Self Review for Self Improvement

from Dr. Brett-

In a recent post, I emphasized that much of the development of trading expertise is a function of pattern recognition and the ability to act upon patterns promptly in real time. A classic example of performance by pattern recognition is the development of competence and expertise among radiologists. Reading an x-ray or other form of imaging means being able to detect normal variations from abnormal ones. In the beginning, to the untrained eye, most medical images will look alike. Only with repeated exposure to images and their variations will medical students learn to make and rule out diagnoses. No amount of book work can substitute for learning at the bedside and reviewing film with experienced physicians.

The trader who video records his or her trading has a powerful tool for accomplishing three learning tasks:

1) Seeing more market patterns and cementing those more firmly in mind;

2) Reviewing performance to assess areas of trading that need more work and to formulate goals for such work;

3) Reviewing performance to assess areas of trading that represent strengths, so that these can be crystallized and recruited during future trading.

When I left my full time work with proprietary traders in Chicago and began working with bank and hedge fund traders, I was surprised by the sophistication of the latter group in terms of portfolio management and equally surprised by that group's utter lack of feel for short-term market movement. Many times, a portfolio manager would describe an excellent idea to me and then execute it at the absolute worst time of day. I realized that, as savvy as the institutional traders were, they lacked the frequency of exposure to short term market patterns and hence had no real "feel" for when buyers or sellers were dominating (or losing their dominance) from minute to minute, hour to hour.

Traders who use video recording in essence double their exposure to market patterns--and to their own patterns as traders. Because pattern learning is a function of the number of repeated exposures to various configurations, the trader who not only views markets, but also reviews them, is more likely to enjoy an accelerated learning (and performance) curve.

The two most common means of recording that I've encountered in my work with traders is desktop video (software that records your screen) and actual video recording with a camcorder pointed at the screen. The former is available through programs such as Camtasia; the latter is best accomplished with a camcorder that includes a large hard drive.

Of course, it doesn't make sense to review the entire trading day, every trading day. In general, the best reviews come from your best trades and your worst: those will cement what you do right and what you need to improve. If traders only reviewed their single best and worst trades each day--what the markets did and what they did--I suspect they would be more likely to achieve competence, and would do so in less time than the trader who packs it in at the market close.

Remember, however, research suggests that it is not just what you review but how that makes all the difference in learning. The most powerful learning takes observations and turns them into concrete goals for future observation. Passive watching of markets (and one's own performance) is much less powerful than active watching and goal setting.

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

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.

How Trading Can Develop Character

from Dr. Brett-

For me, there's no better time than a long holiday weekend to step back and ask the big questions: those that deal with the meaning and significance of being a trader. These segments from my two books capture much of my sentiment on the topic.

"It is better to struggle in the service of one's dreams than to find instant success at meaningless work. The greatest joy in life, George Bernard Shaw once wrote, is being used for a purpose you recognize to be mighty. The greatest fields--those that are a calling and not a mere job--give one room to expand and develop oneself. There is only one valid reason for trading the markets, just as there is only one valid reason for being a psychologist, a dancer, or an architect: because it is your calling, the arena that best draws upon one's talents and passion for self-development." - The Psychology of Trading, p. 317.

"There are few arenas left in life where the independent individual can enact the heroic struggle...This, I believe is the eternal allure of the markets. With a reasonable stake and an online account, each person can undertake his or her own gold rush and enact the highest entrepreneurial quest. Like salmon that swim upstream to spawn, sperm that pursue the egg, and prospectors that dig for precious metal, many will be called and few chosen. It matters not. What matters is the dignity and the dimension of soul conferred by one's noblest impulses. It is not desirable to rule in hell or to serve in heaven; far preferable, to paraphrase Ayn Rand, is to fight for tomorrow's Valhalla in order to walk its halls today." - The Psychology of Trading, p. 318.

"Let us not forget what it means to be a trader. It means that I am free to own property: shares of a private company or contracts in a commodity. I can take delivery of my property and dispose of it as I wish, or I can trade it to others. My decisions are mine to make; I need not follow the dictates of those who would put other interests--those of gods, governments, or guns--above my own. If I lose, it is my loss. If I profit, the gain is mine...Without freedom, there is no trading. Trading is a celebration of economic and political freedom. Slaves are traded; they do not trade." - Enhancing Trader Performance, p. 253-4.

"What are we really developing when we train for expert performance in any domain? We develop skill and knowledge, to be sure, but we also develop more than that. We cultivate will: the ability to formulate goals and direct our actions toward reaching those goals. Every training session is a battle of will: a struggle to overcome our limitations and reach a particular performance goal...When you enhance your performance as a trader, you replace a small piece of randomness with intention. To that degree, your outcomes are self-determined. If you train yourself properly, you will become not only a successful trader, but a more self-determining human being." - Enhancing Trader Performance, p. 254-255.


