Losers Determine Your Success!

Art Simpson: "...understand how simple it can be to not care because of your rules and just do it -- DO IT! ...it only matters what you do with your losers that determines your success.

Phantom of the Pits: "...Keep emotion out of it. If you do the right thing in trading, never be a weeper."

Being Right Is Over-Rated

from Abnormal Return blog (one of my favorites):

Joe Weisenthal at Clusterstock points out today an interesting (long) piece by Holman Jenkins at Hoover.org on the financial crisis. The gist of the article is that the financial crisis was by and large a massive financial accident that was unforeseeable.

Jenkins notes that even investors like John Paulson, who many claim to have foreseen the meltdown of the global financial system, did not in fact foresee the crisis. If they had they would have invested quite differently:

But those who bet successfully against subprime did so through elaborate, expensive, negotiated deals to purchase credit default swaps or buy “put contracts” on subprime indexes. Had they really seen what was coming, they would saved themselves a great deal of expense and bother by simply shorting Citigroup, Bank of America, Lehman, Bear Stearns, etc. Their profits would have been huger, their workload and hassle factor much less.

The point of the above quote is not whether the crisis was foreseeable, nor is it a criticism of Paulson. In today’s financial markets traders can express their viewpoints about the future through derivatives and structured products in a very precise manner. If Paulson had foreseen the collapse of the global financial system there were much easier ways to profit from (and express) that viewpoint. (Not that he is complaining.)

Much too much is made in the media about who is right, and who is wrong. (Not that these thing are well tracked.) On television, in print and on the Internet we are inundated with pundits who crow about their prescience, while omitting their missed forecasts. The funny thing is that for investors, being right is greatly overrated.

Investors and traders need only worry about one thing: profitability. Are you generating requisite profits from your portfolio for the risks assumed? Everything else is just noise.

The need to be right is a common error for beginning investors. Any one who has ridden a stock down for a large loss can attest to this. Behavioral finance experts have a term for this: the disposition effect. Investors tend to sell winners too soon, and losers too late. You could even think of this as ‘get-even-it is.’ Investors do not want to admit that they made a mistake.

The fact of the matter is that all investors make mistakes. It is simply a part of doing business. One way traders look at their profitability is expectancy. In a vintage post, Trader Mike does a nice job describing the components of expectancy. The take away is that the percentage of times you are right is only one component in your profitability. In theory, a trader could be wrong much more that 50% of the time and still be profitable, if the profits from their winning trades far exceed the losses on their losing trades. As he writes:

Expectancy, position-sizing and other aspects of money management are far more important than discovering the holy grail entry system or indicator(s).

Stated another way: For traders, being right is overrated. It is far more important knowing when you are right, and when you are wrong, and acting accordingly.

In summary, being right may be a necessary component of trader profitability, but it is not sufficient. Proper money management techniques are required to turn trading decisions into trading profits. While it is difficult some times to take, being wrong is a part of being a trader. Don’t let the need to be right prevent you from becoming a beter trader.

How Do I Handle the Mood Swings?

from Dr. Brett--
A reader asks the question:

"How do I avoid the inevitable mood swing when a couple of trades go bad? For a few days in March I was afraid to get back on the horse and had to tell myself to jump back on/trade as the only way to get over it."

My response is that you'll *always* have situations in which "a couple of trades go bad". If you average 55% winning trades, you'll have two consecutive losers about 20% of the time. For the active trader, that means that "a couple of trades go bad" occurs every week, if not daily.

Mood swings when trades go bad are *not* inevitable. The professional trader *plans* to be wrong and manages positions accordingly. That trader knows that you can trade well and still have a couple of trades go bad. Embracing risk and uncertainty, the successful trader limits losses by controlling position sizes and establishing loss limits (per trade, per day).

The good trade gone bad often provides a trader with valuable information--if the trader is open to the message. Today I worked with a trader who tried to buy the market in the afternoon, only to get stopped out. Shortly after, he noticed weakness in the 10-year Treasury notes and reversed his position. By day's end, he was profitable by a healthy six figure sum. The "bad trade" offered opportunity, not threat.

If you do experience mood swings around losing trades, it's probably because you are evaluating yourself by the criterion of being right--not by the criterion of trading well. It isn't the losing trade making you feel bad; it's the perfectionistic expectation that you should always be right. By embracing uncertainty and staying open to learning from it, the threat of losing can turn into the opportunity of rethinking market assumptions.

Reader Comments on Handling Performance Pressures

from Dr. Brett--
I recently proposed that performance anxiety is the most common psychological problem faced by traders. In the comments section of that post and in private emails to me, readers have weighed in with their successful approaches to dealing with performance pressures. This post will summarize reader comments; tomorrow's posts will synthesize perspectives from reader emails and add a few views of my own.

Let's start with views from the comments section:

* Reader Charles talks about an approach that is common among proprietary traders I've worked with. When he hits a slump, he temporarily reduces his size, takes pressure off, and then raises his size once he gets back into the groove. I will do something somewhat similar: I will temporarily limit my trading to my highest probability setups and get a winning day or two under my belt during a slump period. The reason this strategy can work is that it takes an important element in stress--perceived control--and puts it squarely in the trader's hands. Often, performance anxiety occurs when we feel out of control of a situation. By creating an enhanced degree of control, we can regain our sense of mastery and minimize stress. The one caveat in this approach is that position sizing is crucial. If you risk too much of your portfolio on individual positions and then hit a losing patch, you could dig too deep a hole for yourself--particularly if you reduce your size in order to recover psychologically. Not betting the farm on any single idea is one great preventive measure for performance pressures.

* Trader David offers a fascinating analogy between trading and skeet shooting. He also provides a link to an Olympic shooting coach who helps his students with performance pressures. He suggests visualization techniques to occupy the conscious mind, enabling the subconscious (i.e., our automatized skills) to take over. Most performance anxiety occurs when a task that normally occurs automatically is disrupted by our conscious focus on the outcomes of that task. Any exercise that absorbs our awareness and directs our focus away from the performance itself will be helpful in that regard. As I will indicate in tomorrow's post, enhancing our state of concentration and directing that concentration toward the process of performing (not the outcome) can form the foundation for an effective self-hypnosis routine. David's approach is much more than simple positive self-talk: it is a redirection of attention and hence a redirection of regional cerebral blood flows.

* Dr. Bruce, who has offered so many fine comments on this blog, puts his training to good use and recommends the use of beta blockers in combating performance anxiety. I cannot agree more. When I ran the counseling program for medical students in Syracuse, I encountered performance anxiety problems all the time: test anxiety, public speaking stress, etc. My first line of assistance was the use of specific behavioral exercises that research has found to be effective in dealing with anxiety. (More on those tomorrow.) There were times, however, when even those exercises were not sufficient to gain self control. The beta blockers were very helpful in reducing physiological reactivity, reducing the secondary anxiety that I mentioned in the prior article. Instead of becoming anxious about their own anxiety, performers notice their reduced arousal and focus on that. Here's a nice summary of the use of beta blockers for professional musicians. Note that these are to be used as temporary measures before major performances and must be prescribed and supervised by a physician.

* Dr. Bruce also recommends relaxation and biofeedback. At present, a combination of these, along with directed behavioral exercises, is my favorite intervention for performance anxiety. Here you're training the body to remain calm--and training the mind to stay focused--under varying emotional conditions. Much of my post tomorrow will deal with this combination. As Dr. Bruce notes, the techniques work much like the beta blockers: by reducing autonomic arousal.

