Saturday, April 05, 2008

Cross-Talk: Why Trading Is So Difficult

Trader's Narrative recently posted an excellent piece on "Why Is Trading So Difficult?" The gist of the post is that, while trading is simple on the surface--it amounts to either buying or selling--it is psychologically difficult, because it requires the ability to meld patience and the tolerance of boredom with the ability to act swiftly and decisively during periods of "adrenaline induced action". I hereby dub this the "fireman's view of trading", as it portrays the trader like the firefighter in the station, sitting around for long periods of time playing cards and washing the trucks, and then suddenly responding to five-alarm events.

There is truth in this portrayal, of course. Trading does require the ability to restrain oneself from acting, just as it requires action in the face of risk and reward. Babak's point that traders need to be both serene and patient as well as decisive--able to analyze as well as act--is well taken. It is possible to be both overly analytical and indecisive or overly impulsive and out of control.

Yet, there are myths embedded in the "trading is simple, but psychologically difficult" formulation.

The idea that trading is easy--that it consists of either buying up markets, selling down ones, or playing for countertrend bounces--is a bit like saying that surgery amounts to either reshaping things, pulling them out, or replacing them. Any skill can be simplified via surface description, and it is precisely such surface description (and the ease of opening an account and trading, as Babak notes) that lures the unwary and unprepared into trading.

Of course, the entire idea that trading is about profiting from directional movement is a gross simplification shared by many traders. Take the example of an energy trader who notices that markets are deviating from historical norms and puts on a complex position of futures and swaps to capture a reversion to those norms. Such a "relative value" trade is anything but simple, as it requires accurate modeling of current markets vis a vis those historical norms. Much stock trading, in fact, is not directional, but rather an attempt to capture abnormal deviations between pairs of stocks or between markets.

It is the very simplification that trading is all about catching directional moves that helps make trading so difficult. The directional trader enters a very crowded space in which market inefficiencies are ruthlessly arbed away. It's when the trader examines more complex relationships--let's say the relationship between fixed income and currency movements and valuations among housing futures--that unexploited patterns are more likely to appear. Perhaps New York real estate will perform better than, say, Chicago properties if reduced interest rates and a falling dollar bring more overseas buying.

This idea that opportunity is to be found among more complex market relationships also changes the trading game psychologically. It is relatively difficult to find a hedge fund portfolio manager who would subscribe to the fireman's view of trading. The reason for this is that the time spent between placing trades is anything but boring. This is the time when you figure out those market relationships, developing/updating your models, assessing deviations from those, and constructing proper hedges following relative value movements. In fact, the actual act of trading is so diminished in importance at many institutions that portfolio managers don't even place trades. Rather, they call in the orders to execution desks, so that they are freed to continue their "real" work: figuring out market themes.

What makes trading difficult is the fact that, for many traders, the time between trades is dead time. Such inactivity--mentally--is what creates the boredom. Locked into a simplistic view of trading, traders perceive nothing to do when markets are providing setups for trades. They don't see their job as figuring out markets--in fact, the entire concept of "figuring out" may be discarded as overanalysis. Instead, they wait for trades like firemen wait for alarms to sound. But where the fireman engages in decisive physical action in the face of adrenaline pumping, the trader has no such outlets. Adrenaline pumping itself becomes a factor that interferes with sound decision-making and trading performance.

So what makes trading difficult is a fundamental misunderstanding of trading. Once a trader views placing trades as a simple matter of anticipating direction and the goal of trading as placing trades, he or she is locked into a perspective in which the goal is action and the challenge is the boredom of inaction. This brings trading perilously close to gambling. It is also not how the best bank traders and portfolio managers operate. Their more elaborated views of markets and trades means that the time between trades is when the real work is done; such time is intrinsically interesting and rewarding.

Consider an analogy: relationships would be difficult if we viewed sexual relations as the overarching goal and purpose. Everything else--the time between escapades in bed, from conversing to sharing experiences--would be boring and difficult to tolerate. To someone who viewed relationships in terms of intimacy, however, those times outside the bedroom would be the heart and soul of encountering the other person--what makes the physical relations *meaningful*.