RELEVANT LINKS AND QUOTES:

Ayn Rand and Objectivism

Colin Wilson

"Dr. Miller says we are pessimistic because life seems like a very bad, very screwed-up film. If you ask "What the hell is wrong with the projector?" and go up to the control room, you find it's empty. You are the projectionist, and you should have been up there all the time." - Colin Wilson

"Every man builds his world in his own image. He has the power to choose, but no power to escape the necessity of choice." - Ayn Rand

Turning Goals Into Consistent Habit Patterns

from Dr. Brett-
My recent post took a look at setting effective trading goals. Properly formulated, these goals focus our development, bridging our real selves--who we are now--with our ideals. Setting goals, however, is easy compared with acting upon them over time. Many of us set well-meaning goals at the start of a year, only to forget our resolutions.

So how do we make goals actual tools for self-development? One answer that I came to in writing my new book is that goal setting must be a process of emotional commitment, not just an intellectual exercise. "The secret to goal setting," I note in the book, "is providing your goals with emotional force. If your goal is a want, you'll pursue it until the feeling of desire subsides. If your goal is a must-have, a burning need...it becomes an organizing principle, a life focus."

In Alcoholics Anonymous, the goal is sobriety. Members spend a great deal of time sharing their stories of lost relationships, lost jobs, and lost health. They openly talk about the horrors of their relapses. Why? Because this keeps them emotionally connected to their goal. AA focuses on the reasons for the goal; every single meeting members remind themselves that they are alcoholics, powerless against alcohol. They can only find sobriety in their connectedness to others and in their relationship with a Higher Power. Next to that, everything else seems inconsequential.

An effective trading journal is like an AA meeting. It is an emotional communication that reminds the trader why he or she is seeking particular goals. The vision of success, the horrors of going through massive drawdowns, the feelings of disgust at missing opportunities due to a lack of nerve or discipline: these keep us connected to our goals.

Once you're emotionally connected to a goal--clearly seeing its necessity--discipline is not necessary. You will automatically gravitate to doing what you know you need to do. It's a bit like the procrastinator: when the assignment is due in several weeks, there's no urgency. When the assignment is due the next day--with one's bonus on the line--the drive to work kicks in with full force.

It is when the perception of "Reach your goal, or else!" arises, that we act decisively. Often it's the "or else"--the clear awareness of the consequences should we not fulfill our aims--that helps turn goals into consistent actions. The man who has had a heart attack may have struggled with his diet for years. Now, aware of his mortality, he has no problem following a heart-healthy regimen. His goal, under the pressure of necessity, becomes a habit pattern.

It helps to clearly visualize what would happen should we fail to meet our goals. What would happen to us? How would we feel about ourselves? Many a drive for greatness was sparked by the hatred of mediocrity. We will ourselves forward only when stasis becomes more uncomfortable than the efforts demanded by self development.

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.

Trader Self-Development

from Dr. Brett-
Successful self-coaching requires an ongoing commitment to tracking and improving performance. Here are some posts that will help guide your self-development as a trader:

* How Can I Learn Trading?

* Coaching Yourself for Profitable Performance

* Self-Efficacy and Attaining Goals

* What Contributes to Success

* Turning Goals Into Habit Patterns

* Setting Effective Goals

* A Secret to Life Success

* Finding the Heroic Within Us

Learning Trading Discipline

from Dr. Brett-

A big part of coaching yourself as a trader is staying in control when you are risking your capital. Here are some posts relevant to maintaining trading discipline:

Training Yourself for Discipline

Staying Cool in the Heat of Battle

Understanding Lapses in Trading Discipline

Top Reasons Traders Lose Discipline

Changing Your Self-Talk

Trading Stress and Emotion

Avoiding Overtrading

Self-Coaching Techniques - Part 1, Part 2, Part 3

Short Explanation of Brief Therapy

My work in coaching professional traders has been shaped by my experience in the field of brief therapy, a collection of short-term techniques for accelerating change processes. Having taught brief therapy for many years to psychology interns and psychiatry residents--and having co-written a standard textbook in the field--I've been steeped in brief therapy as a philosophy, not just as a mode of helping. Here's how that philosophy impacts the actual process of working with traders:

* Seek Targeted Change - Change efforts are most likely to be effective if they are targeted to very specific changes in thought, feeling, and/or behavior;

* Stay Active - Change occurs from *doing* things differently, not just by talking to someone or by writing in a journal;

* More is Not Better - Brief therapists emphasize intermittent helping, leaving people on their own to practice and apply newly learned insights and skills, not encouraging dependence on a helper;

