders talk about their trading and that sets an example for the other traders.  Quite literally, teams expand the number of role models possible to a trader.  We learn, not from merely copying others as Adam points out, but from understanding what they are doing and how.

Seth Freudberg heads up the Options Tribe at SMB, where traders, operating from their own home locations, learn specific options strategies and then meet as a virtual team to work on performance.  Every month I get a P/L statement from Seth regarding the team's performance, so I see how well the development of the traders has progressed.  The returns have been very positive and consistent, and that is because there has been teaching by example.  Seth trades the strategies, shares his mistakes and successes, and establishes a culture where every participant is both teacher and student.

The mistake developing traders make is viewing education as a one-way process, where there is a teacher with all the wisdom and knowledge and students who absorb it all.  The team approach features the leader as an advanced student.  This creates an environment in which sharing becomes the norm and everyone takes responsibility for the development of others.  The advanced students learn from each other and also from the ideas and successes of the newer students.  Those newer students absorb the lessons from the more experienced role models.

Want to immediately benefit from the power of teams?  Find just one study partner for 2018:  someone you will work with in tracking markets, learning from successful and unsuccessful performance, and having fun in growing as a trader.   In traditional Jewish settings, learning occurs chavrusa-style, where students pair up and intensively prepare for lessons and challenge each other to come up with new and deeper understandings.  Just one study partner can create a dynamic learning environment.

There are more resources out there than ever, including valuable training resources.  (I see Adam has come out with a new book to guide traders through his free online course).  We can team up with others participating in trading communities (great way to find like-minded study partners) and create review processes that supercharge our trading.  Teams keep each other focused, they keep each other motivated, and they create multiple role models.  Show me a successful businessperson, researcher, or athlete, and I'll show you someone who has benefited from teamwork.  A great goal for 2018 is to double down on teaching others--and learning from them as well.

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Saturday, October 21, 2017

Will Your Trading Success Truly Last?

You've made strides in your trading.  Results have been favorable.  How can you ensure that today's success won't be tomorrow's flame-out?  

It's an important question.  How many of yesteryear's Market Wizards would earn that designation from their recent returns?  Not one of the Wizards in the original text was a true quant.  If the book were being written for the first time now, we would see several math wizards highlighted.

Times change.  Edges in markets change.  Today's success does not guarantee a bright tomorrow.

How can we achieve, not just success, but lasting success?

Greatness in trading can be found outside of trading hours.  It can be found in how traders prepare for tomorrow's ideas and positions, but it also is found in how traders prepare for the long-term growth of their businesses.  A good trader has an edge.  The great trader is always developing edges for the future.  Great traders treat their craft as a true business, maintaining an ongoing research and development pipeline.

Show me how a trader utilizes their time outside of trading and I'll show you the odds of their long-term success.

One trader I worked with years ago made a spectacular effort to teach himself programming, data management, and quantitative analysis while he held a full time non-trading job.  With his new skills, he joined a portfolio management team and together he and his partner achieved multi-million dollar success.  It took evenings and weekends of effort to get to the point of being prepared for success.

A major challenge is that traders don't feel they have the time for building their pipelines.  They are so busy trading that they have little time and energy for cultivating tomorrow's sources of edge.  They try to manage their time and create opportunities for research, but aren't productive in those leftover hours.

In a recent Forbes article, I wrote about how we can find our success by focusing less on time management and instead energizing our time.  Happiness inspires productivity, because we are most likely to immerse ourselves in activity that is intrinsically rewarding.  When we find opportunities that truly speak to us, the work effort *gives* energy.  Research and development is no longer just another task in a to-do list; it is the pursuit of a vision that provides joy and meaning.

This is why so many traders who experience long-term success display unusual intellectual curiosity.  They are driven, not just by money, but by the process of discovery.  Exercising a strength is not work; it is a high level of play.  Our trading success is most likely to last if it is part of a process that exercises our highest capacities.  You can find tomorrow's edge in what intrigues you today.

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Monday, October 16, 2017

Are You A "Strong" Trader Or A "Weak" One?

There are two types of traders:  

One looks for patterns and relationships that will occur universally and trades those consistently over time.

The other looks for stable periods in markets and trades the patterns and relationships that typify those regimes.

For the first trader, trading psychology is all about consistency and maintaining a consistent mindset.

For the second trader, trading psychology is all about flexibility, creativity, and adapting to changing conditions.

One is a stiff tree; the other is bamboo and willow.

The stiff tree has a hard trunk and looks strong.  It breaks when the wind blows hard.

Bamboo and willow have no trunk and look frail.  They bend with the wind and don't break.

There is a distinct regime in the current market.  There are patterns and relationships playing themselves out with regularity. 

How is your P/L?  Are you the "strong" and stiff tree, or the "weak" and flexible reed?

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