Thursday, November 15, 2007

Scripts and Authenticity: Why We Make Bad Trades

I decided to lie down for a few minutes in the airline lounge at Heathrow prior to my flight back to Chicago. A couple took the couch behind me and began talking louder than I would have liked. The gist of the conversation was that the husband needed something from an airport store, the wife got it for him, but he was not happy with her selection. His tone was whiny, complaining, and not a little irritating. Her tone was clearly frustrated and curt.

A few moments passed and neither of them talked. Spontaneously, he resumed his complaint. As he went on, she became more hostile and the tiff picked up where it had left off. The whole affair sounded quite scripted: he had his role (nothing is good enough) and she had hers (it’s fine and if you don’t like it, go get yourself something else). The more he whined, the more she viewed him as unappreciative and responded with resentment. The more she addressed him in a tone of dismissal and contempt, the more he felt she was not listening to him. It seemed so well rehearsed that I easily could have believed that they had memorized their lines.

As I walked away—rest was clearly not going to happen in that section of the lounge—the thought struck me that the most important part of their interaction was the silence between their episodes of bickering. They had nothing positive to talk about. In the absence of any authentic conversation, they resorted to this scripted interaction. Perhaps any communication felt better than none.

Authentic communication is not scripted. It emerges spontaneously, based upon fresh perceptions, thoughts, and feelings. When a basis for authenticity is missing—when there is nothing fresh to bond the parties in interaction—the only alternatives are silence and the inauthentic. Interestingly, most of us choose to avoid silence. Keep kids inside on a rainy day, and they’ll cart out the old scripts: haggling with each other, trotting out old complaints. Anything is better than boredom.

There’s a scripted quality to much bad trading. One of the curious statements I hear from traders is that they often know they are making a bad trade as they are doing it. That’s a sign at some level that they are aware of an underlying script. Just like the couple’s argument, the trader is well practiced at the scenario of miss a move, get frustrated, and chase a trade. It’s happened so often that it seems staged.

The trader feels as though he’s sabotaging himself, and perhaps the couple feels the same way. The reality, however, is that they are probably taking the better of two unpleasant alternatives. It may feel better to make a bad trade than to not trade at all. In the absence of an authentic framework for decision-making, perhaps all that’s left to market participants are scripted behaviors.

It’s not the bad trade that’s the problem for the trader, just as it’s not the argument that’s the problem for my couple. Both behaviors are responses to the real problem: the absence of any authentic basis for constructive engagement. Without clearly defined and validated ideas, what is there to trade except for our emotional scripts?


Enacting Your Ideals


d said...

dont have your email but wanted to say. This has got to be the best trading/investing blog ive ever seen. TONS of valuable info.

thank you

procol said...

Excellent and insightful post.

Overcoming this kind of 'scripted' behavior is a lot harder then simply recognizing it.

It that apparent setup part of a bad 'script' or is it legit? While you're trying to figure it out, the trade passes you by.

Still, better to know your demons than be at their mercy.

Globetrader said...

Actually the script runs:
Hey Chris....This market is moving so much and you are not able to place one single trade.
Staring at the computer for hours without doing something...
It can't be so difficult to decide what to do...
Don't you realize you are down xxx$ today, without placing a trade you can't make it back
or (if in the green)
Reaching the daily target is fine, but you can't let this opportunity pass, do something...
Let's wait until the frenzy stalls, then enter with momentum
You idiot bought the top
Didn't you realize that CL is up 120 ticks in this run-up?
How can someone be so stupid to go long after the market is up 120 ticks in the last 30 minutes
But now I'm down 25 already, all daily profits gone in 1 minute
I can't cover that trade, it's too expensive....
Great now CL is down 40 ticks, I'm out or it gets really ugly
THAT'S NOT TRUE...CL is back up and trading 40 ticks above my original entry without me...
(as a variation of this script)
I might decide to reverse Short after CL cost me 40 ticks on the long side only to see it rally back up and thereby giving me the Double Punch by stopping me on the long and short side.

I've recently started to train/monitor myself to recognise this boredom. Meaning if I have not placed a trade for hours I question the reasoning more thoroughly before placing the trade.
Still, I have to admit, that it's difficult to overcome these impulses at certain times.

Ziad said...

It's incredible how it seems that every time I'm going through an issue in my trading you write a post about it. But I guess with so much productivity and output you're always hitting on some important issue for traders.