* Build on Strengths - People have many positive, adaptive qualities. Building on those reinforces health, confidence, and self-efficacy;

* Efficiency as Well as Efficacy - Brief therapy emphasizes time-effective methods for change, keeping the helping process affordable and not too burdensome;

* Strike While the Iron is Hot - Work on problems while they're occurring; changes are most likely to stick if they're rehearsed in realistic settings and situations;

In practice, this philosophy has me working very intensively with people for relatively short periods of time, using very hands-on techniques for altering problem patterns and applying those techniques to many situations. Weekly or monthly interactions are simply too infrequent to sustain the momentum of change; once progress has been made, then it can make sense to space meetings out over time to encourage the long-term internalization of the changes and guard against relapse.

To encourage this intensive interaction, I do not charge people for time spent on the phone or interacting by email (a far cry from the practice of coaches who run the meter at every possible opportunity); I want no barrier to regular contact. But once that contact leads to change, the goal is for the trader to sustain the process himself/herself, not meet for unlimited interactions with only a vague focus and agenda.

There is much in the brief therapy philosophy that traders can apply when they're acting as their own coaches. That will be the focus of my next post.

Finding Your Edge As a Trader

from Dr. Brett-

Becoming your own trading coach can be a daunting challenge, but there's no reason to go it alone. Here are some online resources that might be of help to you in extending your edge as a trader:

Vertical Solutions: creative market ideas and resources for testing trading ideas.

Daily Speculations: a range of insights about trading, markets, and life from Victor Niederhoffer and Laurel Kenner.

Quantifiable Edges: offers tested trading ideas in blog and newsletter, including a tracking of (very solid) performance.

Market Tells: loads of market data and indicators, tested trading patterns, and an excellent trend-catcher system.

SentimenTrader: tested market patterns, sentiment analyses, and insightful commentary.

Trading Success: Ray Barros is a coach and experienced trader who offers plenty of resources for traders to mentor themsleves.

Twitter Trader: My Twitter service that posts to the TraderFeed blog (or to you directly if you subscribe; it's free), highlighting trading themes, news, and updated market indicators.

Links Related to Self-Coaching

from Dr. Brett-
These recent posts may be of particular help to traders in their self-development:

Resources and Reflections for Traders

Five Successful Trading Behaviors

Breaking Cycles of Trading Problems

Breaking Trading Slumps

Two Common Trading Problems

The Need to Be Right vs. The Need to Make Money

Trading the Way You Want to Trade

Hindsight Bias and Regret in Trading

The Gambler vs. The Entrepreneur

How Personality Affects Risk Taking

The Power of Repetition

From Dr. Brett--
The previous post emphasized the importance of daily trading goals. The challenge for traders, however, is not simply to set goals, but to turn the achievement of goals into consistent habit patterns. When coaching--including self-coaching--doesn't work, it's often because traders initially reached their goals, but then relapsed into old patterns.

Such relapse occurs even when traders are ready to make changes. If change efforts are not made in powerful ways, and especially if they are not rehearsed to the point where they become automatic, the gravity of our old patterns becomes too great and we easily return to what we've overlearned. This is why repetition is key to making coaching efforts work. Through repetition, we internalize changes: they begin to feel normal and natural to us. When we rehearse new patterns of thought and behavior and link those to distinctive states of consciousness, we can summon those patterns whenever we re-enter that state.

If you can teach yourself to enter a state of focused relaxation each day and--in that state--mentally rehearse good trading practices, you will create a situation in which just taking a few deep breaths during trading can tip the scales and help you gain access to your best practices. As I stressed in an earlier post, the idea is not to become your own shrink, but rather to expand your mind's scope.

A key idea from the trader performance book is that practice multiplies experience. That is the key to learning how to trade, and it is the key to self-change. A key idea from the trading psychology book is that the solutions to our trading problems are already occurring, if we can just identify them and become more consistent in recruiting them. It is the consistency of change efforts that contributes to their permanence. The links in this post--and the links within those posts--should get you started on your self-coaching journey. My next post will outline what you can do if you encounter roadblocks on that journey.

Drama Creates Trauma: Risk Management

from Dr. Brett-


I recently received an email from a trader who was going through difficult emotional swings as a result of swings in his portfolio. He assured me that he was a knowledgeable, experienced trader and that he limited his risk to 5% per trade.

I didn't need to read any further to know the problem.

So let's return to Henry Carstens' P&L Forecaster to see what's gone wrong.

