Saturday, April 14, 2007

Pain and Gain in a Trader's Development

One of the most important steps traders can take to improve their craft is to intensively review their performance. If you think of every trader as a trading system, then it makes sense to see how the system has behaved over a year's time. This will reveal both weaknesses and strengths, aiding in the formulation of goals for self-development.

My favorite form of performance review is also my most painful. Every year I complete my income taxes--by hand. That means that I write out every single trade that I placed during the year in chronological order, along with its profit/loss (P/L). This past year, that meant reviewing approximately 240 trades, roughly one a day.

Yes, there are ways of capturing this information electronically to avoid the hand-numbing task of writing each transaction, but I choose the old-fashioned method. Writing the trades out makes me reflect on them: "What the hell happened here?" and "What was going on in the market then?" Writing the trades makes me sensitive, not only to their P/L, but to their sequencing: How many runs of winners and losers did I have? How far did I draw down during the year? How well did I trade after I had a losing period? What happened following winning periods?

Other important questions that arise during the income tax exercise have been: How many winners and losers did I have? Did that change over time? What was the average size of my winners and losers? How did the size of my largest winners and losers compare?

Such review is a powerful learning mechanism. Recall the world-class trader I recently described. I'm convinced his daily reviews have helped him make that movement from competence to expertise.

So why do so few traders conduct such intensive reviews?

Quite simply, it really is painful. Every mistake--every lapse of judgment and discipline--is laid bare. Too, the review starkly reveals how successful or unsuccessful you truly were. Such review forces us to face the question: What was the return on my investment of time in trading? I suspect many traders would rather not know. They'd rather comfort themselves with vague assurances that they're "working on things" and "learning". They prefer filling out a few emotive lines in a journal and calling that review.

But with the pain comes gain. My past reviews found that a handful of large losing trades were greatly reducing my P/L for the year. No longer. I became so disgusted looking at large losing trades that I simply cut them out. Out of 240 trades in 2006, none lost anywhere close to 1% of my total trading capital. My largest drawdown the year--from equity peak to trough--was on the order of 2%. I was profitable, not because I made so many great trades, but because I stopped losing. And I stopped losing when I started hating losing. And I only *really* hated losing when I had to write it down, face myself in the mirror, and truly feel the pain and disgust with how I was interfering with my own success. That emotional connection is critical to the process of change.

You'll never hear me prattle about positive affirmations and turning positive images into reality. It's the hard, painful looks in the mirror that have brought me progress as a trader. Maybe that's why I've always admired alcoholics who truly work their AA programs, conducting fearless moral inventories and making amends for their pasts. I also admire the soldier who stands steadfast before his commanding officer's critique and responds, "No excuse, Sir!", with resolve to rectify mistakes. I respect companies like Toyota that scrutinize every weakness of their production processes; bodybuilders that relentlessly focus on each muscle group for development; and NASCAR pit crews that meticulously film and review each stop, in hopes of shaving a mere fraction of a second from routine maintenance.

In times of peace, Nietzsche wrote, warlike individuals turn upon themselves. They create their own discomfort...and thereby generate the motivational thrust for new rounds of self-improvement.

They find their gains in pain.


mOOm said...

I also do my own taxes and fill the form by hand apart from Schedule D-1 which I print from Excel. All the calculations are done in Excel versions of the tax forms linked to my underlying data I collect. But I thought you were mainly trading futures and so don't need to enter transactions? Or are these just your stock trades?

Brett Steenbarger, Ph.D. said...

Hi Moom,

Alas, I'm doing the D1 by hand with all my ETF transactions. My trading has increasingly shifted toward ETFs to exploit sector strength and weakness, international themes, style box variations, etc. while still covering the major indices.


On the Road said...

Excellent discussion of dealing with the inner struggle to accept more and shun less. There is a difference between determination and persistence as persistence has the word and energy of resistance within. I am determined to make the changes necessary within me to improve my enjoyment of life.

I have always enjoyed your discussions of what needs improvement within me..thanks again!!!!


Brett Steenbarger, Ph.D. said...

Hi Paul,

Thanks for the note; great point. It's a real switch of mindset to embrace your failures as opportunities for learning and growth. Hard to imagine learning from experience by not facing shortcomings head on.


mOOm said...

PS -Yes this article was great.

mOOm said...

Oops. I was going to say I sent the link to my girlfriend to explain the process that traders have to go through.

MikeH said...

Thanks for the article. I enjoyed your book immensely, one of the best on performance irregardless of the topic that I'd recommend to anyone. And I appreciate your blog articles that expand further on those points with real world examples.

It's so easy to get caught up in a quest for the golden trading system/strategy. We forget that perhaps more important is our performance within that system or strategy.

Will Rahal said...

I love your work. Keep it up!
Have you done any work on the mentality of generations? Is our society obsessed with consumerism to the point where we make irrational decisions (level of debt) driven by pier pressure?
I presented market bottoms based on 25 year cycles( a generation?) on my blog.

Will Rahal said...

Correction: PEER not pier

Keith Shepard said...

That's an interesting way to do it (by hand that is). I must admit, that I flush everything through Qucken™ into TurboTax™ On-line. I do, however, review my trades on a monthly basis throughout the year.

By the way...both VNV Nation and Assemblage 23 have new albums out this month. I saw you quoting them some time ago. I love their work.

Cheers. =^.^=


Bri said...

"My trading has increasingly shifted toward ETFs to exploit sector strength and weakness, international themes, style box variations"

Have you written about that? Would certainly like to know more.

Thanks, Bri.

Brett Steenbarger, Ph.D. said...

Hi Mike H.,

You raise a great point; thanks. Many traders flit from trading approach to trading approach hoping to find the magic bullet. Trading is far more of a performance activity, requiring development of the performer.


Brett Steenbarger, Ph.D. said...

Hi Will,

It's an interesting question, but one I haven't researched. My hunch, FWIW, is that generational effects in equity markets are probably more due to demographics than to differences in "mentality". Generations seem equally clueless, assuming that things were always better when they were kids... :-)


Brett Steenbarger, Ph.D. said...

Hey Keith,

Any trader who loves A23 and VNV is OK by me. Thanks for the heads up re: their new work. Great, great music from beyond the mainstream. Do stay in touch--


Brett Steenbarger, Ph.D. said...

Hi Bri,

I have an earlier set of posts re: style box investing/trading; an advanced search in Technorati should pick it up. Basically I'm looking to exploit the strongest sectors in a market with bullish expectations and vice versa. I especially like the ability of ETFs to trade emerging/international markets, something I can't readily achieve with futures.


bwilhite said...

Great post!

I have to admit I wussed out as far as doing it (schedule D) by hand...I just wanted to get the stupid thing done. But I see how this can be a great review process, and maybe I'll incorporate it next year.

On the topic of disgust...Nietzsche is a very good mirror. He gets right to the heart of things much of the time. There's even a theologian that recommends reading Nietzsche for Lent. Not for 'disgust' per se, but for the purpose of personal reflection


Brett Steenbarger, Ph.D. said...

Hi BW,

Thanks for the note. Nietzsche's aphorisms are must reading, IMO. Thought-provoking and, at times, inspirational--


Ziad said...

Hi Dr. B,

Just wondering what ur winning percentage and win to loss ratio (how much your winners outstrip your losers) were for your last year of trading. Since my style is similar to yours, knowing these statistics would give me a good benchmark to aim for.

Brett Steenbarger, Ph.D. said...

Hi Ziad,

My overall win rate was a bit over 60% last year.