A frustrated trader writes to me, "I was searching for something that would aid me in making decisions in trading the index on a 3-10 day swing basis, but I am failing again and again. I think I have failed more than 10 times and swore 10 times that I will not trade again. But I come again with new money and donate it. Can I stop it??? You are the only person who can help me in stock trading in real terms."
Every week, I receive emails similar to this one. Traders have lost money, are desperate for success, and seek my assistance. We hear many breathless stories, promoted by the industry, of those who have made it big or who seemingly effortlessly trade for a living. What we don't see is the tragic financial and human toll among the 80+% of people who do not succeed at trading. I give major credit to the trader who wrote to me, for the honest self-appraisal.
What advice can I offer the reader? Let's take the reader's words in turn:
* "I was searching for something..." - I wrote the trader performance book to better understand how traders progress from being novices to becoming expert. What I found is that much of trading expertise is the result of long hours in front of the screen, properly structured, internalizing patterns of market strength and weakness. The key to trading success lies in the cultivation of our own pattern recognition (and our ability to act on patterns); not on a search for external answers or grails. There are no gurus with answers.
* "Trading the index on a 3-10 day swing basis..." - The reader is competing against many hedge fund portfolio managers at that time frame. To succeed at that time frame, you have to be good at picking up catalysts for multiday price shifts (significant news items, shifts in central bank policy, etc.), and you have to be good at picking up intermarket themes (how interest rates and currencies affect stock markets; how markets overseas affect the U.S., etc.). If you don't have a handle on those patterns, your odds of success are vastly diminished, as markets will move without your understanding why.
* "I have failed more than 10 times and swore 10 times that I will not trade again. But I come again with new money and donate it. Can I stop it???" - This is not a problem with trading. It is a problem with addictive behavior. When people engage in activities that are designed to bring a "high", experience painful consequences, but cannot desist from the activity, that is the hallmark of an addictive pattern. Please evaluate yourself honestly and check out this trading addiction linkfest if you think this problem might affect you.
* "You are the only person who can help me." - This blog, the Twitter posts, and all my books will not be helpful if you don't possess self-control. Addictive patterns of behavior rob us of self-control. The one piece of advice I can give is to seek professional help from a psychologist experienced in working with addictive behaviors and then, if you're still interested in trading, build your learning curve in simulation mode before risking any further money. Only when you're consistently successful in simulated trading should you put your capital--and your emotions--at risk. Simulated trading is the not the same as live trading with real risk/reward, but if you can't make money on paper, you surely won't make it when the pressure is on.
If trading is your path, the learning curve should not be a tortured one. You need a certain degree of well-being to sustain the motivation and concentration needed to sustain your learning. Most of all, you need self-control to develop and follow trading strategies that build upon your pattern recognition. Before you work on the markets, it may be necessary to work on yourself and regain that self-control.
Wednesday, April 1, 2009
When Trading Becomes an Addiction
Control Your Brain By Controlling Your Risk
from Dr. Brett --
I received an eloquent email from an excellent trader who marveled that he trades very well when he trades moderate (but still significant) size, but then trades quite poorly when he trades his maximum size. His level of risk-taking, he finds, affects his emotional experience in trading. Yesterday, when he traded moderate risk through the day, he traded consistently and made significant profits. Last week, when he maximized his risk, he violated a number of his trading rules and lost significant money.
Same trader, same trading methods--only risk levels altered his emotions, his decision-making, and his performance.
Research suggests that different areas of the brain process risk and reward. Moreover, brain activation in the face of reward tends to be more rapid than in the face of risk. Other research shows that individual differences in our patterns of brain activity are closely correlated to our risk tolerance and risk aversion. This research finds that "reward centers" in the brain become more or less active depending upon how much money can be won or lost. Significantly, these reward centers are "some of the same areas of the brain that are activated when people take cocaine, eat chocolate or look at a beautiful face."
It appears that the thrill of risk and prospect of reward "hijack" the reward centers of the brain, particularly the dopamine system. This research emphasizes that gambling affects the portions of the brain associated with "planning and forming strategies". Is it any wonder that traders report "losing discipline" as a common psychological concern?
There is a very important lesson to be learned from the trader who wrote to me: By controlling our exposure to risk and reward, we control the degree to which our brains get hijacked. Trading 100% of our risk turns planned trading into gambling; cutting risk back moderates the reactivity of our dopamine systems.
There is also another sobering conclusion: failing to moderate our risk--day after day, week after week--can make permanent changes in the brain. According to one researcher, "In people that develop problems with gambling it seems that parts of that area don't work as well as they used to." By altering the dopamine system, a normal person can turn into a gambling addict. This is an example of neuroplasticity: the ability of the brain to change structure and function as the result of experience.