In the top chart above, we're looking at forecasted returns for a $100,000 portfolio in which the standard deviation of returns per trade is 1% or $1000 and the trader has entered a period of flat performance (average zero return per trade). That might represent the scenario in which a trader risks 1% of portfolio per trade with moderate discipline. Over the course of 100 trades, that trader shows an equity peak of about $9000 (up 9%) and trough about -$3000 (down 3%), for a peak-to-trough drawdown of 12%.

In the world of professional money management, such a swing would merit the attention of risk managers. I don't know too many portfolio managers who would feel good about going from up 9% on the year to down 3% within the span of 100 trades. It wouldn't be a catastrophe, but it would be a concern.

Now, in the bottom chart, let's take a look at the performance of the trader who ramps up risk to a 5% standard deviation per trade, like our correspondent. That again might represent a scenario of risking 5% of the portfolio per trade with moderate discipline. Over the course of 100 trades, that trader displays an equity peak of about $15,000 (up 15%) and trough of almost -$30,000 (down 30%) for a gut-wrenching peak-to-trough drawdown of 45%.

In the world of professional money management, that would be wholly unacceptable.

We all hit periods of flat performance; during those times, note how risk levels affect *psychological stress*. In one scenario, we swing from 9% up to 3% down. Raising the risk per trade by a factor of five swings up from 15% up to 30% down. Note that the order of the gains and losses could just as easily have been reversed: in the first scenario, we could have first gone from 9% down to 3% up; in the second scenario, we could have gone from 30% up to 15% down.

It's the swings that are important--and the effect of those swings on the psyche.

When we trade size that is too large for our account size, we subject ourselves to drastic swings in P/L, and that subjects us to drastic swings in mood. In turn, we then make trading mistakes that bring a negative expectancy to each trade, and the size eventually blows us up.

My advice to the gentleman? Think of the charts above as measuring risk per day instead of risk per trade, so that the equity curves represent 100 days of trading. You can see that a 1% standard deviation of returns still generates peak-to-trough drawdowns of over 10%. I would cut risk below that level--risking less than 1% per day, and thus significantly less than 1% per trade--for at least a month of consistent, disciplined trading before considering a *modest* rise in size (which, in turn, would need to be accompanied by a full month of consistent, disciplined trading).

Only such a sustained period of trading without large swings will counteract the emotional fallout created by the large equity swings. In trading, if you create drama in your returns, you'll create trauma--and that's how trading careers end. The links below explain this in detail.

RELATED POSTS:

The Psychology of Risk and Return

Risk Management and Human Biology

Inside the Trader's Brain

After a Devastating Trading Loss

from Dr. Brett-
The year was 1982. I had been short most the year and was doing quite nicely in this, my fourth year as a trader of U.S. stocks. For the first time I allowed myself to think about trading as more than an avocation: as a potential source of ongoing income that could help free me to do the writing that I loved best.

Then we hit mid-August. A ferocious rally drove prices sharply higher and left me in the red. I decided to hold and wait for a pullback, but the pullback was mild. We moved sharply higher again in the fall and I was forced to take losses that consumed not only most my profits, but all my dreams of supplemental income.

I'd have to say it was the most depressing period of my life overall. I was questioning the work I was doing in community mental health--a great learning experience, but not a viable career path--and I was not happy in my personal relationships. The trading losses were the icing on a not so delectable cake. The bottom came in a bar in Homer, NY after too much to drink and a smoke that I discovered too late to be adulterated. It was not a happy time.

I'm convinced that the most successful people are not those who avoid those ruts in life, but the ones who use those to turn themselves around. I discontinued trading and embarked on research regarding market timing that, I vowed, would enable me to never make the same mistake. Out of that research came the work on new highs and lows and sector lead/lag relationships that I draw upon to this day.

I also turned it around socially. After consuming a full bottle of scotch at a New Year's party at the end of 1983, I found myself too inebriated to ask the pertinent questions of the woman I had met. Had I asked the questions, I would have found out that she was not yet divorced, had three children, and was nine years my senior--not at all what I was looking for. Today, after 24 years, she remains my wife and the best decision I ever made.

With the marriage in 1984, I inherited shared responsibility for three children. The steps I didn't take for myself I had to take for the new family. Gone were the drinking and partying. I parlayed my community mental health experience into a student counseling position at Cornell University, taking a 33% pay cut in the process. One year later, impressed by the Cornell experience, Upstate Medical University in Syracuse hired me and I joined a medical school faculty.

At Upstate, I realized that my counseling skills were not ideally suited for the medical school environment. I undertook a lengthy review of the research and practice literatures and taught myself the fundamentals of an emerging approach to helping called "brief therapy". Shortly thereafter, I began teaching brief therapy in the psychology and psychiatry programs. In 1990, I published my first review paper in the field, then another in 1992. I had found my niche: one that would lead to over 50 published papers and book chapters, two books in psychology and psychiatry, and two books combining my trading and psychology loves--and, of course, this daily blog.