Globetrader put it right when he said that his script was "This market is moving so much and you are not able to place one single trade." Totally discretionary traders that trade largely through feel for price action and momentum probably face this issue quite a bit. The reason, I think, is that even though they may have a demonstratable edge seen through extensive record keeping, their edge comes from their skill and not from exactly defined and quantifiable set-ups. As such, at any given time when there is good volatility, their ego is put on the line and they think: "how can I use my skill to get in on this move? I can feel the directional bias strongly, I should be able to exploit it if I am skillful. Other discretionary traders surely can't be sitting on the sidelines and doing nothing throughout all of this movement. All this volatility and no opportunity to exploit? No way it's gotta be a lack of skill in identifying it."

I certainly go through all of these thoughts when the market moves with good volatility and momentum. Because my edge (seen in my exhaustive record keeping) doesn't come from exactly defined set-ups, my skill and therefore self-concept as a trader gets put on the line. System or rule-governed traders know they have to wait for their set-up, so it's relatively easy to sit on the sidelines. But discretionary traders get their set-ups from real-time reading of market flow, and it seems that they have to hold themselves accountable for identifying them when there's good movement.

Now the reality is that if you are a discretionary trader and you do have an edge, then you are clearly good at identifying when there is real opportunity and when it's just meaningless volatility (or else you really wouldn't have an edge). Personally, I can tell when something is a good opportunity as opposed to just volatility by the internal feeling I get. If it's a real opportunity it's usually a feeling of confidence and a sense of "this trade will be a winner and I really want it". When it's just a lot of volatility however, the feeling is subtly different. It's "I really want to enter, but I just don't know about this trade." The key is the difference between why I want to enter. In the former it's because I feel confident, in the latter it's because I feel uncomfortable just sitting there.

So I guess it's really an issue of ego and self-worth as a trader as determined by perceived trading skill. Luckily for me, even though I feel uncomfortable just sitting there, I usually can restrain myself from entering based on that nagging feeling. But it's still a very difficult thing to do. Why? Because as a discretionary trader, how do you know the true limits or potential of your skill? As you sit there and do nothing, you naturally have to wonder, what if I SHOULD be able to find opportunity in this movement? What if my true skill potential is much greater than I am allowing to be because I sit on the sidelines for so much of the time? What if attempting to trade more environments will expand my skill set?

And so it becomes a dilemma. How do you stand aside when you don't see opportunity, while at the same time you have a nagging feeling that maybe you should be seeing opportunity if your skill level was where it could be. Do you accept the fact that a lot of times you just won't know what's going on and you have to sit with that discomfort to be a great trader, or do you use that discomfort as a sign that you could be expanding your skills to be able to trade much more of the action? Those are questions I'd love an answer to...

SMW said...

Enjoyed the comments Globetrader / Ziad.

Ziad, I'm not suitable to provide any of those answers, but something I do:

I'm quite a discretionary trader myself. I know exactly that feeling you described with seeing volatile markets, and the feeling of 'lost opportunity'.

What I now do, is on the weekend, I will trade past market data like I am a 'trading god' - I'll jump on every single possible opporunity, try and catch every single move. I'll 'indulge' my over-trading ego.

Why am I doing this - aren't I just 'reinforcing bad habits'?

I like to think of trading sometimes like dieting - throughout the week, I'm 100% strict on the diet. I take solid, nutritious trades only. No trading snacks or "just one bites" of tasty volatile moves.

Come the weekend - it's all you can eat pizza and ice cream. I'll indulge all those cravings I had during the week. For those of us who have dieted before, it's almost certain that afterwards, you feel sick from all the food and regret ever 'binging out'.

What normally happens is I finish the practice trading day DOWN. No surprise, but SMW is not the trading god his ego might try and convince him of.

What's the advantage of this? Come Monday, let's imagine it's volatile again.

Let's say I've taken 2 good, normal trades.

Then let's say I get that 'craving' to trade and snatch some of that volatility, BUT now my brain says: "Hang on, didn't we just do that ALL weekend, and you net LOST every time? Why do we want to do this again?"

For all the 'questioning moments' – the 'what if I traded XX way in XX market' during the trading week, I attempt to answer those on the weekend. I spend as much time as I need to GET those answers. Often , it's about associating 'pain' to that craving of overtrading for me. Those hours spent on the weekend PROVE to me that if I traded all the 'new' ideas I had, I'd go broke in record time. I've done this that many times now that I really DON'T want to take those 'impulse' trades.


Brett Steenbarger, Ph.D. said...

Thanks for excellent and insightful comments re: scripts. I especially appreciate the insights re: the "craving" to trade. It's a topic that I think is very important, particularly for the more discretionary trader--