Thursday, August 02, 2007

The Trading Coach Project: Cementing Gains

The most recent post in this series found Trader C engaging in two steps to alter trading patterns that were holding him back. First, he began grading himself each day on three criteria: 1) his position sizing; 2) his use of stops; and 3) his use of profit targets. Second, he began daily use of a meditative exercise prior to trading in which he became calm and focused and vividly visualized the specific behaviors he'd need to engage in to receive an "A" grade on these criteria. Thus, for instance, he would visualize trades in which he'd size the position appropriate and exit when his stop was hit. Then he might visualize an entry at proper size and visualize the market going his way, taking profits when the target is hit.

The key to these two steps is repetition: developing new patterns of thought and behavior. By making visualizations highly vivid and by mentally rehearsing desired trading patterns, the trader creates a kind of practice outside of actual trading hours. Moreover, by combining the focused relaxation with the positive trading patterns, the trader becomes more able to access these patterns simply by taking some deep breaths and getting focused during the trading session.

Our timing couldn't have been better, as we began work on this just as the market volatility began to pick up significantly. For the most part, Trader C has been able to grade himself well on the three criteria, and this has corresponded to an upward move in his equity curve to fresh yearly highs. The exceptions occurred when he was particularly fatigued with an illness or distracted by family health concerns. I encouraged him to gauge his readiness to trade at the start of each session and size positions smaller if he was not feeling 100%. I have found this "taking your emotional temperature" to be a simple, but helpful step in avoiding unnecessary bad trading due to poor concentration. Just as an athlete should not start a game if he is injured, a trader should not be putting capital at risk if his focus isn't there.

Recall that Trader C trades both intraday and a longer-term set of themes in which he is long stocks from particular market segments. With the market's recent decline, his longer-term portfolio has taken a hit. Nonetheless, he resized those positions per his grading criteria and he also instituted a hedge with SPY to reduce exposure to overall market weakness. The combination of these two steps prevented him from undergoing a crippling drawdown.

Moreover, Trader C has used the enhanced volatility to trade well intraday and play the short side of the market. Indeed, as of our last conversation, his combined equity curve--intraday and longer-term portfolio--was actually up modestly during the market meltdown.

The takeaway is two-fold:

1) Consistent following of rules produces consistency of trading and that yields emotional consistency. Despite the enhanced market volatility, Trader C was able to trade well intraday and stay grounded in what he does best;

2) Having a combination of uncorrelated strategies is among the best of all risk management tools. By holding his longs, hedging them, and trading around them intraday, he has managed to stay profitable during market turbulence and has positioned his portfolio for the next rebound.

I was pleased to learn that Trader C was granted an interview at a major trading firm. He'll certainly have a number of positives to present; it's rare to see someone with both short-term trading skills and a knack for portfolio management. The formal part of our coaching project is over, but we will stay in touch and work on things as they arise. The goal is not for me to be Trader C's coach, but for him to get to the point of coaching himself well.

RELEVANT POSTS FROM THE TRADING COACH SERIES:

Changing Behavior Patterns

Beginning the Change Process

Creating a Focus for Change

Conducting an Assessment

When Performance Coaching Works
.

2 comments:

timothy_aldous said...

Brett,

This is useful as usual. I'm glad to hear you working with Trader C is bearing fruit. What types of traders do you see making money in this recent volatility? Scalpers, intraday swing traders, traders holding overnight? Just curious coz I read all over the place that people like volatility but then that this volatility is too wild and hard to trade. Maybe it would make for a good article.

Brett Steenbarger, Ph.D. said...

Hi Timothy,

I think you're right: traders have to be careful what they ask for. The enhanced volatility can be difficult to trade. Very short term traders at prop firms skilled at reading order flow can do well in this environment; at the other end of the spectrum are long/short traders who aren't so dependent upon market directionality and thus can weather the declines.

Brett