By creating the right kinds of experience, we literally can shape our brains for success. By generating the wrong kinds of experience, we can turn ourselves into impaired decision-makers. The difference between right and wrong, for traders, often boils down to the amount of risk we take with the capital we have.
I try to avoid overstatement, but in my opinion, this is one of the most important topics I've ever posted to the blog. Those who read the research linked above and the posts linked below--and who heed the message of risk levels and brain function--quite literally can save their trading careers and meaningfully advance their odds of success. You can't succeed if you don't have control, and you don't have control if the reward circuitry of your brain is hijacked by the risks and rewards you're pursuing.
RELATED POSTS:
The Brain and Handling Volatile Markets
Trading and the Brain
Trading Performance and the Brain
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ADP Jobs Decline of Nearly 3/4 Million
From Reuters:
Job losses in the U.S. private sector accelerated in March, more than economists' expectations, according to a report by ADP Employer Services on Wednesday.Private employers cut jobs by a record 742,000 in March versus a 706,000 revised cut in February that was originally reported at 697,000 jobs, said ADP, which has been carrying out the survey since 2001.
The big drop foreshadows a huge decline in the non-farm payroll reading in the government's employment report that will be released on Friday, some analysts said.
"It's a terrible number. It is almost a loss of three quarters of a million jobs which is possibly the highest we have seen so far over the length of this crisis," said Matt Esteve, foreign exchange trader with Tempus Consulting in Washington.
U.S. stock futures and the dollar fell after news of the bigger-than-expected job losses, while U.S. Treasury bonds regained some of their lost ground.
The market is shrugging this jobs report off, perhaps becuase it expect the BLS one on Friday.
Tuesday, March 31, 2009
When Market Indexes Don't Confirm Each Other
from Dr. Brett:
OK, so here's a little lesson for you developing traders out there. Was yesterday a weak day or a strong day in the stock market? Of course, it was a weak day, because many more stocks declined than advanced on the day and there was net selling pressure on the day, as measured by the Cumulative NYSE TICK. Indeed, the day was so weak, it toppled many stocks off their (up) trending perches. If you take a look at this morning's Twitter posts, you'll see that the ratio of stocks closing below their volatility envelopes (Supply) exceeded those closing above their envelopes (Demand) by over 25:1.
Look, however, at my 2:16 PM tweet yesterday, indicating that small cap stocks were not confirming afternoon weakness in the large caps. Even the large cap NASDAQ stocks (NQ futures) were not confirming the weakness in the S&P 500 Index. If you review the recent post on indicator non-confirmations, you'll see that, in the most durable trends, sectors will tend to move in unison. When important segments of the market can't hold their weakness, it's a sign that the downtrend does not have good legs. Now, this morning, we're seeing the result: much of Monday's decline has been reversed in overnight trade.
If you click on the chart above, you'll see how the Russell 2000 Index (IWM) did not confirm weakness in the S&P 500 Index (SPY) at point 2. You'll also see that the Russell actually closed above its opening price--hardly an indication of weakness on the day time frame!
Note, also, that at point 1, the Russell had not only begun outperforming the large caps, but had actually retraced its decline from the open. That was actually our first indication that not all stocks were tanking in the day session. Yes, Monday was a weak day, but the weakness became less broad over the course of the day. And that emboldens the bulls for the next day.
Benefiting From a Small Statistical Idea
In this article, I will give you a crash course in a couple of statistical ideas and show you how you can use them to your advantage. Before your eyes glaze over and traumatic stresses take you back to the dreaded math classes of your youth, let me assure you that no heavy mathematical lifting will be involved. All you'll need to do is juggle three things in your head instead of two.
Most of us think in terms of what statisticians call main effects. A main effect says: A is related to B. For instance, vigorous exercise is related to health. More vigorous exercise, more health; less vigorous exercise, less health. That's a main effect. You can think of it as a simple correlation.
Many relationships among things in the world are more complex, however. One slightly more complex relationship is called an interaction effect. Here we are saying: A is related to B, but only when C is present. For instance, vigorous exercise might bring more health for people below the age of 75, but not for people above age 75. You can see why interactions are important. If we assume a simple main effect, we might encourage everyone to exercise vigorously, putting older people at risk.
Many market relationships are interactions and not main effects. This means that when we adopt simple "A, therefore B" thinking, we can put our portfolios at risk.
Here's a simple example. As I noted on Traderfeed, large cap stocks in the Major Market Index have been up over 2-1/2 percent in the past six sessions. If we look at what typically happens after six-day periods of large cap strength going back to March, 2003 (N = 762), we find that the S&P 500 Index ) tends to underperform its historical norms over the next six days. That's our main effect: strong six days in XMI leads to subnormal S&P performance.