Trading is not difficult because it blends action and inaction. It is difficult when we view trading through the lenses of firemen, creating both adrenaline spikes and boring interludes.


Three Market Idiots


Bryan said...

Great stuff. Thanks Doc.

Jeff said...

Dr. Steenbarger, excellent post! This is something I've been mulling over for about a year now. I am primarily what I would consider an active intraday trader, but my desire is to take a step back and trade longer term. However, I have found this a LOT easier to think about and consider than it is to do! I am wondering if you've ever come across any research specifically on traders who switched trading styles/timeframes and whether or not they tend to me more/less successful going to higher/lower timeframes.

I feel this "fireman's view" is what I have and has made becoming a position trader nearly impossible!

CharlesTrader said...

"The reason for this is that the time spent between placing trades is anything but boring. This is the time when you figure out those market relationships"

As I continue to develop myself into a market trader, I am realizing that there is no such thing as "dead time" in daily market activity.

In the first hour of trading yesterday, for example, I did not place a trade, but I did watch every tick being placed as the market trended downward following the reaction to the Employment Situation Report. I hesitated to place a short position because I sensed that the market was being sluggish in its downward movement. It just did not "feel" right.

At 1038 ET, the ES futures made a new lower low, but the NYSE Advance - Decline and $TICK indicators made higher lows. Soon after, the ES futures started a nice up swing wave that lasted for 3 hours and 19 ES points. If I had spent that first hour being bored, I would not have developed the "feel" for the market's desire to trade upward.

If I am not mentally drained by the end of the day, I know that I did not do my job of focusing on the market's activity. By developing that focus, I am slowly developing a "feel" for what the market is wanting to do from minute to minute.


Ziad said...

I don't know about the conclusion of this article Dr. Brett. It seems that you are saying that the directional view of trading is oversimplified and that real trading is all about arbitrage and complex pairs trading. To me however, what you are describing is merely one style among many. Sure many fund managers and professional traders take a global macro slant to their trading, but does that mean this is the only right way to go?

What about personal strengths and interests? what if a trader's strengths and interests lie neither in fundamental nor statistical research? What if this research time between trades is neither intrinsically rewarding nor interesting to a particular trader. What if what provides the motivational high to the trader is as CharlesTrader said the activity of continually watching the market play out, and assessing all of the different possibilities, which then provide a directional trade idea (and indeed this directional idea may be a result of much intermarket relationship analysis among other things)?

Given this, I don't think the correct conclusion is to imply that traders have to think about putting on pair trades and look for mean reversion, or that they have to take a longer-term view thus focusing mostly on research and relegating actual trade placement to a secondary activity. This may be the best fit for some, but it is not for many, and I don't think that means that those who do not find that it fits them are taking an incorrect view on trading.

To me, the fireman's view is a partial reason why SOME styles of trading are difficult, with the only oversimplification being to say that is the MAIN or only reason it is difficult. In reality it is difficult because so many mental as well as technical skills are needed even to come up with a deceivingly simple directional trade idea with a true edge. It is not that a directional view itself is simplifying things, it is all about what traders think is involved in coming to a directional view. If they think it is all about waiting in boredom until a predefined mindless set-up arises, then yes it is being oversimplified. If, however, they think that it is all about intense focus and constant assessment of a hundred different variables which are constantly changing their rules of engagement, and thus forcing the trader into alternating periods of patience and periods of needed aggressiveness, then I think they have a correct view.

Brett Steenbarger, Ph.D. said...


Thanks for the comments on this post; I'll be following up with a second post on the theme shortly. That second post will underscore an important point that Charles is making: that being mentally active between trades is key to avoiding the swings of adrenaline and boredom.

Of course, Ziad, I'm not saying that pairs trading, arbitrage, etc are "real" trading and that directional trade is simple. Even casual readers of my blog know that I trade directionally myself. No, the view that trading is a matter of finding direction is the simplification. There is much more to trading than directional trade.