* Finally Dr. Bruce emphasizes the role of preparation in preventing performance anxieties from taking over. Making skills automatic is the best way to enable performances to flow. When I have a public speaking engagement, I will always prepare the opening of my talk most extensively. I'll also use overheads to cue me through the opening. I know that if performance pressures are going to be present, they'll get to me early in a talk. By being super prepared with the first portion of the presentation with plenty of cues, I get into the rhythm of the speech and the automatic skills take over. Similarly, I will intensively mentally rehearse the entry of a trade and what I'll do if it goes against me. This preparation takes the scariness out of a situation and, as noted before, enhances the sense of personal control. Please also take a look at Dr. Bruce's point about running wind sprints (increasing your physiological arousal) when you're anxious; it's an excellent point. By exercising vigorously when you're anxious, you override your body's nervousness with normal pumped-up arousal, which no longer plays into the secondary anxiety. Indeed, as the good doctor notes, you can actually use your awareness of your pumped-up state to aid your performance.

* Trader Dan mentions a technique that psychologists call cognitive reframing. Remember that performance anxiety occurs when we perceive a situation to be a threat. By reframing the situation, we take much of the threat out of it. His reframing is based on an analogy to the baseball player: The hitter can get on base less than half the time and still be an all-star player. It is not necessary to win on each trade to be a successful trader, and all successful traders have strings of losers simply as a function of chance. Making losing a normal, expectable part of the game--and making sure position sizes are reasonable in order to survive those losing streaks--is very helpful in taking the threat out of trading losses. My own approach, as readers know, is to view outcomes in two ways: trades that make me money and trades that teach me something about myself and/or the market. By embracing loss as a learning experience, I reduce the stress often associated with thoughts of losing.

* Reader AnaTrader, who has also graced this blog with many fine comments, offers several perspectives from her mentor. The essence of her mentor's approach is enhanced self-awareness: taking one's "emotional temperature" hourly to monitor stress levels and thought patterns associated with stress. AnaTrader passes along a key insight: the importance of staying focused in the present. It's when we become wrapped up in the past or future--worrying about past losses or possible future ones--that anxiety is most likely to appear. By using breathing techniques to stay grounded in the present and reduce physiological arousal, it is possible to regain a present-centered awareness. Citing Steidlmeyer, AnaTrader's mentor notes the value of immersing yourself in current market data as a way of staying focused on the present. Immersing oneself in meditation music and constructive self-talk, as AnaTrader notes, can also short-circuit the worry process that generally precedes performance pressures.

* Trader Jeff mentions returning to paper trading mode as a way of regaining one's rhythm. This is similar to the above-mentioned technique of reducing trading size, but now it takes money off the table altogether and just has the trader focus on the process of putting on trades and managing them. This approach is common in the area of sexual performance anxiety, where psychologists will help couples by telling them to *not* engage in intercourse and simply get comfortable with themselves and their partners in bed. By taking the performance pressure away from the sexual situation, couples can allow their natural feelings to take over. Similarly, the trader who goes back to paper trading temporarily can find his or her rhythm return relatively quickly, making it easy to return to putting money on the line. One caveat here is that you don't want to retreat to paper trading for too long a time; that could be an escape that would not enhance a trader's sense of master. As a temporary measure for getting away from money pressures and returning to sound trading practice, however, going into simulation mode can be very useful.

* KC Equity Trader makes a super-important point about making sure you can always survive losing trades. In my own position sizing, I always assume that I could have six consecutive losing trades. If my bets are so large that six consecutive losers would put me in an emotionally bad place (and a large P/L hole), then I know I'm trading too much size for my own risk tolerance. Because KC Equity Trader knows he's always going to survive to make another trade, no single loss is unduly threatening for him. KC's point about keeping things mechanical--carefully following planned entry and exit signals--also makes the trade automatic, reducing performance worries. By making losses planned and routine, the trader takes away their threat.

* Dinosaur Trader mentions how it's easy to become more focused on P/L when a new child enters the home and there are greater household expenses and perceived trading pressures. He also mentions reducing trading size as a way of reducing this pressure. Sound financial planning is also key: making sure that you always have cash reserves to handle unexpected expenses, loss of a spouse's income, etc. I'm a firm believer that one should not be trading one's household savings. There should be separate accounts: one for savings/investment that remains safe and secure and one for trading. If your trading account is also your savings and retirement capital, that is too much objective pressure for most traders. What that means in practice is that a portion of trading profits should always be devoted to rainy days, trading slumps, and future needs. It also means that new traders should have enough reserve capital not at risk (or secondary sources of income) to survive their learning curves. That having been said, I know many traders who have traded more cautiously (and smaller) immediately following a major life event (marriage, birth of a child, relationship break) until they're sure they have their equilibrium. The ounce of prevention in such cases is truly worth the pound of cure.

* Finally Trader M. mentions anxiety that comes from being unable to anticipate market trends. He engages in considerable market preparation to make such anticipations and feels pressure to incorporate new methods/information in order to not miss anything. The risk here is one of perfectionism: setting a standard of being able to predict trends that not even highly successful traders live up to. Many, many successful traders (trend followers, short-term traders) don't succeed by anticipating market trends. Rather, they identify shifts in trend as those are occurring or right after they've been confirmed. I know quite a few successful breakout traders who don't try to predict the breakout: they simply go with it once it's confirmed by volume and the participation of large traders. Trader M. perceptively notes that trading is like speed chess. In speed chess, however, you don't succeed by trying to predict your opponent's moves. Instead, you train yourself to respond to board configurations as they emerge. Moderating one's demands on oneself can be a powerful method for reducing performance pressure.

So there we have it! There are many more fine insights from commenters than you'll get in any high priced seminar or coaching session. Tomorrow, I'll summarize the equally astute insights of those who have emailed me with comments and then I'll post my own techniques for handling performance anxiety. Thanks to all who have participated in this exercise and shared their learning and experience!

I recently posted comments from readers regarding ways of handling performance anxiety. In this post, I'll summarize emailed ideas from readers and also add a few thoughts of my own. Because these readers opted to email me rather than comment publicly, I am not mentioning them by name to preserve their anonymity.

* Trader O recommends a book by Terry Orlick entitled In Pursuit of Excellence: How to Win in Sport and Life Through Mental Training. Orlick is a former Olympic athlete and coach and has worked with many Olympians on mental training. His methods include focused goal setting, visualization, relaxation, and methods to block out distraction. Recall that performance anxiety occurs when concerns about the outcomes of performances interfere with the actual act of performing. By learning how to direct awareness and achieve a state of focused concentration, a performer can become immersed in the act of performing. For instance, during my best trades I focus intensely on what various sectors are doing and how volume is behaving. My thoughts are on how the market is trading, not on whether my trade will make money. As Trader O and the book suggest, one can train oneself to sustain such focus as a positive habit pattern.

* Trader M observes that "The most effective technique I use for dealing with anxiety is to remember that anxiety is missing the letter ‘d’. There is no entry in any English dictionary entered as “andxiety”." His excellent point is that we tend to lapse into thought patterns where we see ourselves as either all good or all bad. Anxiety can be seen as a form of justice, pushing us toward a more balanced perspective. The word "and" itself adds a balancing element, reminding us that we are subject to both good and bad: winning and losing. This simple reminder--by turning "anxiety" into "andxiety"--helps a trader think and feel with "and". That's a balanced perspective that doesn't put pressure on the performer.

* Trader S recommends the book Emotional Intelligence and its description of methods to resolve problematic emotional patterns. He particularly mentions becoming aware of your own breathing, especially when it becomes short and shallow. By purposely elongating those breaths, he is able to slow himself down both mentally and physically. He has used the Journey to the Wild Divine biofeedback software to help him learn to control his body's arousal. Finally, after undergoing some traumatic losses, Trader S. has limited himself to trading one contract and losing only $100 per trade. This takes the possibility of large losses entirely off the table and enables him to regain confidence. In my next post, I will outline some of my own uses of biofeedback to deal with performance pressures. This can be a very useful tool for self control.