Now, however, let's add a third factor: the performance of small cap stocks. When the large caps have been up strongly and the small caps have been strong, the S&P 500 actually modestly outperforms its average six-day performance over the next six days. When the large caps have been strong and the small caps have been weak, the S&P 500 has actually had bearish expectations over the next six days. In other words, whether a strong six-day period in the large caps is bullish or bearish depends upon the relative performance of the small issues.
Now let's take the reverse scenario. When we have six-day strength in the small-cap stocks (a gain over 3%), the next six days in the small caps average a loss of -.003% (46 up, 36 down). That is weaker than the average six-day gain of .62% for the general sample (464 up, 298 down). Once again, that's our main effect: six days of strength in the small caps leads to small cap underperformance in the next six days.
Let's look at those strong days in the small caps, however, as a function of S&P 500 performance during those six days. When small caps are strong and the S&P is strong, the next six days in the small caps average a gain of .41% (28 up, 13 down). When small caps are strong and the S&P is weak, the next six days in the small caps average a decline of -.41% (15 up, 26 down). Clearly, the main effect is misleading. When the small caps and the S&P are strong, the next six days in the small caps tend to be bullish, in line with historical norms. When the small caps are strong and the S&P is weak, the next six days in the small caps tend to be bearish.
You need not be a statistician to benefit from the presence of interactions. The way I like to think of it is that rising tides will lift all boats, just as falling tides will drop them. If we see discrepancies between small stocks and large ones, it's time to question the market tide. I'll be keeping one eye on the big issues and one on the small ones this week to see how strong the current market tide really is.
Brett N. Steenbarger, Ph.D. is Associate Clinical Professor of Psychiatry and Behavioral Sciences at SUNY Upstate Medical University in Syracuse, NY.
Relationship Between Small and Midcap Stocks
from Dr. Brett:
My recent Trading Markets article took a look at how small cap performance acts as a mediator of past and future S&P performance, creating a statistical interaction effect. Today we had an interesting situation in which the S&P Midcaps ($MID) underperformed the S&P Small Caps ($SML). Specifically, SML was up .03% and MID was down -.34%.
Going back to March, 2003 (N = 766), I found 127 occasions in which the day's change in SML was within plus or minus .20%. The next day in SPY averaged .01% (63 up, 64 down), which is weaker than next day results for the sample overall. Once again, however, we see an interaction effect. When SML is neutral and MID is strong, the next day in SPY averages a loss of -.11 (29 up, 35 down). When SML is neutral and MID is weak, the next day in SPY averages a gain of .13% (34 up, 29 down).
Once again we see that a critical mediating effect is played by the relative outperformance or underperformance of the small cap stocks. When SML is neutral but outperforms MID, next day results in SPY are more favorable than when SML is neutral but underperforms MID. Score this as a mild bullish consideration for tomorrow.
Monday, March 30, 2009
OECD Predicts 10% Unemployment in 2010
Unemployment has been predicted to escalate above 10% next year by the OECD, which represents the western democratic nations of the world. Ouch!
Russia and China Cooperate to Propose New Reserve Currency
from Breitbart.com "We have received proposals from our colleagues in China, detailed proposals," President Dmitry Medvedev's top economic adviser Arkady Dvorkovich said. "Our positions are very similar. "We have similar positions on the development of the international financial architecture," he told reporters. Ahead of the Group of 20 summit in London later this week, the Kremlin has published a raft of proposals to overhaul the global economic order, including plans for a supra-national currency that could replace the US dollar. China has come forward with similar ideas.
Russia and China are coordinating proposals on a new global currency that could replace the US dollar as a reserve currency to prevent a repeat of the global economic crisis, the Kremlin said on Monday.
Traders Liquidating Grains in Anticipation of USDA Report Tomorrow
Grains were weak again today across the board. Only wheat closed marginally higher; wheat was already at strong support that had held firmly for the past month at $5/bushel. I am writing this post so that I can refer to it in future years. This phenomenon of grains liquidating in anticipation of the USDA report is something that I can anticipate in future years.
Stocks Crumble on News of Forced GM CEO Resignation
Pres. Obama forced GM CEO to resign today. The market is concerned that the government is going to take over greater and greater control of private companies.
Saturday, March 28, 2009
Turning Trading Rules Into Commitments
from Dr. Brett:
Saturday's post on following trading plans emphasized that our actions are intimately related to our states of mind. When we undergo state shifts, our perspectives change, and those can alter our priorities. What seemed urgent in one frame of mind becomes lost in another. This most often occurs during trading when profit/loss (P/L) concerns take front and center stage, obscuring our best laid plans for our positions.
The links from the earlier post cover a variety of reasons why traders lose their discipline. There is, however, another reason why traders find it difficult to follow the plans they set: their plans aren't truly plans.