I look back on that trading loss in 1982 and now see it as the beginning of a turnaround, not as the ending of a dream. But it took an unflinching and unforgiving look in the mirror to make that turnaround. It also took relationships with people I loved enough to want to make more of myself.

I've received several emails and blog comments from traders who have been through devastating trading losses. This post is for you. What doesn't kill you *can* make you stronger, if only you can sustain that hard look in the mirror.

RELEVANT POSTS:

Resilience and the Courage of Your Convictions

Blueprint for an Uncompromised Life

Controlling Emotions is NOT the Goal of Trading Psychology

Pick up a book or magazine article about trading psychology and you're likely to find prescriptions for success based on controlling emotions and increasing discipline.

Yes, emotional arousal can interfere with performance, but does that mean that elite performance is a function of dampened emotions?

When you look at some of the greatest performers in sports--and in trading--you'll find highly competitive individuals. They are quite emotional and don't take well to losing. Lance Armstrong? Michael Jordan? Tiger Woods? Muhammad Ali? All were quite intense, emotional individuals who managed to channel their emotional drive into victory.

Conversely, I've encountered many well-balanced individuals who have sought success in trading. They don't blow up, they follow rules faithfully, and they have no intense, competitive emotional flame burning within. I've never yet seen one go on to become successful.

Can anyone watch the really successful college basketball coaches--Coach K., Jim Boeheim, Bob Knight, Tom Izzo--and attribute their success to emotional restraint? Yes, there have been emotionally reserved winners--think John Wooden and Dean Smith--but one suspects their emotionality was that of a warm mentor, not that of a cold fish.

The important ingredient in success is not emotional dampening per se, but the enhancement of concentration and focus. That is what enables people to act with sustained purpose and stay rooted in their goals.

When we review the lives of great individuals across a variety of fields--the research of Dean Keith Simonton and K. Anders Ericsson stands out in this respect--what we find is that the greats have prodigious capacities for work. They are hugely productive. They sustain effort hours at a time, day after day, week after week, year after year.

Only the ability to regularly access "the zone"--that flow state of consciousness that comes from being wholly absorbed in an activity that captures our interests, skills, and talents--can account for the amazing dedication of the Olympic athlete, the great career scientist, or the chess grand master.

Indeed, such exemplary performers can use emotion to access the zone. Michael Jordan used to provoke players on opposing teams so that they would argue and fight back. That would arouse Jordan's competitive instincts and elevate his game.

When we operate outside that "zone" and lose our focus, we are no longer activating that executive center of our brains--the frontal lobes--that control planning, judgment, and reasoning. Left with a weak executive center, we become like the person with Attention Deficit Disorder: prone to wandering attention, reduced self-control, and impulsive behavior.

That makes it look as though "emotion" and "lack of discipline" cause our trading problems.

In reality, however, these are the results of the problem; not the causes.

The goal of trading psychology is to build consciousness, not reduce emotion. The goal is to create regular access to the flow state of heightened learning and focus. Talking to a trading coach, in itself, won't accomplish that; nor will well-intentioned efforts to calm oneself or take breaks from trading.

We can only build consciousness by working on consciousness. That is why I find meditation, heart rate and galvanic skin response biofeedback, self-hypnosis, and newer methods such as hemoencephalography to be valuable tools for traders and emphasized their use in my book on the psychology of trading.

These methods don't eliminate emotion; they build minds. If we can exercise for 30 min./day and build our cardiac fitness and our physiques, maybe--just maybe--a similar commitment could strengthen our abilities to operate within life's "zone". I'll be posting more re: my personal experiments with mind training in the near future.

Brief Therapy and Philosophy -- a Primer

from Dr. Brett-
My work in coaching professional traders has been shaped by my experience in the field of brief therapy, a collection of short-term techniques for accelerating change processes. Having taught brief therapy for many years to psychology interns and psychiatry residents--and having co-written a standard textbook in the field--I've been steeped in brief therapy as a philosophy, not just as a mode of helping. Here's how that philosophy impacts the actual process of working with traders:

* Seek Targeted Change - Change efforts are most likely to be effective if they are targeted to very specific changes in thought, feeling, and/or behavior;

* Stay Active - Change occurs from *doing* things differently, not just by talking to someone or by writing in a journal;

* More is Not Better - Brief therapists emphasize intermittent helping, leaving people on their own to practice and apply newly learned insights and skills, not encouraging dependence on a helper;

* Build on Strengths - People have many positive, adaptive qualities. Building on those reinforces health, confidence, and self-efficacy;

* Efficiency as Well as Efficacy - Brief therapy emphasizes time-effective methods for change, keeping the helping process affordable and not too burdensome;

* Strike While the Iron is Hot - Work on problems while they're occurring; changes are most likely to stick if they're rehearsed in realistic settings and situations;

In practice, this philosophy has me working very intensively with people for relatively short periods of time, using very hands-on techniques for altering problem patterns and applying those techniques to many situations. Weekly or monthly interactions are simply too infrequent to sustain the momentum of change; once progress has been made, then it can make sense to space meetings out over time to encourage the long-term internalization of the changes and guard against relapse.