* Trader A mentions a technique from a book that helped him greatly when he started a new trading position with a firm. He kept a daily journal and wrote down the time of day whenever he experienced feelings of panic regarding his trading. He then wrote down the time of day when that anxiety subsided. Although it seemed as though the nervousness was lasting a long time, he could see that, in fact, it only lasted a few minutes at most. Each time he repeated the exercise, the duration of the anxiety period lessened. This is an excellent method, because it reinforces for the trader the sense of "This, too, shall pass." It is one easy way to deal with secondary anxiety: the fear of becoming anxious.

* Trader F recently went through a harrowing loss and dealt with it by shedding half his position and protecting his remaining capital. He notes that such a loss can spiral, taking a trader out of his discipline and interfering with subsequent opportunities. I believe his basic point is so important : we should always have loss limits in place that we can live with. This takes much of the pressure off of losing. I personally try to ensure that no single loss in a day's trade could prevent me from having a green week; no single losing week could prevent me from being up on the month. The key is to have control over one's losses, rather than letting them control you.

Once again, I thank readers for sharing their experiences and life lessons. One great advantage of a blog is that it can become a two-way vehicle for communication, in which we learn from each other's experiences. In the last post and this one, readers have written a virtual manual regarding how to overcome performance pressure. My next post in this series will offer a few perspectives of my own and attempt to contribute to that manual.

Favorite Techniques for Overcoming Performance Anxiety

from Dr. Brett-
A little while back I made the observation that performance anxiety is the most common psychological problem that I encounter among traders. It occurs in many forms--during slumps, at times when traders attempt to raise their size/risk, when life's financial needs add pressure to trading outcomes--but the common element is that a concern with the results of trading interferes with the process of trading itself.

I thought that both the comments of readers and their emailed suggestions offered very useful ideas regarding the handling of performance pressures in trading. In this post, I'll add two suggestions of my own.

* Self-hypnosis - This builds on the ideas from my first trading book, The Psychology of Trading. When a trader is responding to a trading situation with anxiety, I ask the trader to close his eyes, breathe deeply and slowly, fix his attention on a musical selection, and hold his hands in front of him with palms facing each other a couple feet apart. The music, taken from Philip Glass' early works, has a highly repetitive structure and serves as an object of focus. After an extended period of the slow, rhythmical breathing and focus on the music, I then suggest to the trader to imagine that there is a magnet between his hands, pulling them slowly and steadily together. As his hands are drawn closer and closer, I suggest, he will find himself feeling more and more relaxed, calm, and confident. The exercise is brought to a close when the palms finally touch. Altogether the exercise lasts at least 15 minutes.

The exercise becomes a self-hypnosis routine when traders give themselves suggestions during the time that the hands are moving together. For example, they might suggest to themselves (internally or even via a self-made audio tape) that, as their hands move together, they will feel increasingly accepting of a recent loss and able to put it behind them. The key is to enter a highly focused and relaxed state prior to the self-suggestions and to perform the exercise thoroughly and regularly on a daily basis. Over time, traders find it easier to enter the focused state of relaxation and invoke their own suggestions. Eventually it's possible to get back to that state (and activate the suggestions) by merely taking a couple of deep breaths and bringing one's hands together. This makes the technique very practical for real-time trading situations, when all you have time for is perhaps a few deep breaths and a simple gesture. Repetition is essential to such mastery.

* Reprogramming Anxiety Through Biofeedback - Regular readers know that I consider biofeedback to be a best practice in trading, with broad application to a variety of emotional situations that affect performance. Of late, I've been making use of heart rate variability feedback through the Freeze-Framer program, which offers a nice graphical interface to help users track their progress and visually determine whether or not they're in "the zone". In the first step of biofeedback training, I simply teach traders how to enter the zone, as above, by regulating their breathing and sustaining a tight cognitive focus. This, by itself, is a very useful skill that can serve as a preventive measure regarding performance stress.

Once the trader becomes adept at this, I then add a second component to the exercise: The trader must vividly visualize a mildly anxiety-producing trading situation while hooked up to the biofeedback and maintaining the calm focus. Once the trader can repeatedly visualize this low-anxiety situation and sustain "the zone" on the biofeedback readout, we then move to a second, higher-level anxiety scenario. Often it's helpful to vividly imagine variations of the same scenario in separate biofeedback sessions. Eventually we move to the most anxiety-producing situations, repeating them over and over in variations, until the trader can sustain the calm focus even in the worst case scenarios. The added benefit of this method is that it teaches traders what they need to do to get their minds and bodies under control. This awareness can then filter down to real time, when all the trader needs to do is focus attention and regulate breathing during stressful market periods. A variation of the biofeedback work that is quite effective involves practicing constructive self-talk while staying in the zone.

Notice that both of these methods involve shifting one's state--physically, cognitively, and emotionally--as a way of dealing with performance pressure. By enhancing our control over our states, we can place ourselves in modes of thinking and feeling that are incompatible with performance anxiety. My experience is that traders can learn this competency on their own or with only a minimum of coaching intervention. With steady practice, one develops a degree of self-mastery that carries over to other areas of life. I believe I'm much more able to deal with life's various stresses as a result of what I've learned from managing my trades--and my reactions to those trades!

Breaking Through Slumps

from Dr. Brett -
It's never easy going through a trading slump, but it's especially frustrating and difficult when markets are moving and you're missing out on so much seeming opportunity. I've received quite a few calls and emails from traders in slumps lately, and frustration is the common emotion: frustration that is channeled as self-blame. It's not just that the traders are losing money; they also hold themselves responsible for their losses--and they can't let it go.

Generally, what initiates a trading slump is not what sustains it. The initial cause is often a misreading of markets, an outsize losing trade, or a careless trading error. Those are things that happen to any trader who participates in markets long enough. Rarely, in and of themselves, do these initial mistakes and losses ruin overall profitability.

What does ruin profitability is compounding these unfortunate but expectable errors with subsequent bad trading. By "bad trading", I don't just mean trades that lose money. Rather, I'm referring to trading decisions that one would not have taken had those initial losses not occurred. The bad trading could entail ignoring an obvious signal to buy or sell. It could result in buying and selling in the absence of signals. It could result in a shift in position sizing or a large change in how manages the risk associated with each trade.

This transition from normal, expectable initial mistakes and losses to subsequent bad trading is what turns loss into slump: it is what sustains a slump. The trader cannot accept the initial loss or mistake, learn from it, and put it behind them. They cannot simply deal with it as one of those normal, expectable frustrations, like getting caught in traffic or like choosing the wrong restaurant. Instead, the initial losses and mistakes are personalized. They become threats, not so much to P/L, but to self-esteem. Suddenly, the trader convinces himself or herself that this is not acceptable: I must get my money back or I must stop trading altogether, because I have performed so poorly.

Can you imagine a professional athlete--say, a football quarterback--who throws an interception and then becomes so self-blaming or so fearful of repeating the error that he abandons the game plan that he rehearsed with coaches and players? That is the trader who turns mistakes into slumps.

Of course, once the initial error is compounded, now the motivation for self blame is doubled: the slump becomes self-reinforcing. The more money is lost and the more the trader makes bad decisions, the more he or she alters those "game plans".

The answer to this problem is to embrace your fallibility. You *will* throw interceptions at times. On occasion, you'll lose, and, on occasion, you'll make mistakes that cost you victory. That happens to professional athletes, chess players, performing artists trying out for positions, and business leaders. What makes you a professional is not perfection--making no mistakes, taking no losses--but the ability to accept setbacks, learn from them, and move on.