To understand this, consider the difference between plans and intentions. If I tell myself that I need to go to the gym and get into shape, that's an intention. It is not a plan. If I actually join a gym, sign up for classes, set up a schedule for exercise, and create weekly goals for how often I'll exercise and how much weight I'll lose, that is a plan.
Similarly, I might intend to take my wife on a trip that will help her get away from work stress. That is very different from actually planning the trip by discussing it, creating an itinerary, shopping for best airfares, etc.
Intentions are thoughts of future actions, often accompanied by "should". Plans require action--taking steps in the present to achieve the desired end--and they often have a social and motivational component. A business plan, for instance, is much more than intended success; it can be vital in attracting investors and key employees. Because intentions lack committed action, they are generally weaker than plans. We're likely to break a New Year's intention, but less likely to break those vacation plans once they've been formulated with a spouse.
Many traders formulate intentions for their trades and then wonder why they have veered from their "plan". When I ask to see their plan, however, there is nothing written down; nor is there anything specific that has been planned. To be sure, high frequency traders are not going to formulate detailed plans for each trade. In their case, trading rules about such matters as execution, sizing, and risk control would take the place of unique plans for each position. Often, however, I'll hear from "scalpers" that they've violated their discipline. When I ask which rules they've violated, they cannot give a ready answer.
My response is that you can't violate a discipline that isn't there to begin with. The problem is not that an excess of emotion interfered with their plans and rules. Rather, they were never sufficiently planful and rule-governed to begin with.
The single greatest way to build discipline is to turn rules and plans into commitments. That means that you have to give those rules and plans distinct life of their own. The more you think of them, look forward to them, talk them to others, write them down, grade yourself on them, reward yourself for them--the more real they become. You are most likely to abandon rules and plans that haven't been internalized as commitments.
Please check out the comment of reader Adam following the post on learning to think like the herd, but not follow the herd. You'll gain a valuable lesson in turning rules and plans into routines and commitments. Adam's observation regarding the value of checklists in high risk professions is excellent. He explains, "Trading is a matter of repeating over and over again behaviors that trap errors before they are released into the market".
Intentions aren't strong enough to trap errors. To catch the mistakes before they're released, you need the emotional force of commitments and the reliability of routines. Turning intentions into checklists and checklists into commitments is a great way to ground yourself in best trading practices.
Best of Dr. Brett for 2008
Here we have the best of the posts from the third quarter of 2008. Archives can be found for the first two quarters of 2008; 2007; and 2006 via the Trading Coach blog site.
The Limits of Self-Esteem
The Psychology of Profitability
The Idiot Wave
Consistent Returns With Small Edges
Adapting to Shifts in Market Regimes
The "Should Have" Syndrome
Distinguishing Trend and Range Days
False Breakouts and Reversals
Trading Success and Teamwork
Where to Place Stops
Position Sizing and Risk Management
Avoiding Overtrading
Trading Stress and Emotion
Mindful and Mindless Trading
Greatness in Life and Trading
Market Communications and Metacommunications
Implicit Learning and Detachment
Implicit Learning and Trading Performance
A Common Coaching Error
The Psychology of Mechanical Trading
Behavioral Finance and Trading
Personality Traits and Trading Success
Risk Taking and Personality
Market Gamblers and Entrepreneurs
Trading and Regret
Best of Dr. Brett for 2007
Here are the top posts from the second quarter of 2007; first quarter can be found here, and 2006 is here:
Trading Techniques
Visiting a World Class Trader
When Coaching Works and Doesn't Work
Trading and Poker
Changing Your Self-Talk
Information Processing Biases in Trading
What to Do If You're Losing Money
The Most Dangerous Word in Traders' Vocabulary
Performance Anxiety
Handling Performance Pressures, Part Two
Solution-Focused Linkfest
Finding a Trading Coach
Short-Term Market Transitions
When Coaching Doesn't Work - Part One, Part Two
Assessing Trader Personality
Heroic Dimensions of Trading
Becoming Your Own Coach
Trading Transitional Structures
Trading Discipline
Attribution and Cognitive Bias
Trade Like a Scientist - Part One, Part Two, Part Three
What Makes a Trader's Marriage Work
How Can I Learn Trading?
