Saturday, October 14, 2006

Losing Your Money Begins With Losing Your Focus

If you have a valid trading methodology, the role of psychology is to aid your executing it more consistently and effectively. One of the most important points I made in the Psychology of Trading book is that trading performance is not so much a matter of controlling emotions as controlling your focus and concentration. If you treat your emotional responses as market data--information, not problems to be covered over--you'll find that focusing on your experience (not getting lost in it) can pay off handsomely.

Let's take an example. The market has bounced off a price level a couple of times, and you're noticing reduced volume as we test those lows. The third time we approach the lows, you decide to buy the market. We bounce higher, stall, and then a large local begins to put large offers in the book, capping the buying. Within seconds, locals (perhaps that very same local) pulls bids and the market whooshes lower, breaking the recent support by a couple of ticks. Your trade is under water.

Does a trader feel fear or frustration at those moments? Of course. The question is not whether you have those emotions, but whether or not you lose your focus and blindly act upon them. As the slide above notes, to lose your focus is to become undercontrolled--impulsively putting on "revenge" trades--or to become overcontrolled, frozen with fear like a deer in the headlights.

A better alternative is to become an observer to those emotions. Perhaps, if you are becoming concerned about your position, other traders are as well. That prods you to increase your focus: look harder at what's going on in the market. When you notice that there are very large bids just below the market, you realize that large players are pushing the market into those bids. Your fear and frustration are what will make you hit their bids and get them out of their positions. Volume, after all, has not expanded on the move down: the running of stops was the result of a vacuum caused by strategies played out in the order book. Within moments, the market is back trading where you bought it.

There are good reasons to stay in a trade, and there are good reasons to exit and stop yourself out. The question is whether your decision is the result of enhanced focus--using your emotions as warning signals that alert you to important market changes--or the result of attention that has been shifted toward your P/L fears and frustrations. As any competitive athlete or soldier knows, emotion can be your friend or foe: it can make you focus harder on your circumstances, or it can distract your focus. It's much easier to maintain your focus when you have a well thought-out trade idea to focus upon. Much loss of focus (and resulting emotionality), I find, is simply the result of trades that lack a firm grounding.

Free psych resources for traders are available on my personal site. Trading, at its best, develops us as it develops our skills.


yinTrader said...

Hi Brett
The question is whether your decision is the result of enhanced focus--using your emotions as warning signals that alert you to important market changes--or the result of attention that has been shifted toward your P/L fears and frustrations- Unquote

I can see what you are getting at, ie traders especially novices tend to focus on P/L bottom line rather than to focus on experiences as marekt data.

I am a novice but I do a daily, weekly and monthly journal at this stage to review my mistakes and good moves so that they become my market data when I trade.

Focusing at what is going on in the market ie volume, real bids and offers, will certainly pay off handsomely, as you put it.

Brett Steenbarger, Ph.D. said...

Hi Yin,

That review process via the journal is itself a kind of focusing that turns results into learning experiences. Very, very useful. Thanks--


Glen said...

I enjoy and learn from your research and many postings. This comment is not relevant to this particular post, but to your posts about using Tick. I've used extreme Tick readings for years to help time long and short entries for IWM ETF, and have found the indicator to have good value. However, what I've found in the last several months is that Tick now tends to follow, with a slight delay, the moves in IWM. The ETF appears to be jumping up or down just before the Tick jumps up or down. This change has made it more difficult to scalp trade, which is what I like to do. Have you noticed this in your trading?

As for the cummulative Tick, a trader named Mark Cook out of Sparta, Ohio, used and promoted this indicator at least 10-15 years ago to time turns in the market. When the cummulative positive tick exceeded his cutoff, the market was due to decline; when the negative cummulative tick grew to a certain point, he would go long. He was often quoted in Barron's regarding this indicator, and was spectaculary right sometimes, and terribly wrong as well. Eventually they stopped quoting him. So I guess the cummulative tick is like many other indicators - it works often, but can stop working at critical junctures. What's my point? There are no perfect indicators, and even the best ones don't work in all trading environments.

Brett Steenbarger, Ph.D. said...

Thanks for the note, Glen. I find the cumulative TICK much like the advance-decline line: a general measure of strength/weakness, not a precise timing tool.

My sense is that your observation re: IWM and the Russell futures is right on the mark. Program trading is pushing the futures up and then players are buying the stocks and selling the futures as an arb trade to bring the two in line. When they buy the baskets of stocks, the TICK rises--but it's after the move in the futures.

That is why TICK is *not* a scalper's tool. It's too late. It does, however, track longer timeframe buying/selling sentiment per my earlier posts.


surfntrade said...

Speaking of fear, this topic got me thinking about overall fear in the market measured via the VIX. There certainly has not been a lot of "fear" in the market lately, which got me to review where we are. What I found has given me a solid piece of information to assist in my trading in the upcoming week and beyond. As can be seen from the VIX, "fear" has been steadily moving down since reaching a high June 16th. Interesting thing about the June 16th high in fear, it represented the 38.20% fib retracement of the double top set in '02. The long term bottom of fear was established in 93 and has since been confirmed in 94, 95, 05, and 06. The base of complacency established and confirmed by those years is 10.04 - give or take. We are currently at 10.75.
I checked fear gaps down off of significant highs over the years. Since 1990 there has been approximately 13 gaps down from significant highs. All of the gaps have been filled (in fact, all gaps regardless of their significance have been filled) - except.....except for two times - the most recent times they have occurred (4/19/03: 24.44 unfilled weekly gap, and 7/28/06: 17.40 unfilled gap). I then switched my attention to the daily charts. there were about 12 gaps down off of significant highs since October '03 (data available). all of the gaps have been filled - except....except for the two most recent gaps down from significant highs (6/15/06: 21.46 unfilled gap and 7/19/06: 17.74 unfilled gap). There is also a gap open for 10/12/06: 11.62.

I should also note that the trend as measured by the ADX is up for the monthly chart (27.25) and weekly chart (27.89). There is no trend for the daily charts.

Takeaway? My takeaway, is that there is a good likelihoods that people will be hitting the sell button out of fear in the near future and your post today will be most relevant in a few weeks when people are wondering why they are too nervous to stay in trades. Your post is ahead of what is occurring in the markets today, but people will be searching in the near future as to why they are having problems staying in trades - may be worth re-posting when we hit this situation.

One other take way - the longest a VIX significant top gap down has been left open is 164 days. The significant top gap of 6/15/06 has been open for 123 days.

Is a significant sell off in order in the near future - who knows for sure. However, I will be leaning fairly heavily on the short side (e-mini trades) if my early morning trading data tells me that we may be in for a weak day.

It is one thing to know why you have fear, it is another thing to know that there are plenty out there that have no idea of why they have it, they just know that they do have it. We can then take advantage of that and pounce.

Brett Steenbarger, Ph.D. said...

Thanks, surfntrade, for the thorough and creative look at gaps in the VIX. When the VIX has been small relative to its longer-term moving average, that, indeed, has not yielded impressive returns in the S&P 500 Index. Best of luck filling that gap and capitalizing on it!