It sounds paradoxical, but mistakes and losses won't turn into slumps once you embrace those setbacks as opportunities to learn: to learn about markets, to learn about yourself. Every mistake is there to teach you something; you're either losing because you've missed something in the market, or because you did not execute an idea properly. Either failing is there to teach you something, to provide you with an opportunity to grow. We overcome losses by accepting and transforming them; it's when we fight them that they turn into frustrations and then slumps.

For more information related to slumps and positive trading performance, I've selected several past blog posts below for additional reading.

RELEVANT POSTS:

Why Traders Lose Their Discipline

Characteristics of Successful Traders

Improving Your Well-Being

Overcoming Performance Anxiety

Assessing My Coping Style

from Dr. Brett--
How do you handle adversity in the markets? My recent post suggested that the effectiveness of your coping methods is important both in moderating the flight or fight effects of stress, but also in helping us retain access to our implicit knowledge of market patterns. Here is a short self-assessment that I've put together to help you identify your coping styles.

Imagine the following situation: You are in a trade and it is gradually moving in your favor. You have a mental stop set and a target price. A program trade hits the market and your position blows through your stop, putting you further in the red that you wanted to be. Rate each of the following reactions to the situation on a 1-5 scale, with 1 indicating that you're not at all likely to respond that way; 3 indicating that you sometimes respond that way; and 5 indicating that you usually or almost always respond that way:

1) I vent my feelings out loud and take immediate action to rectify the situation.

2) I step back from the situation mentally and make sure I'm calm and collected.

3) I tell myself it's not a big deal and that I can get the money back in a later trade.

4) After the trade, I seek support from other traders and from people I'm close to.

5) I hold myself responsible for what happened and take the blame.

6) After the trade, I try to not dwell on what happened and turn my attention elsewhere.

7) I go into problem solving mode and figure out how I can manage the position.

8) After the trade, I review what happened and try to figure out what good might come from the trading experience.

If, like many traders, you respond to this kind of situation in more than one way, write down which response you're most likely to have first, which second, etc.

Think back to a trade situation that you did *not* respond to effectively. Go back to the list and identify which response came first, which came second, etc.

-----

Let's take a look at the results. The eight responses represent the coping strategies assessed by the Ways of Coping Scale developed by Folkman and Lazarus:

1) Confrontive Coping - Responding immediately to challenging situations with action.

2) Distancing - Gaining emotional distance from a situation.

3) Self Controlling - Making efforts to keep oneself in control in the situation.

4) Seeking Support - Looking to others for emotional support in the situation.

5) Taking Responsibility - Putting the responsibility for the situation on oneself.

6) Escape/Avoidance - Making efforts to get away from the situation.

7) Planful Problem Solving - Making plans to deal with the situation.

8) Positive Reappraisal - Trying to look at the situation in a positive light.

Remember, none of these coping methods are all good or all bad. All can have their place and all can be overused and misused. The key question is: How do *your* coping efforts work for you?

One easy way to determine that is to examine what I call your "conditional trading outcomes". Take a look at your trading results immediately after you have a meaningful losing trade, a meaningful losing day, or a losing week. Take a look at how well you trade after a position has gone against you. Do you trade better after a drawdown or worse?

How about after you have a few winning trades, days, or weeks in a row? Do you trade better or worse? Breaking down your performance as a function of recent performance will tell you a great deal about how effective you are in coping with risk and reward.

The other excellent indicator of whether your coping is working for you is your emotional experience during trading. If you find that anxiety, overconfidence, frustration, and stress are pushing you into poor decisions, you know that you're not coping well with the uncertainties of markets.

Finally, it is helpful to identify the sequences of coping behaviors that you utilize when you're making good decisions and the sequences when you're trading poorly. Knowing how your individual coping responses come together to form coping strategies can help you cultivate your coping strengths. How to develop those strengths will be the topic for the last post in this series.

RELEVANT POSTS:

Overview of Coping and Trading

Coping and Appraisal

Trading, Coping, and Intuition

Coping Effectively With Trading Stress

from Dr. Brett--
I recently read a book that claimed that the best traders trade completely clear headed, free of emotion. What rubbish. The best traders I've known have been highly competitive individuals who take significant risk and seek significant reward. They are no less emotional than boxers in a ring or basketball players at tournament time.

What enables these traders to perform at high levels is that they are able to prevent the normal stresses of work from becoming distress. Another way of saying this is that they employ effective techniques for coping with the daily stresses of managing money in uncertain and volatile markets.

Here is the post I linked yesterday via Twitter; it will enable you to assess your coping style.

Many times, we employ coping methods that have worked for us at one time in life or in other situations, but do not work in trading situations. We go back and back to the same ineffective coping behaviors, not because we're self-destructive, but because we have overlearned those behaviors through past experience.

Here are a few examples of such good coping gone wrong:

* A person who has learned to confront problems head on cannot back away from markets when trading poorly;

* A person who withdraws in situations of conflict to keep the peace finds themselves unable to stay in good but uncertain trades;

* A person who deals with problems by taking responsibility for them becomes self-blaming and punitive during periods of normal drawdown;

* A person who has learned to put a painful past behind them fails to focus on trading problems and never adequately addresses them.

In all these cases, coping actions that have been effective do not work for the trader.

This is where the solution-focused approach can be quite useful. In the solution mode, we focus on examples of times when we *have* coped effectively and figure out what we did that worked. Once you can identify a positive pattern--a way of dealing with challenging market situations that works for you--the task is then to rehearse it to the point at which it becomes second nature.

As I emphasize in the chapter of the new book devoted to this topic, traders frequently run into problems when they fail to enact their best coping strategies. Tracking how you deal with challenges when you are at your most effective enables you to create a mental model of that coping that you can call upon during periods of high stress. We cannot avoid the stresses of trading, but those do not have to generate distress and biased decisions.

Regaining Trading Consistency

from Dr. Brett--
A reader recently wrote to me the following:

I was a successful consistent trader who always hit singles and doubles ($1000-$3000 a day) for 48 months in a row without having a losing month (1999-2003).Then one day I struck out. I lost $38,000 in one stock and had my first losing month as a trader ever. Since then I have not had two consecutive winning months and in fact have only had a handful of profitable months since then. I am still looking for the road back to consistency. No matter how close I get I always find a way to screw it up even if it is on the last day of the month. Or I give back the month with just some silly unimportant trade that turns into a disaster. It is like I subconsciously look for these situations just so I can mess up.

This is not such an unusual scenario. One large loss can trigger a cascade of attempts to make back the money, further mistakes, and expanding losses. The key is breaking this cycle of losing money, attempting to make the money back with aggressive trades, and continuing to lose.

The first thing I'd have our trader look at is where he is placing stops and targets for his trades. Note that his successful period was 1999-2003. That was a period of much higher price volatility than we've seen since then. What constitutes "singles and doubles" in a high volatility environment is a home run trade in a slow, low-volatility market. It is entirely conceivable that our trader is placing targets too far from his entries, allowing small gains to reverse on him. Similarly, he may be letting trades get too far away from him simply because he is calibrated to a higher level of volatility.

A good way to test these hypotheses would be to study trades over the last several months. If losing trades are larger than winners on average, and if many losers start out as winners, that would suggest that our trader needs to adjust to the post 2003 environment.

To break the cycle mentioned above, the first step is to drastically reduce trading size. I would cut size to 1/4 the average at the most. The goal is to keep a little skin in the game, but take P/L (and the push to make back money) off the table temporarily. The initial objective is not to make money, but to regain a trading rhythm by getting back to singles and doubles.

The next step is to identify those singles and doubles. That means deconstructing the account statement and identifying which trades are making money and which aren't. I would break the data down into time of day, stock/index being traded, long/short, and size. I would also look to see if there are large outlier trades to the downside that are pulling down P/L, and if there are some trades that are making money consistently.