Assessing Your Strengths
Therapy for the Mentally Well
The First Steps of Brief Change
Becoming the Actor of Your Ideals
Programming Your Experience
Four Qualities of Successful Traders
My Trading Framework
Coaching Yourself to Let Profits Run
Personality and Trading Performance
Personality Questionnaire for Traders
Interpreting the Personality Questionnaire
Subjective Well-Being and Trading
Improving Well-Being
Transforming Stress Into Well-Being
Good Trade Execution
Keys to Trading Success
Tracking Large Traders in the Markets
Identifying and Trading Breakout Moves
Somatic Markers and Trading Decisions
Five Guiding Principles of Trading Psychology
Best Practices in Trading
Resilience and Courage of Your Convictions
Trading Opening Range Breakouts
Psychological Risk Management
The Epistemology of Trading Expertise
Why Traders Self Sabotage
Why Traders Don't Trade Their Plans
Steps Toward Joining a Prop Firm
Underconfidence and Overconfidence in Trading
Using Imagery to Accelerate Behavior Change
Ten Principles of Short-Term Trading
Winning Trades vs. Making Money
Trading and Learning Styles
Assessing the Learning Styles of Traders
One of My Best Market Posts
Trader as Entrepreneur
When Traders Lose Confidence - Part One, Part Two, Part Three
Five Steps Toward Self-Coaching
Very Important Post on Trading and Pain
Life Lessons From Mali
Trading and Emotional Well-Being
Our Moods and Our Trading; Here is a Mood Questionnaire
Our Emotional Style
Coping Strategies; Stress and Coping; Coping and Intuition; Assessing Your Coping Style
Improving Your Coping
Goal Setting for Traders
How Problem Patterns Develop
The Importance of Emotional Experience in Change
Making the Right Decisions Under Conditions of Fear
Using Emotion to Change Emotion
Making Cool Decisions With a Hot Head
Ayn Rand, Objectivism, and Trading
Trading and Worry
Trading With a Philosophy
Somatic Markers During Trading
The Psychology of Losing
Knowing Your Strengths
Emotional Balance in Trading
Identifying Your Edge
The Cognitive Development of Traders
Ten Short-Term Trading Guidelines
Regret and Trading
Keys to Emotional Resilience in Trading
How to Change Yourself
Self-Evaluation and Success
Preparing for the Day's Trade
Four Common Trading Problems
Trade Like a Card Counter
Finding Your Voice as a Trader
Considerations RE: Trading for a Living
Common Stresses Faced by Traders
Stress and Cognitive Regression
The Psychology of Scarcity and Abundance
Self-Confidence and Performance
Six Positive Trading Behaviors
Signs of Burnout
Cultivating Self-Awareness
Trading and Anxiety
Turning Setbacks Into Goals
Trading Myths and Questionable Assumptions
Achieving Emotional Self-Regulation
When Trading Performance Declines
Predictors of Coaching Success
Greatness, Happiness, and Performance
Physical Exercise, Self-Efficacy, and Well-Being
Living a Purposeful Life
The Brain and Trading Performance
Best of Dr. Brett for 2006
It's been a great year, and I want to wish all readers a very happy and prosperous 2007. Below are links to TraderFeed posts from the first half of 2006 that capture a few of my New Year's thoughts--and resolutions! Tomorrow I'll post links to favorite psychology posts from the second half of the year.
* How I use volume flow information in trading to capture the market's psychology;
* Why I find historical analyses of the markets to be useful;
* Reflections on life and the markets;
* Why having odds in your favor doesn't assure success;
* How the S&P 500 Index behaves on a very short time frame;
* Some defining features of market pros I've worked with;
* VIX as a measure of daytrading opportunity;
* A psychology checklist for traders;
* Lessons that traders have taught me;
* Why scalping the stock indices has become so difficult;
* The opening range and market opportunity;
* A solution-focused framework for working on one's trading;
* How the markets confound human nature.
* The most common trading problem of all.
* Why traders lose their discipline.
* Diagnosing trading problems.
* Playing it safe avoids reward as well as risk. Even for investors.
* Living the heroic life: Part one, two, three, four, five
* What a bodybuilder teaches us about life success.
* Smooth vs. choppy moves and what they mean: Part one, two;
* What it means when there are lots of bears out there;
* What every short-term trader should know; one of my best posts, IMO;
* Why attacking your trading problems can be a mistake;
* Markets and people are wired differently;
* NYSE TICK and stock market momentum;
* Identifying breakout trades;
* Mean reversion as a trading strategy;
* The need for dynamic thinking in trading;
* What a market's opening minutes tell us;
* A framework for looking at markets, short-term;
* Why it's easy to lose money when trading;
* Trading opening gaps, Part One, Two;
* Life lessons from trading;
* What contributes to trader success?
* Shifts in the NYSE TICK and their significance;
* A very simple psychological test;
* What a lack of discipline can teach us;
* The multiple personality of the stock market;
* Learning how to lose at trading;
* Becoming your own trading coach;
* How people make changes;
* Identifying market reversals;
* Lessons from sport psychology;
* An important psychological skill for traders: Part One, Two;
* Figuring out how much opportunity is in the market;
* Finding your niche as a trader: one of the important ideas from my recent book.
* Four facets of market psychology.
* Participation in a market move affects the likelihood of continuation vs. reversal.