To encourage this intensive interaction, I do not charge people for time spent on the phone or interacting by email (a far cry from the practice of coaches who run the meter at every possible opportunity); I want no barrier to regular contact. But once that contact leads to change, the goal is for the trader to sustain the process himself/herself, not meet for unlimited interactions with only a vague focus and agenda.

There is much in the brief therapy philosophy that traders can apply when they're acting as their own coaches. That will be the focus of my next post.

From Problem Patterns to Solutions: Brief Therapy for Traders

from Dr. Brett:
An experienced trader writes to me:

"I am having a good year trading but today marks the THIRD TIME this year that I've made a critical error which goes against my whole philosophy of trading.

I am a trend trader. That is how I make very consistent gains regardless of what the market is doing...I was buying a stock at levels where I believed it would bounce...of course the stock didn't bounce so I added more at lower levels and more even lower...

I got out of the trade on a rally, but it cost me the next two weeks of average profits...

I knew it was stupid when I was doing it, yet I continued to compound the problem. I didn't necessarily want to be right and make money on the trade, just minimize the losses (by buying more at lower levels)...

What I am not comfortable with is WHY I engaged in such risky behavior...what is the root, how do I find it, eradicate it?...The other two times were similar trades with similar results."

This is a very typical scenario that I help traders with. In this post, I'll walk you through how I view such problems and what I typically recommend.

The framework that I operate from, broadly speaking, is one that is known as brief therapy. These short-term approaches accelerate cognitive, emotional, and behavioral change by emphasizing hands-on skills building and the creation of powerful, new experiences that change how we view things.

Brief therapy is not appropriate for all people and situations, particularly those with chronic (longstanding) emotional problems that significantly interfere with areas of life functioning. Fortunately I know my writer and can vouch for the fact that he does not suffer from any significant emotional disorders.

So what is the key to his problem? What one feature stands out in his presentation? Take a moment and look over his words. What most strikes you about the difficulty?

One such key is that this has happened before in very similar ways. That tells us that it is likely a cyclical problem. Something initiates the pattern (sets it off); something keeps it going (even though he knows it is "stupid"); and something later kicks in to get him out of the pattern.

Most cyclical patterns are there for a reason: they serve a function. The trader's intense desire to find the problem and "eradicate" it is probably part of the problem pattern itself--much as the desire to eradicate insomnia can keep a person awake all night or the desire to eradicate fat can lead a bulimic person to binge eat.

In short, fighting the pattern is a mistake. The challenge is to understand the function of the pattern and then rehearse a different way of satisfying this function. Instead of viewing the problem pattern as maladaptive, the brief therapist views it as a form of problem solving that no longer works for the individual.

Let's take a simple example: Bill grew up with a mother that was anxious and overbearing. Conflicts at home were very unpleasant, so Bill learned to avoid conflict by minimizing communication with his mother whenever she sounded upset. This worked well throughout his childhood. Now Bill is married to Susan, who at times feels overwhelmed at work and reaches out to Bill. Much to Susan's dismay, Bill withdraws at those times and fails to offer support. She feels as though he doesn't care about what she's going through. Bill feels guilty about not being there for Susan and tries to make it up to her, only to fall short the next time she is worried or frustrated.

One might imagine Bill saying the same thing as our trader: "This is the THIRD TIME I've let my wife down...I know it's stupid when I'm pulling away from her, but I continue to compound the problem." It's a cyclical problem that represents a past, overlearned response to a stressful situation.

So how do we help Bill? We don't try to "eradicate" the problem--that hasn't worked. Rather, we get him to *talk* with Susan when he's feeling uncomfortable with her emotions. Step by step, we coach him through such a conversation, opening up about his thoughts and fears instead of pulling away. For example, we teach him to say to himself, "I'm not really uncomfortable with Susan; this is my old fear of my mother cropping up again. How can I tell Susan about that?"

As it turns out, just about anything Bill says to Susan in the situation about his experience will be helpful, because it will disrupt the old pattern and show her that he truly is listening, that he really cares. That sets the stage for the two of them to develop new patterns. Instead of trying to eradicate and bury his feelings, we use them as an opportunity for Bill to connect with Susan.

