Wednesday, July 25, 2007

When Traders Lose Confidence - Part One: Gaining Perspective

One of the questions I first ask traders who are going through a drawdown is "Were you wrong, or were you trading poorly?" It's a key question. There will always be risk and uncertainty in markets. Even the best traders I've worked with at the top firms go through strings of losing trades and losing periods of time. A losing trade is not necessarily a bad trade. Sometimes the odds can be with us and we can lose the bet. Sometimes we're just wrong.

That is different from trading poorly. Trading poorly means that our process was incorrect, not just our idea. We sized the position too large; we ignored our stops; we overtraded a slow market.

The key, whether we're wrong or trading poorly, is to gain perspective by transforming downturns into opportunities. If you've been wrong, you may have an opportunity to reassess the market and revise your ideas. Many times wrong trades lead me to realize that the market is stronger or weaker than I realized, and that sets up some very good trades.

If you've been trading poorly, you have an opportunity to revisit periods in which you've traded well so that you can get back to basics and work on becoming more consistent with your strengths. This is where trading journals can be invaluable: they keep you in touch with what you do well and help you build on those strengths. It is at those drawdown times that you most need to be reminded of your strengths, so that you can return to those and draw confidence from them.

In the end, confidence comes from developing as a trader, not from being right all the time. Confidence is knowing that you'll lose, but also knowing that you can recover those losses. At the end of each trading day, I used to ask rookie traders to write down the one thing they did well that they wanted to continue and the one thing they did wrong that they would work to correct the next day. Imagine the cumulative impact of intently addressing just these two questions every day for a full year! The net result is a building of confidence, a deep knowing that you can expand your strengths and correct your shortcomings.

Confidence comes from mastery--and especially self-mastery. That is why I love trading: it's an intensive vehicle for self-mastery.


bzbtrader said...

Dr. Brett,
Another great,timely post. The tendency for many traders is to go into shock and freeze on the trigger after days like Tuesday if not positioned correctly. The trick is to shake it off, evaluate what went wrong, adapt the trading plan as required and then get back in the game. This relates back to your previous entrepreneur post. Trading is a business .. a serious business. If you mess up its going to cost real money. If your business as failing you'd better figure out how to fix it .. or go out of business. Girding ones' loins and jumping back into the fray after a bruising requires a special set of mental skills however, and I look forward to your future posts on this topic.

AlvaroF said...

Great post, Brett. Traders have the opportunity to learn faster than other proffesionals given the amount of data available to them and the quick feedback cycles.

Not easy, but doable.

Brett Steenbarger, Ph.D. said...

Hi BZB Trader,

Great points; thanks for the comment. One way I shake off losses is by sizing my positions smaller during periods of high volatility. In other words, I adjust size so that each trade represents a relatively constant risk. That very much helps ensure that a series of losses don't create an abnormal drawdown.


Brett Steenbarger, Ph.D. said...

Hi Alvaro,

That is especially true of short-term traders who make use of simulation. It really accelerates the learning curve.


Deborah said...

Great post.

One thing I'd like to add is that if you are unsure there is nothing wrong with stepping back and just watching the market for a while.