Once our trader has identified what's working, the idea is to keep position size fixed and *only* trade those setups that have been working. This is the foundation to build upon. These setups can be written down and mentally rehearsed ahead of the trading day to build consistency. The idea is to not increase size *and* not trade other patterns until consistency is achieved with smaller size and the most successful setups.

There is only one cure for trauma, and that is repeated experiences of control and safety. We want trading to be routine, not highly emotionally charged.

Finally, I would encourage our trader to take a look at how he is viewing his situation. Note above that he talks of the $38,000 loss and the silly trade that "turns into a disaster" as if these are things happening to him, not things that he is actively doing. A simple strategy would be to have the trader write down the four things he is responsible for prior to each trade:

* The Entry
* The Target(s)
* The Stop
* The Position Size

We can't control whether any individual trade will be a winner, but we can control how much we are willing to bet on each trade. Outsized losses don't happen to a trader; they are actively caused. It is harder to allow those things to occur if you're talking aloud those four trade parameters and have them written in front of you.

So there it is in a nutshell. My advice is to get small, get selective, and take responsibility for what can be controlled.

Do readers have additional advice? Let's see if we can help a reader. Thanks!

Brett

Painful Truths About Trading

from Dr. Brett-
The markets have been exceedingly volatile, and that has created pain as well as opportunity for traders. Here is a portion of an unusually perceptive email to me from a reader:

I have to trade conservatively since I am still in the beginning stages of the trading process…I trade a miniscule amount of shares. (I used to trade a large number in the beginning, which was not a smart thing to do, needless to say). But for now…I am trying to be as careful as possible...

When I enter a trade (upon breakout)…, I know exactly where to put my stop, so I know the exact amount I am willing to lose (less slippage). It usually…rallies a little bit, then pulls back, many times even below my entry point.

So far lately, I have taken the very tiny profit as it rallies a little after the breakout and then I quickly get out with a market order (...just because I have been burnt so much in the past - so I am being neurotically cautious to my detriment perhaps, since I could have so much more by staying in the trade). But then often the stock will rally back up and up and up ...without me on board....

So, then I get in again at the next breakout point and I am nickel and diming myself to wealth (to achieve wealth this way could take the next thousand years)....

Would it be actually smarter for me to just set my stop loss...but IF it does not retreat that far back, then, after it definitely cleared my entry point, just move my STOP LOSS to break-even (or arrange trailing stops) and go to find another trading opportunity?

There is so much pain involved in trading....

The reader is well aware that these trading patterns will not bring success. The question is how to address them. Here are a few considerations from both a trading psychology perspective and a pure trading one:

1) End the Pain - If you were experiencing significant spinal pain every time you walked, I would tell you to stop walking and call for help. Pain is a warning signal, and that includes emotional pain. A key to our trader's post is that he used to trade larger, but no longer because, "I have been burnt so much in the past." It is the retriggering of those losses that is contributing to his sense that "there is so much pain involved in trading." This is the dynamic of traumatic stress: events in the present flash us back to the painful events of the past, and we relive many of those emotions. While we may not be able to resolve traumatic stresses immediately, we certainly can stop restimulating them. Above all else, do no harm. Stop trading. Totally. Learn some behavioral methods of controlling anxiety and frustration and practice these daily (meditation is a great skill in this regard; combining biofeedback with deep breathing and guided imagery can also be effective). Once you master these methods, make yourself relive your prior trading losses *while you perform the meditation or relaxation exercises*. Keep repeating that until you get to the point where you can vividly visualize and reexperience your past trading losses without getting physiologically worked up. This is far and away the most effective approach to reprogramming traumatic memories. A therapist trained in behavioral methods (exposure work) can assist you with this work; it's not necessary that the person be a "trading coach" or know anything about trading.

2) Re-create Safety - Once you've made significant strides in reprogramming your emotional experience, go into simulation mode and rehearse proper trading strategies (see below) while keeping yourself calm. Only when you can implement your strategies *consistently* and with a calm focus should you consider going live with small positions. Then make yourself achieve consistency and calm with small positions before you gradually raise your size. The only way to overcome trauma is to experience repeated safety. The worst thing you can do is get frustrated and try to make your money back all at once, risking further emotional injury.

3) Research, Research, Research - If you're trading breakout patterns, study every breakout and false breakout you can find to become sensitive to the differences between the two. Look at volume on breakout moves; study normal retracements of valid breakouts vs. the more significant and rapid retracements of false breakouts. Examine behavior of indicators such as NYSE TICK on breakout moves. Your trading approach should reflect your research. Study the "tells" that occur prior to the big volume moves: selling (negative TICK) that cannot move the market to relative lows or buying (positive TICK) that fails to push the market meaningfully higher. Work on entering the long side on those TICK pullbacks; the short side on the TICK bounces. That little execution edge adds up over time. It also provides a natural stop point for short-term traders if the market initially goes your way and then reverses.

4) Practice Hitting Targets - What's missing from our trader's email? Profit targets! We hear a lot about stop loss and pain, not much about profit targets. In the absence of such targets, it's easy to get caught up in tick-by-tick action and take a quick, small profit, reducing reward as well as risk. It is important to have explicit profit targets. These may be pivot points, support/resistance levels, etc. Moreover, these targets should enable you to enjoy as much reward from trades as risk. Some of my own targets are indicator based: if I'm short, for example, I will cover at least some of my position if we get very negative TICK readings on enhanced volume, regardless where that price level may be. Once you establish your targets, practice in simulation mode letting trades run until they either hit the target or are stopped out. While the trade is running, you practice keeping yourself chilled with those relaxation exercises. You can't develop confidence in a trade if you never let the trade run. Simulation is a safe way to build experience and confidence.

I am often asked why I don't accept advertising on my blog, and why I don't participate any more in the popular trading conference events. One important reason is that I want the freedom to speak my mind, with as much honesty and integrity as I can muster. Our reader's email is not unusual in my experience. Writers blithely quote statistics that 80% or more of traders lose money, but rarely do we stop to consider that trading is creating pain for 80% or more of its participants.

Trading can be an incredibly destructive activity. You can pour money and dreams into trading without a demonstrable edge, go against professionals who have the best in research and execution, and you can lose everything.

Lose a house? Lose all your money? Lose your marriage? I've seen it all with traders. For every fortune made, I've seen many, many dreams dashed.

No one in the trading magazines, books, or seminars talks about that. One time I did mention it in a seminar and was told by the conference organizer to not talk on that topic further. I have not appeared at that conference since, by their wishes as well as mine.

The trading industry exists to get people to trade. Brokerages offer products that will get people to trade more. Software firms build in features that make it easier to place orders. Coaches and vendors offer promises of trading for a living and winning in markets.

But no one talks of the pain. No one wants to read the dozens and dozens of emails I receive every week from traders who are hurting.

So I choose to speak my mind without fear of commercial repercussions: If you're going to trade, do it the right way. Don't traumatize yourself. Observe and research before you trade; practice trading small and in simulation mode before you put your capital at risk. Don't abandon your day job until you have a track record of consistent profits across various market conditions. Trade less, not more: emphasize the high probability trades and keep your capital safe in the interim. Forget about riches and don't put yourself in a position where you need to trade large and often to make a living; work on covering costs consistently and managing risk. If you don't see objective evidence of an improving learning curve after a year or two of consistent effort, consider the possibility that your talents lie elsewhere.

Trading may or may not produce gain, but it should not be a continual source of pain. No one has ever traumatized themselves to success.

RELEVANT POSTS:

When Trading Gets Out of Control

Addictive Trading

How to Lose Right; The Psychology of Losing

from Dr. Brett--
A large body of research conducted by James Pennebaker of the University of Texas, Austin finds that the expression of emotion has long-term mental and physical health benefits. His book Opening Up is an excellent, readable summary of his investigations, with numerous practical applications.