The advantage of some of the types of trading conducted at hedge funds is that they require active engagement and problem solving between trades. Certain kinds of intraday trading can provide the same engagement, as Charles illustrates. But many, many daytraders are not actively engaged in figuring out markets and market patterns; they are on the prowl for the next trade. If they're not trading, they're bored. And that's a recipe for overtrading.


Ziad said...

Thanks for the comment Dr. Brett. Of course I am an avid reader of your blog and know that you trade directionally. It's just the way the post was written, I was afraid that any novice trader that may read it may incorrectly conclude that they need to be totally focused on statistical research and broaden their time frame. It just seemed that this type of analysis was being put in a more favorable light, and that the type of thinking that Charles highlighted was not mentioned at all. I guess my main objective from the comment was not to argue with your view but to highlight the fact that arriving at certain conclusions that seemed possible from it would be erroneous. I apologize if it came off as being wrongly critical as I greatly respect your views and what you do for all of us traders.

Brett Steenbarger, Ph.D. said...

Hi Ziad,

Thanks as always for your comments. You're absolutely right; it's not that traders need to be absorbed in statistical research; it's that they need to be absorbed in the process of understanding markets. That's the piece missing among those "fireman" traders.


LiggerPig said...

The only time I ever found trading easy was when I first started out!
And, of course, those profits soon went and, in time, so did the rest of my account.

What makes trading so difficult? In 7+ years of trading I've learnt the hard way and the fireman analogy doesn't answer the question. Along the learning curve I've had to ask myself if I wasn't mentally setting out to lose?, Was I seeking recognition, praise, or cash in the bank? Was my perception of market behaviour tainted by my engineering background?

Then there's exploring the world of trading methods, strategies and money management that I needed to find to suit my personality, lifestyle and mental aversion to losing.

Once I was able to consistently break even the fireman scenario was a phase which was to come
back regularly to this day but I have still had to overcome problems with anger, frustration,
lack of confidence, over-confidence, etc.
Hard work and study, going back to re-answer the same questions, returning to look at other methods and strategies then honing what little skill I have into swing trading was far from easy.

Eventually I got to the stage where I spent most waking hours, when not working, trying to learn a few markets,each with their own individual characteristics I felt I could exploit. But, that too, proved difficult for me.

My home life then changed and gave me a new desire to be at home more but brought it's set own set of
difficulties into the mix.
Circumstances forced me to concentrate my efforts in one market (ES) but I found help from other traders that led me to trying to understand why the market moved the way it did. If they were able to anticipate rather than react to moves, then so could I? But, is it that easy?

Giving up a full-time job, relying on swing trading to pay my mortgage and living expenses added pressure which became another obstacle.

More recently, the difficulty has been to change to intra-day trading. This has meant re-learning strategy, intra-day moves, risk, and most importantly, more about myself.

After all this time, I'm only averaging a few ES points profit per day and have difficulty getting away from my swing trading ideas. Just trying to be consistent is not easy. This week I was well ahead of my weekly goal, became over-confident, then the market quickly brought me back down to earth and put me back in my place!

So, in my opinion, the fireman analogy is not at the core of why trading is so difficult.

mOOm said...

A few ES points can be a reasonable wage (as long is it doesn't disappear again in large but rare losses in "blow-ups). Though I guess this depends on how much you might earn in an alternative occupation.

Ryan said...


Great article, I love your "fireman's view of trading" analogy! I believe trading is one of the most difficult endeavours one could take on primarily because where not trading the markets but our own psychology. Where experiencing a mirror effect of our awareness, beliefs, experiences, and habits. I believe successful trading has to begin with the mindset and then backed up with the right strategies and tactics. Even though I continue to do daily neural reconditioning to “retrain” my brain, I still question my strategies and tactics daily and correct my system where needed.


Bill Moore said...

I'm glad i came across your website. This series on trading emotions is invaluable. If I had any suggestion, it would off the topic and one about website usability: consider changing your blogger template and lose the green colors, they make it hard to read your great articles.

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