* What happens in the brain affects how we trade.
* My advice for new traders.
* How personality traits affect trading discipline.
* More observations on life and markets.
* Market patterns are different from our own thinking patterns.
* Tracking how large traders are behaving in real time and why big traders matter.
* The safest times to trade are the most risky.
* Good example of the value of looking at historical trading patterns.
* The importance of trading the right things, not just the right ways--even for daytraders.
* Do gaps tend to fill?
* Why short-term trading has been so different from investing in recent times: the market is really two different markets.
* Becoming your own trading coach: Part one, two, three.
* More on the solution focus in trading.
* Unappreciated problem: addictive trading. Here's a self assessment.
* What you trade should match how you trade.
* Myths in trading psychology.
* Style cube: one way of thinking about *what* you trade.
* Some trading wisdom.
* What we see on charts is not necessarily what we get in the future: perceptual distortions.
* Success takes a lot more than taming emotions.
* A different way to measure market sentiment with relative data.
* Learning how to lose: a key to winning.
* We can learn a lot from the opening minutes of trade.
* Steps we can take to develop ourselves as traders.
* Devon's post: an important principle.
A Quick Note on Trading Psychology
from Dr. Brett:
I just finished an email to someone at a trading firm in which I tried to summarize the essence of trading psychology in a single post. Here's the gist of what I had to say:
Under conditions of perceived risk and uncertainty (after all, what we react to is what we perceive) we no longer process information in our accustomed ways. At a brain level, regional cerebral blood flow shifts from the frontal cortex (our executive center) to motor centers that facilitate those famous flight or fight responses. This denies us access to our usual good planning, judgment, and decision making. As a result, we can end up making decisions that we look back upon in amazement: "What was I thinking?!" The answer, of course, is that we *weren't* thinking at the time. We were reacting: managing our perceptions of threat rather than the objective trades in front of us. Effective brief therapy for traders enables them to reprocess perceptions of risk and uncertainty, so that the blood shifts--and the associated state shifts that generate anxiety, frustration, and impulsive behavior--cannot occur.
My book The Psychology of Trading was an effort to explain this process and provide basic tools and techniques for traders to use under conditions of heightened risk and uncertainty. In the new book I'm currently writing, I will provide actual "therapy manuals" to help traders become their own therapists.
Anticipating market movements from historical studies provides a valuable edge in trading, but any edge is worthless if our states of mind prevent us from acting upon the information effectively. My hope is that the articles on my personal site, as well as the book, provide traders with some help on that front.
10 Lessons From Working With Traders
by Brett N. Steenbarger, Ph.D.
When I sat down to write this article, I thought it would be challenging—but useful—to distill over 20 years of trading experience—and 25 years of specializing in brief therapy—into ten lessons that I have learned while working with traders (including myself!). In that time, I’ve written two books on trading and worked with dozens of professional traders at a proprietary trading firm. What has this taught me? Let’s break it down:
1. Trading affects psychology as much as psychology affects trading – This was really the motivating factor behind my writing the new book. Many traders experience stress and frustration because they are trading poorly and lack a true edge in the marketplace. Working on your emotions will be of limited help if you are putting your money at risk and don’t truly have an edge.
2. Emotional disruption is present even among the most successful traders – A trading method that produces 60% winners will experience four consecutive losses 2-3% of the time and as much time in flat performance as in an uptrending P/L curve. Strings of events (including losers) occur more often by chance than traders are prepared for.
3. Winning disrupts the trader’s emotions as much as losing – We are disrupted when we experience events outside our expectation. The method that is 60% accurate will experience four consecutive winners about 13% of the time. Traders are just as susceptible to overconfidence during profitable runs as underconfidence during strings of losers.
4. Size kills – The surest path toward emotional damage is to trade size that is too large for one’s portfolio. We experience P/L in relation to our portfolio value. When we trade too large, we create exaggerated swings of winning and losing, which in turn create exaggerated emotional swings.
5. Training is the path to expertise – Think of every performance field out there—sports, music, chess, acting—and you will find that practice builds skills. Trading, in some ways, is harder than other performance fields because there are no college teams or minor leagues for development. From day one, we’re up against the pros. Without training and practice, we will lack the skills to survive such competition.
6. Successful traders possess rich mental maps - All successful trading boils down to pattern recognition and the development of mental maps that help us translate our perceptions of patterns into concrete trading behaviors. Without such mental maps, traders become lost in complexity.
7. Markets change – Patterns of volatility and trending are always shifting, and they change across multiple time frames. Because of this, no single trading method will be successful across the board for a given market. The successful trader not only masters markets, but masters the changes in those markets.
8. Even the best traders have periods of drawdown – As markets change, the best traders go through a process of relearning. The ones who succeed are the ones who save their money during the good times so that they can financially survive the lean periods.