So back to our trader. He has a cyclical pattern in which he adds to losing trades, eventually taking outsized losers. This is frustrating to him (note the all-caps when he describes the THIRD TIME he's experienced the problem this year), and it is something he wants to get rid of. But what is the function of the pattern? Our trader perceptively notes it himself: "I didn't necessarily want to be right and make money on the trade, just minimize losses." So there it is: our trader is trying to avoid loss by averaging down. This is his way of fighting against failure, falling short.

In a subsequent communication, the trader revealed to me, "Each of these bigger losses occured after a period of very good trading. I didn't feel cocky, but my actions were. I cannot increase my relative risk tolerance after a period of success." This is a very good observation. The problem pattern is NOT triggered by a losing trade. It is triggered by success! After a winning period, our trader becomes emotionally attached to winning: he wants to eradicate losses. This has him resisting taking normal losses at his stop points and instead averaging down to minimize the loss. It's not that he's trying for a home run trade: he doesn't want to stop winning.

So there's the trap. Once the trader hits a winning streak, he wants to keep winning. This makes even normal losses feel threatening. So what can he do? Ironically, the answer is to purposely engage in guided imagery exercises before the trading day starts in which he mentally rehearses honoring his stop levels and taking normal losses. These exercises would be doubled following winning trading days. Just as we had Bill talk with Susan about his discomfort, we encourage our trader to openly confront his need to keep winning. Fighting the pattern hasn't worked; by facing the problem head on, he can keep a level head even when he's in his best winning streak.

I don't know our trader very well, but my guess is that there's more to his drive and desire for success. Perhaps he's *needing* to win instead of passionately *wanting* to win. There's an important difference. Once we're in the "need-to-win" mindset, losses become threatening and we try to avoid them by doing "stupid" things. By rehearsing an "ok to lose" mindset, we interrupt the need pattern and set the stage for initiating new patterns of trading well.

I enjoy trading and I find markets endlessly fascinating. But it's working with people and helping them make changes in their lives that really makes my day. Once we stop viewing patterns as "problems" to "eradicate" and simply discover fresh ways to meet the needs underneath those patterns, we eliminate many of our blocks to success and happiness. And isn't that what coaching is all about?

RELATED POSTS:

Therapy for the Mentally Well

Using Brief Therapy to Become Your Own Coach

The First Steps of Brief Therapy

Brief Therapy With a Solution Focus

Using Emotions to Change Emotion

from Dr. Brett -

In my recent post, I suggested that many of us avoid emotional upset by substituting action for feeling. This is a pattern that lies at the heart of many impulsive trading decisions, including many lapses in trader discipline.

Let's take a common example: a trader is working a bid a bit below the market and suddenly a ferocious sell program takes the market five ticks lower. The trader's order is filled and, in an instant, the market is several ticks against him. He reacts first with shock, then with anger at people who "manipulate the market". In a flash, he buys more contracts, even though this sizes his position much larger than his plan allows. It's a classic revenge trade: he's going to get even. The market moves a few ticks lower, and he is forced out at the worst possible price with a much larger loss than his initial trade planned for. In remorse, he makes a note in his journal that he needs to be more disciplined in his trades.

As long as the trader views "discipline" as his problem, he is sunk psychologically. He sets up a condition in which he is split: part of him is impelled to do something under particular conditions, another part attempts to exercise control by dictating what *should* be done. This is how anorexic and bulimic patients fight with food intake; how addicts fight with drug abuse; how many of us fight with sticking to diets and exercise regimens.
We cannot substitute thought for emotion: shoulds cannot overcome emotional impulses.

The key to moving past an emotional reaction is to experience it fully and then substitute a different emotional experience. Psychologists such as Leslie Greenberg and Robert Elliott have developed emotion-focused techniques to accomplish just that. The basic principles and techniques are straightforward, well-supported by research, and described in detail in a growing professional literature.

What is happening with the trader in the example above is that he first experiences hurt and disappointment. He might also experience a fleeting sense of failure and loss. These are too painful to feel, so he has learned to respond to hurt with anger. He transforms sad to mad and then acts on the angry feeling. What appears to be the problem--loss of discipline--is his way of coping with the *real* problem, which is vulnerability.

Suppose, however, I ask our trader to go more deeply into the experience of having his order taken against him. As he talks, I notice an unhappy look on his face and a slight slumping of his shoulders. I point that out and ask him to give voice to what he's feeling. He talks about how it seems as though nothing is working in his trading, how he and his wife just bought a new house, and how they're concerned about making the payments.