One particularly interesting finding is that the venting of emotion alone does not help people deal with traumas and other difficult experience. Rather, it is placing experience into words--either through speech or writing--that helps us achieve a perspective that enables us to move on from difficult circumstances.

Study after study finds that, when people cannot give proper voice to their troubles, they experience significant health problems and increased medical utilization down the line. Perhaps this is why psychotherapy, online social tools, and religion confession are so popular in our culture: they are ways for us to process our daily experience--not just to unburden ourselves, but to find new views of our situations.

The relevance to trading is clear: It may not be losing that damages traders, but unacknowledged losing.

I recall one trader I met with who went through a nasty downturn in his P/L. He felt guilty about his losses and felt that he could not tell his wife, who was going through her own problems at the time. The more he hid the problems from her (and from friends), the more he felt stressed and upset--and the more his emotional state interfered with his trading. Only once we had a couples session and laid everything out was he able to clear the air emotionally and get back to trading basics. The losses were manageable in their size, but hiding them took too much of a toll.

Similarly, a trader who ignores a stop and turns a short-term trade into a longer-term hold is attempting to squelch the experience of loss. Instead, internal tension builds and helps the trader make further bad decisions, such as doubling down on the losing position.

Contrast that with the situation I described in my most recent entry on the Trader Performance page, where I look at the epistemological unit of a trader's thought. When a trade idea is based upon an anticipated market movement, not a single entry/exit, it frees the trader to anticipate a loss in advance and flexibly reverse a position. Psychologically, this means that a loss is processed before it even occurs. It is used as information that can help the trader capitalize upon the anticipated market move.

Increasingly, my trade ideas take the form of "what-if" decision trees that include the possibilities of initial, small positions moving my way and moving against me. The decision trees address adding to positions and scaling out of them, and they enable me to be wrong with the initial small position and still benefit from the larger idea.

By requiring yourself to map out these decision trees, you can process trading experience proactively and constructively. A losing trade is placed into a larger context in which it has potential value.

A trading journal at the end of the day then serves the purpose of reviewing performance, highlighting what you did right and wrong, and setting goals for the next day. Such a journal, too, has its psychological benefits. Pennebaker has found that the same benefits achieved by talking about one's feelings can be achieved by writing for 30 minutes in a journal.

I am increasingly convinced that how traders process experiences of loss--including extended periods of drawdown--separates those who come back strong and those who become bogged down and even traumatized.

* * *

PS - I'm now forwarding links to worthwhile readings across the Web via Twitter. If you do not have the Twitter comments automatically sent to your reader, you can check out the daily reading links and indicator summaries on my Twitter page. The most recent five Twitters appear on the TraderFeed home page under the column "Twitter Trader".

RELEVANT POSTS:

Some Painful Truths About Trading

Regaining Your Trading Consistency

Inside the Trader's Brain

When the Body Controls the Mind

from Dr. Brett--

Thanks to readers for their interest in The Daily Trading Coach. It seems as though the book, with its 101 short, practical trading "lessons", has struck a chord with traders and portfolio managers looking to improve their performance. As I write, the book is sitting near #1000 on the Amazon list, unusual for a niche trading text.

One aspect of the book that is unusual is the inclusion of a dedicated email address that readers can use to ask me questions about applying the techniques. A number of traders have taken advantage of that feature, and I'm happy to offer them tips on customizing the ideas and getting the most from them.

A theme that the book tackles is how what goes on in the body affects the mind. Indeed, many times traders use their bodies to gain control of emotional turmoil, only to lose control in a more profound way. The following segment comes from Lesson 47:

"...defenses are coping strategies that protect us from the emotional pain of past conflicts. One of the most basic defenses is repression: keeping thoughts, feelings, and memories out of conscious awareness so that they cannot trouble us. The problem with repression, of course, is that a conflict repressed is a conflict that remains unresolved. We can't overcome something if we remain unaware of its presence. Many traders use their bodies to repress their minds: their physical tension binds them, restricting the physical and emotional expression of feelings. I've met traders who were quite tight physically and yet who had no insight into the degree and nature of their emotional stresses. In an odd way, getting tense was their way of coping: they were always mobilized for danger, tightly keeping themselves in control. It is difficult to stay in touch with the subtle cues of trading hunches--the implicit knowledge we derive from years of pattern recognition--when our bodies are screaming with tension and even pain" (p. 151).

This is part of a much larger problem that impacts traders: when our modes of coping interfere with our day-to-day performance. One of the most important functions I perform when coaching traders is simply watching them when they trade and helping them stay loose mentally and physically. It's amazing how flexible we can be mentally when our bodies are not filled with tension.

Free Chapter From The Daily Trading Coach

Regaining Self Control

from Dr. Brett-

Here is a sequence I observe among many active traders:

It begins with uncertainty. The trader isn't sure which way the market is going, but feels the need to make a trade. Instead of sitting back and letting the market show its hand, the trader is leaning forward, hand on mouse, ready to pounce.

The market moves higher by several ticks, as one or more program trades take out a few levels in the ES futures.

The trader now expresses frustration, "I should have bought there." He leans forward even more, hanging on every tick.

The market ticks down, then up. It's a slow market. The trader doesn't see that the recent move up was on minimal volume and that the midday trade is quite narrow. Suddenly the market ticks up one more time and the trader can't take it any more. He lifts the offer with his usual size, afraid of missing the move up.

There is no profit target or stop loss articulated. This is not a trade designed with good risk/reward parameters, because there *are* no parameters. This is a trade designed to minimize the discomfort associated with not being on board for a move.

The market suddenly reverses and retraces its recent gains. Now the trader either has to get out with a loss or hang in there and hope for a reversal. His frustration builds, leading him to continue his overtrading, and making it more likely that he will stick with--and even add to--losing trades.

Our trader is not trading to make money. He is trading to regulate his emotional state. Once he becomes attached to the need to trade and make money--and once his perfectionistic voice of "I should have bought there" enters the picture--he is no longer grounded in markets. It's when those frustrations build over time, becoming self-reinforcing, that traders "go on tilt".

By staying physically relaxed in one's breathing and posture and by mentally rehearsing a mindset in which it is OK to miss moves--there will always be future opportunity--traders can prevent many of these train wrecks. The practice of taking a break during the trading day, reviewing one's state of mind, and clearing one's head is remarkably effective in this regard. Clearly identifying the parameters of one's trade--the optimal size, reasonable targets given market movement, stop loss points that put risk and reward into proper alignment--also ensures that you are controlling your trading, not the reverse.

There are many ways in which the body controls the mind. If you are not physically calm and collected, it will be difficult to make calm, focused trading decisions. By working at observing yourself as you trade, you gain the ability to interrupt destructive sequences and regain control. Ultimately, going on "tilt" is the result of a loss of self-awareness. Once you remember yourself, you'll be able to access your skills and knowledge.

RELEVANT POST:

Trading Scared and Scarred

Secondary Anxiety and Trader Performance

A while back I wrote about performance anxiety as the most common emotional issue faced by traders and covered some of the techniques that are most effective in combating performance anxiety. There is, however, another variety of anxiety that affects traders that receives almost no attention. Psychologists call it secondary anxiety.

Let's say a person has a panic attack, an overwhelming experience of anxiety and dread that isn't connected to anything obvious. That panicky feeling may be so frightening that the person develops a fear of the attacks. That is how panic disorder patients often develop agoraphobia: they assume that their attacks are caused by something in their environment, so they avoid going places that (they think) might trigger further attacks.

Similarly, I've worked with students who have suffered from test anxiety, a very common form of performance anxiety. They become so fearful that they'll become anxious during a test that they generate the very fear that they hope to avoid!

When people become anxious about their own anxiety, that is called secondary anxiety. It is a particularly thorny problem, because it sets up a vicious cycle: more anxiety leads to more fears of anxiety leads to further nervousness.