9. The market you’re in counts as much toward performance as your trading method – Some markets are more volatile and trendy than others; some have more distinct patterns than others. Finding the right fit between trader, trading method, and market is key.
10. Execution and trade management count – A surprising degree of long-term trading success comes from getting good prices on entry and exit. The single best predictor of trading failure is when the average P/L of losing trades exceeds the average P/L of winners.
Well, I’ve already hit ten and I have at least ten more I could jot down. Number 11 would be that successful performance mentors have content expertise in their particular domain. What I mean by that is that teachers of concert musicians themselves have experience as musicians; basketball coaches invariably have played the sport themselves. You learn trading by seeing your mentor trade and by having your mentor observe your trading. The right mentorship goes a long way toward shortening learning curves.
Figure it out: what proportion of baseball players, golfers, actresses, chess players, singers, or bicyclists can make a consistent living from their performance activities? Is trading really so much easier than those activities? The stark reality is that expertise in any performance field is the exception, not the rule, requiring dedicated practice and training. If you are emotionally prepared for the learning curve—and excited by the challenge—you are well ahead of the game. Start with finding the Three M’s: right methods, markets, and mentors. Those are the foundation of success, upon which you build skills and experience. Enjoy the journey!
5 Things You Should Know About Trading Psychology
from Dr. Brett: The overlap between trading and psychology is complex. Psychological factors, such as performance anxiety, can interfere with clear-headed decision-making about markets. Similarly, poor trading practices--such as taking on too much risk with excessive size--can magnify the normal stresses of the marketplace. Sometimes it is difficult to separate chicken and egg. Many traders put their money at risk without a demonstrable edge. It is difficult to imagine such trading *not* generating frustration over time. Other traders ground themselves in solid methods, but these may not fit their talents, skills, or personalities. A very short-term, aggressive method of scalping markets, for instance, may work fine on paper, but prove completely unworkable--and stressful--for a highly analytical, risk-averse trader. Sometimes, however, trading psychology problems have nothing to do with trading. They are the results of pre-existing problems that will not be solved by different trading methods. Nor will they go away with simple coaching advice to control emotions and build discipline. If you have considered getting help for trading psychology concerns, here are five things you should know before deciding upon the kind of help that is right for you: 1) Psychological problems are more prevalent in the population than most people realize - The prevalence of clinically significant depression in the population is about 5-6%. There is a similar prevalence among such anxiety disorders as phobias, obsessive-compulsive disorder, and generalized anxiety. There is a prevalence rate of over 5% for substance use disorders; 1% for bipolar disorder; 2-3% for eating disorders; and 1% for post-traumatic stress disorder. That suggests that well over one in ten people--including over one in ten traders--has a diagnosable emotional disorder at any point in time. If, say, 20% of traders are experiencing emotional disruptions of their trading, it is not unlikely that fully half of these are dealing with treatable psychological problems. 2) Psychological problems can benefit from therapy - A wide range of controlled outcome studies suggest that the average effect size across various therapies is close to 1.0. That means that people improve their functioning (lower their symptoms, report less interference with their work and relationships) by close to a full standard deviation. Some problems benefit more than others from therapy or require longer-term treatment. Many anxiety problems, for instance, can be successfully aided with brief therapies. Other problems, such as major depressive disorder and substance use problems, have higher rates of relapse and may require more extended assistance. 3) Psychological problems can benefit from medications - Medications, such as selective serotonin reuptake inhibitors (SSRIs) for depression and many forms of anxiety, can be quite helpful in situations where symptoms are so debilitating that it is difficult to fully engage in therapy and/or where symptoms are impairing functioning at home and work. There are some conditions, such as bipolar disorder and attention deficit hyperactivity disorder (ADHD), for which medications are typical treatments of choice. Some research for depression, for instance, suggests that intervention is most effective when combining medications and therapy. 4) Some psychological problems can benefit from very brief therapy - In general, if a problem is not severe (i.e., it is not impairing wide areas of a person's life) and if it is not chronic (present throughout a person's lifespan), it will probably be amenable to brief forms of therapy. This is particularly the case when problems are the result of situational life stresses. When problems are chronic--and especially when there is a family history of emotional disorders--it is much more likely that longer-term therapy and/or medication assistance will be needed. 