When I ask what that's like, feeling as though he can't support his family, he acknowledges, "I feel like such a loser". Then, however, he speaks with a different voice: "But I know I can trade. If I would just stop trying to catch exact tops and bottoms with these orders, I can ride moves once they happen."

"So when you're working orders in the book...", I begin.

"I'm being an idiot," our trader interrupts. "I know I shouldn't be working orders that close to the market. It's too thin."

"But you're trying to catch a top or bottom to feel good and help your family," I offer.

"Yeah," he acknowledges. "But I'm f*****g it up."

"So it all starts with you feeling concerned about your family. You have to get something going in the market to make some money, so you throw an order in the book to catch a turning point," I suggest. He nods.

"Could you pretend your wife is in the room right here, right now and talk to her about that concern and what you want to do about it in the market?"

We set up an exercise where our trader talks aloud his concern for his family finances. He has no problem telling his wife that he needs to be patient and trade well in order to regain his success. By the end of the exercise, there's no hint of the angry revenge trader. In its place is the direct experience of facing his worst fear--his feelings of inadequacy--and emerging with a different emotional experience: empathy for his wife (and for himself).

Greenberg notes:

"People can recognize that a feeling is not helpful to them once it has been accepted fully. The paradox is that, if the feeling is judged as not acceptable--as "not me"--it cannot be changed, because it hasn't been accepted. Only when a feeling has been accepted can it be evaluated and changed if necessary" (Emotion-Focused Therapy, p. 93).

Doing can be a way of avoiding feeling, and that keeps people stuck in problem patterns. Ironically, the solution is to deepen the feeling that is being avoided. At the other end is a very different--and usually quite constructive--emotional experience.

RELEVANT POSTS:

Brief Therapy Techniques for Traders

What Works in Trader Coaching

Tips on Using Trading Journals

from Dr. Brett -
In my last post, we took a look at trading journals and how those can be used to improve performance. The report card format for journaling is particularly helpful for goal-setting, tracking progress, and recognizing patterns in our own trading. In this post, I'll review some of the patterns that most often appear across journal entries--and that are important to work on.

1) Patterns of Negative Self-Talk: These occur during frustrated moments in markets. We miss a trade, a trade blows through our stop, we give back our money on the day: all of these create frustration. This frustration then triggers an anger response that we direct toward ourselves. For example, we might find ourself saying, "Here it goes again! Other people are killing these markets, and I can't get it going." At that point, your frustration is no longer about the specific trade or market event, but is directed to *you as a person*. Trading should be about trading; not about you. After all, you wouldn't be boasting and crowing in the journal if the trade went your way. If you wouldn't like to hear your message coming from someone else (imagine your buddy at the workstation next to yours saying, "Whoa, dude, other people are killing these markets, and you can't get it going!") and if you wouldn't be speaking that way to your trading buddy, then you shouldn't be speaking that way to yourself. Interrupting that negative self-talk and turning your frustration toward a constructive kick in the pants ("C'mon, Brett, you know you shouldn't be trading so large in the chopfest. Let's stick with the rules!") can be very helpful in preventing frustration from snowballing.

2) Patterns of Impulsivity - Out of excitement, boredom, desire to regain profits, or overconfidence, you find yourself trading too frequently or with too much size. This, in turn, leads to uneven performance and outsized trading losses, which then produce discouragement. Many traders keep their goals--and their trading rules--taped to their screens; this helps keep them in the forebrain as a check on impulsivity. One trader I worked with actually had a brief checklist that he had to check off before placing any trade. This prevented him from acting hastily. If you can figure out the triggers that make you impulsive (sometimes these are winning trades, where you start playing with "house money"), you have a good chance to put on the brakes before you act on impulse.

3) Patterns of Fear - Particularly after losses, but sometimes after making money and being afraid of losing it, traders fail to act on good signals or do not size their trades adequately. The result is missed opportunity. Often this occurs if the trader is engaging in "catastrophizing": making a normal potential loss into something much larger. Worry, physical tension, and feelings of nervousness are great clues to track in a journal. Once you recognize your fear patterns, you can take some deep breaths, calm yourself, and focus on assessing opportunity (and focus on those trading rules). One way of breaking overwhelming fear after large losses is just to put on some small trades when your signals are good and get your rhythm and confidence back. Then you ramp back up to normal size in a gradual, but steady manner. Playing defense is not giving into fear: having rules about risk control and hanging onto a day's profits can help you distinguish the two.

Once you notice your patterns, it's easier to construct specific goals for the next day's and week's trade. The overarching goal is changing your patterns: controlling how you think and feel rather than having them control you. It's difficult to imagine changing your patterns if you're not aware of them in the first place!

RELEVANT POSTS:

Using Emotion to Change Emotion

Some 2007 Posts on Trading and Emotions