A key element that perpetuates the cycle is avoidance of situations that might trigger anxiety. As long as we try to avoid what we fear, our fears control us. Psychologically, the only cure for anxiety is to directly confront our fears *while we remain under control*. That way, we learn in our experience that threatening situations are manageable.

What happens with traders is that they respond to losses (or threatened losses) with disruptive anxiety, often because they are trading excessive size/risk. As a result, they develop a fear of these disruptions and avoid situations that could lead to repeat incidents. One trader I worked with never increased his size in a way that was commensurate with his skills. He made money, but never as much as he should have. It turns out that this was his way of coping with large, painful losses early in his career. His small size was his way of keeping secondary anxiety at bay; he wasn't simply afraid of losing money, but was also afraid of losing his mind.

Another trader I worked with was so afraid of going on "tilt" that he overanalyzed trading opportunities, often missing good trades. The "tilt" that he feared had its roots in anxiety: losing control over trading, because of losing emotional control.

The approach I've found most helpful for such secondary anxiety is guided imagery, aided by biofeedback. In intensive sessions, I will have traders mentally rehearse scenarios of losing money *while they keep their bodies under control*. Heart rate variability biofeedback has been especially helpful in this regard; the Freeze Framer program that I refer to in this post is now known as emWave and has worked well for me.

The key is to use the biofeedback as a training device to help yourself stay physically calm and collected, even as you visualize the anxiety provoking situations that would normally trigger secondary anxiety. By repeating these situations in your mind again and again until you sustain physical control, you literally train yourself to master your responses, eliminating secondary anxiety by building self-efficacy.

We cannot avoid feelings of nervousness, fear, and anxiety, especially in situations that involve performance under conditions of risk and uncertainty. We can, however, avoid become nervous about our nervousness and fearful of our fear. We will always have emotions while trading; we don't have to be controlled by them.

Staying Cool in the Heat of Battle

from Dr. Brett-
So often in my meetings with active (intraday) traders, I hear the phrase "in the heat of the battle." Usually what follows that phrase is a description of some trading mistake: trading too aggressively, ignoring risk guidelines, deviating from planned ideas, etc.

The problem is not that traders make these mistakes; we all do at times. Rather, the problem is that the mistakes become compounded "in the heat of the battle". Once traders are caught up in that heat, they lose the ability to recognize what is going wrong. They also lose their perspectives on markets.

Heating systems in homes have thermostats that control temperature. When the room becomes too cool, heat kicks on. When the room becomes warm, the heat turns off. Many active traders lack an emotional thermostat. They don't know their temperatures. They are like heating systems that get the room hotter and hotter, until the house is unbearable.

One of the core ideas from The Psychology of Trading--and perhaps one of the most important ideas I've ever put forward--is that many of the problems that affect traders are state-specific. How traders think and behave is relative to the states of mind and body that they are experiencing at the time. The reason that coaching (and self-coaching) often doesn't work is that we are in one state of mind and body when we are analyzing and working on our problems and in a completely different state when we are experiencing the triggers that set off those problems.

This explains the common experience that traders have when they look back on their day's performance and wonder, in amazement, how they could have made such rookie mistakes. In a normal frame of mind, they wouldn't have acted so rashly. In "the heat of the battle", they become a different person; they process information differently.

Few challenges are more important to active traders than the ability to develop an emotional thermostat. But talking with a coach, writing in a journal, or vowing to oneself that next time will be different won't touch the problem. As my earlier book stressed, you can only solve the problem by entering the state that is specific to that problem and then reprogramming your patterns of thought and behavior.

My upcoming book will have much to say on this topic, with specific exercises. In my next post in this series, I'll outline a specific strategy that has helped me and many of the traders I've worked with.

Traits of Successful New Traders

from Dr. Brett-
In response to my recent post on trading for a living, one reader asks, "In your opinion what are the starting qualities needed to be a great trader?" This is a difficult question, because different kinds of trading require different skill sets. For example, many of the best hedge fund portfolio managers have superior analytical skills and abilities to detect themes in noisy data. Many of the best market makers have an uncanny speed of mental processing and level of concentration that enable them to stay on top of order flow throughout the day. This is why I emphasize, in the trader performance book, that matching one's style of trading to one's strengths--talents and skills--is an essential component of success.

If I had to identify qualities that distinguish "starting qualities" that are important across all traders, the following come to mind:

1) Capacity for Prudent Risk-Taking - Successful young traders are neither impulsive nor risk-averse. They are not afraid to go after markets aggressively when they perceive opportunity;

2) Capacity for Rule Governance - Successful young traders have the self-control needed to follow rules in the heat of battle, including rules of position sizing and risk management;

3) Capacity for Sustained Effort - Successful young traders can be identified by the productive time they spend on trading--research, preparation, work on themselves--outside of market hours;

4) Capacity for Emotional Resilience - All young traders will lose money early in their development and experience multiple frustrations. The successful ones will not be quick to lose self-confidence and motivation in the face of loss and frustration;

5) Capacity for Sound Reasoning - Successful young traders exhibit an ability to make sense of markets by synthesizing data and generating market and trading views. They display patience in collecting information and do not jump to conclusions based on superficial reasoning or limited data.

Finally, I would say that successful developing traders approach their work with a kind of humility. They don't know it all and they don't pretend to know it all. They absorb wisdom from mentors and markets, and they are quick to acknowledge when they're wrong, so that they can get out of bad positions and learn from their experience. Show me a stubborn young trader with a defensive ego, and I'll show you one who will fight his or her learning curve every step of the way, with predictably poor results.

If you want to identify potentially successful young traders, look at their trading journals and gauge the amount of time they spend behind the screen. The good ones will have detailed entries about markets and about themselves, with constructive ideas, goals, and feedback. The less successful traders will have sparse entries that display little effort or analysis, with no goals, no constructive direction. The good ones watch markets closely, even when not trading. The less successful ones find little reason to watch markets if they don't have a position.

Effort alone won't make a trader successful, but lack of it will almost certainly ensure failure.

Winning As a Trader Is 90% Learning Not to Lose

from Dr. Brett-
One of the fascinating conclusions of the research I posted yesterday is that traders learn by trading; that it is the number of trades placed--not the amount of time spent trading--that best predicts success in markets. That same research, however, finds that there is a very high attrition rate among traders; the most common learning that occurs in markets, quite literally, is that traders find out that they can't make money at what they're doing.

So we have a catch: traders need to learn by trading, but they also need to preserve their capital as they traverse their learning curves.

As I stressed in the Trader Performance book, much of learning in trading is pattern recognition. If that is the case, than it may be the frequency and intensity of exposure to patterns--and not the trading itself--that facilitates learning. This very much fits with my experience that traders can accelerate the development of competence by engaging in simulated trading (with live data) and by reviewing their trading via video. "Any techniques that you use in trading--whether for money management, self-control, or pattern recognition--require frequent repetition before they will become an ongoing part of your repertoire" (Psychology of Trading, p. 154).

Traders drop out of markets, perhaps not because they lack talent, but because they fail to achieve the necessary repetitions to internalize skills prior to depleting their capital.

They also fail because, even with repeated trading, they do not have a system for reviewing their performance, setting goals for improvement, intensively working on goals, and holding themselves accountable for those. Instead of a week's worth of experience, they repeat a single day's learning five times over.

The research cited yesterday, as well as this interesting study, suggest that an important component of learning to trade is learning to avoid behavioral biases in taking profits and losses. The traders who lose their disposition to sell winners early and hold onto losers are those that tend to be most successful. Ironically, turning loss-taking into routine behavior may be one of the most important learned skills in the evolution of a trader's success. The key is staying small enough, long enough to learn from the experience of losing.