5) Some psychological problems can result from purely medical/physiological causes - Fatigue from sleep apnea, high blood sugar, or a host of other medical conditions can be mistaken for depression. Endocrine disorders may manifest as signs of anxiety or depression. There are seasonal forms of depression and depression related to hormonal changes in pregnancy and menstrual periods that have a purely medical basis. Many addictive problems have roots in underlying attention-deficit/hyperactivity and resulting loss of impulse control. Such conditions are not likely to go away with therapy alone and require competent medical evaluation. How do you know if your trading psychology problem is really just about trading or is a sign of larger problems? Here is a quick checklist: A) Does your problem occur outside of trading? For instance, do you have temper and self-control problems at home or in other areas of life, such as gambling or excessive spending? B) Has your problem predated your trading? Did you have similar emotional symptoms when you were young or before you began your trading career? C) Does your problem spill over to other areas of your life? Does it affect your feelings about yourself, your overall motivation and happiness in life, and your effectiveness in your work and social lives? D) Does your problem affect other people? Do you feel as though others with whom you work or live are impacted adversely by your problem? Have others asked you to get help? E) Do you have a family history of emotional problems and/or substance use problems? Have others, particularly in your immediate family, had treated or untreated emotional problems? If you answered "yes" to two or more of these items, I would recommend a professional consultation with a trained, licensed professional. I would also recommend consultation with a physician to rule out possible medical causes or contributors to your problem. Trading coaches and self-help books have their places, but neither are likely to provide the kind of help that research finds to be most effective in these circumstances. The bottom line is this: Do you feel you are in control of your thoughts, feelings, and behaviors or do you feel that those too often control you? The good news is that the vast majority of people can get help in reasserting control. Your well-being will help determine the well-being of your trading account. Note: For research about the prevalence of emotional disorders and the benefits and limits of therapy, I recommend the following book:
Dealing With Emotional Disruptions When Trading
from Dr. Brett:
Every week I get a handful of emails from blog readers wanting advice on dealing with emotional interference with their trading. Many of these readers feel that they have solid trading methods and plans, but simply cannot follow these with consistency.
In an earlier posting, I explained that there are many reasons for problems of trading discipline. Not all of these reasons are due to primary emotional problems. Many traders suffer emotional disruptions of trading because of how they are trading.
The two main trading reasons for emotional interference are:
1) Improper risk management - Many traders are trying to make a comfortable living from an inadequate capital base. They are undercapitalized relative to their income goals, and this forces them to trade too aggressively. The drawdowns, as a result, are severe and create unnecessary frustrations. As I mentioned recently to one reader's surprise, I have yet to meet a trader who can sustain a good living from an account base of $100,000 or less. Perhaps there are people who can make 50-100% on their money year after year after year, but this is not the norm even among the world's money management elite. Taking large risks in hope of such rewards creates emotional impacts that are difficult to overcome.
2) Trading methods that don't fit a trader's skills or personality - You would not believe how common this is: traders attempt to make money in ways that don't genuinely exploit their strengths. Many times, when traders don't follow their trading plans, it's because those plans don't truly fit who they are. Daytrading might not exploit the analytical skills of a trader; many traders don't have the speed of mental processing to succeed at scalping. Similarly, traders with intuitive skills might be frustrated by trying to trade mechanical rules. Traders not only need methods that possess a reliable edge; they need those methods to fit who they are. A risk-averse person won't follow an aggressive system of scaling into trades; a highly active, distractible individual won't stick with long-term investing.
When emotional disruptions of trading *are* primarily due to emotional factors and not one's trading approach (or lack thereof), there are short-term techniques to change patterns of behavior that are quite effective. A little while ago, I helped write a training guide for helping professionals that summarizes these techniques; my upcoming book for traders has two chapters that are self-help manuals to hands-on change methods. For many people, months and months and years and years of psychotherapy are not necessary to change their patterns of thinking, feeling, and behaving. There are short-term change approaches that have been extensively studied in controlled research and validated for their effectiveness.
Unfortunately, most coaches and mentors of traders have not been trained in these brief methods. They try to help traders by repeating simplistic strategies that can be found in the self-help section of any bookstore. Not surprisingly, these strategies don't dent emotional patterns that seem to have a will of their own.
For 19 years at a medical school in Upstate New York, I not only applied brief therapy methods to medical students, physicians, and other professionals; I also taught these methods to the helpers training to be psychologists and psychiatrists. So it's natural that I try to teach some of these psychological skills to professional traders.
Here are some free resources from my personal site that might help you better understand the common emotional disruptions of trading:
Behavioral Patterns That Sabotage Traders - Part One
Behavioral Patterns That Sabotage Traders - Part Two
Changing How We Cope
Expose Yourself
Finding Solutions: How Traders Can Become Their Own Therapists
Remapping the Mind: Cognitive Therapy for Traders
Turning Your Trading Around - Part One
Turning Your Trading Around - Part Two
Turning Your Trading Around - Part Three
After you read those, feel free to email me with any questions about application. (My email address is included in the "About Me" section to the right). I'll post questions and responses to this blog over the holiday weekend. As I so often say to traders I work with, my goal isn't to become your psychologist. My goal is to enable you to be your own shrink.