Recharing the Emotional Batteries

from Dr. Brett -
I'm writing this from the oceanfront (literally) in Virgina Beach; it's early enough that there aren't too many people around. Just the wind and the waves: ocean as far and wide as I can see.

Something about sitting by the ocean on an empty beach is quieting. There are few distractions; eventually, it's as if you adopt the rhythm of the waves and are just left at peace with yourself. It's at those times that I often have my best and biggest thoughts: fresh inspirations and insights.

Following my sophomore year at Duke, I sat on a Florida beach early in the morning reading a book called The Fountainhead by Ayn Rand. Looking over the water, I was suddenly seized with the recognition that this was what I was meant to do with my life: use psychology to help people find their greatness--not to fight mental illness.

That was almost a quarter century ago. The memory of that morning on the beach--and the mission I felt at that occasion--is as strong today as it was when I returned to school and reorganized my life.

We could not survive without life's routines. Routine helps us perform repetitive tasks automatically, so that we can direct our attention elsewhere. As Colin Wilson emphasized, however, we become so caught in routine that there is no "elsewhere". Life becomes a series of routines, our work and relationships become stale, and suddenly we find ourselves growing old before our time.

Not everyone will find their break from routines in travel and the ocean. Some find it in spiritual pursuits; others in the adventure of hiking or sports. Sitting with the ocean reminds me of the need to escape the mundane and recharge mind and body. At those moments, our most productive times--those that can shape a lifetime--can be our moments away from work.

Techniques for Overcoming Performance Anxiety in Trading

from Dr. Brett-

A little while back I made the observation that performance anxiety is the most common psychological problem that I encounter among traders. It occurs in many forms--during slumps, at times when traders attempt to raise their size/risk, when life's financial needs add pressure to trading outcomes--but the common element is that a concern with the results of trading interferes with the process of trading itself.

I thought that both the comments of readers and their emailed suggestions offered very useful ideas regarding the handling of performance pressures in trading. In this post, I'll add two suggestions of my own.

* Self-hypnosis - This builds on the ideas from my first trading book, The Psychology of Trading. When a trader is responding to a trading situation with anxiety, I ask the trader to close his eyes, breathe deeply and slowly, fix his attention on a musical selection, and hold his hands in front of him with palms facing each other a couple feet apart. The music, taken from Philip Glass' early works, has a highly repetitive structure and serves as an object of focus. After an extended period of the slow, rhythmical breathing and focus on the music, I then suggest to the trader to imagine that there is a magnet between his hands, pulling them slowly and steadily together. As his hands are drawn closer and closer, I suggest, he will find himself feeling more and more relaxed, calm, and confident. The exercise is brought to a close when the palms finally touch. Altogether the exercise lasts at least 15 minutes.

The exercise becomes a self-hypnosis routine when traders give themselves suggestions during the time that the hands are moving together. For example, they might suggest to themselves (internally or even via a self-made audio tape) that, as their hands move together, they will feel increasingly accepting of a recent loss and able to put it behind them. The key is to enter a highly focused and relaxed state prior to the self-suggestions and to perform the exercise thoroughly and regularly on a daily basis. Over time, traders find it easier to enter the focused state of relaxation and invoke their own suggestions. Eventually it's possible to get back to that state (and activate the suggestions) by merely taking a couple of deep breaths and bringing one's hands together. This makes the technique very practical for real-time trading situations, when all you have time for is perhaps a few deep breaths and a simple gesture. Repetition is essential to such mastery.

* Reprogramming Anxiety Through Biofeedback - Regular readers know that I consider biofeedback to be a best practice in trading, with broad application to a variety of emotional situations that affect performance. Of late, I've been making use of heart rate variability feedback through the Freeze-Framer program, which offers a nice graphical interface to help users track their progress and visually determine whether or not they're in "the zone". In the first step of biofeedback training, I simply teach traders how to enter the zone, as above, by regulating their breathing and sustaining a tight cognitive focus. This, by itself, is a very useful skill that can serve as a preventive measure regarding performance stress.

Once the trader becomes adept at this, I then add a second component to the exercise: The trader must vividly visualize a mildly anxiety-producing trading situation while hooked up to the biofeedback and maintaining the calm focus. Once the trader can repeatedly visualize this low-anxiety situation and sustain "the zone" on the biofeedback readout, we then move to a second, higher-level anxiety scenario. Often it's helpful to vividly imagine variations of the same scenario in separate biofeedback sessions. Eventually we move to the most anxiety-producing situations, repeating them over and over in variations, until the trader can sustain the calm focus even in the worst case scenarios. The added benefit of this method is that it teaches traders what they need to do to get their minds and bodies under control. This awareness can then filter down to real time, when all the trader needs to do is focus attention and regulate breathing during stressful market periods. A variation of the biofeedback work that is quite effective involves practicing constructive self-talk while staying in the zone.

Notice that both of these methods involve shifting one's state--physically, cognitively, and emotionally--as a way of dealing with performance pressure. By enhancing our control over our states, we can place ourselves in modes of thinking and feeling that are incompatible with performance anxiety. My experience is that traders can learn this competency on their own or with only a minimum of coaching intervention. With steady practice, one develops a degree of self-mastery that carries over to other areas of life. I believe I'm much more able to deal with life's various stresses as a result of what I've learned from managing my trades--and my reactions to those trades!

Trading Scared is Trading Scarred

from Dr. Brett-
A trader dropped me an email today to explain that he was "trading scared": missing out on opportunities because he was overly risk averse. As luck (or Freudian psychology) would have it, he spelled "scared" as "scarred". That little slip revealed considerable psychological insight.

Most traders who trade scared are also trading scarred. Normal losing trades and periods of drawdown are processed normally, as expectable--if somewhat disappointing--events. When losses are substantial, however, they can be processed as traumatic events. Instead of being processed through normal, explicit, verbal channels, they activate the flight/fight emergency mechanisms of mind and body, leaving their emotional imprint. Later, events similar to the traumatic losses--even normal ones--can trigger the emotional and physical reactions of emergency, including paralyzing anxiety.

Interestingly, our trader had an excellent March after losses in December - February. During those losses, he explains, "I basically got pretty close to running out of money in my bank account." He feels that he should increase his size after the good month, but instead he's trading even more scared than he did before the winning month. As he recognizes, the making of money in March has restimulated his experience of losing money in December through February following a profitable fall season. Because the earlier losses nearly bankrupted him, they weren't experienced as normal losses. They scarred him in a traumatic way, and now he's trading scared.

When traders need profits to make the next paycheck that will put bread on the table, that is too much performance pressure. I've commented in the past that the smartest thing I ever did when learning trading was to begin with a trading stake that I could afford to lose in its entirety without affecting my family's lifestyle. Having the cushion of a second income and/or a secure savings account as backup means that normal slumps don't have to turn into career-threatening events. I've worked with traders who felt that, if they didn't make money in the current month, they would not be able to cover their mortgage payments. Normal losing trades became extreme threats, and the traders traded scared as a result.

It's when the desire to profit becomes an acute need for profits that performance anxiety is likely to overcome efforts at prudent risk-taking. Any business, when it gets off the ground, has to be adequately capitalized, so that it can weather initial adversity. The lack of adequate capitalization leads many traders to take large risks (to make enough money to support themselves), but also to trade with large fear (due to the absence of any cushion in the event of loss). Our trader should not be thinking of ramping up size after only a month in the black. Rather, he should work on achieving consistency with the kind of trading that worked in March.

That will build his cash cushion, his confidence, and ultimately his ability to take risk in a secure manner. The links below outline methods that are quite useful in addressing psych issues related to trauma.

RELEVANT POSTS:

Drama Creates Trauma

Favorite Techniques for Overcoming Performance Anxiety

Expose Yourself