Saturday, April 19, 2008

A Few Trading Psychology Observations

* From working with developing traders, I'd say that 90% don't/can't sustain the process of keeping a substantive journal. Among the group that does journal, well over 90% of the entries are about themselves and their P/L. I almost never see journal entries devoted to figuring out markets.

* A sizable proportion of traders who have been having problems are trading methods and patterns that used to work, but are no longer operative. The inability to change with changing markets affects traders intraday (when volume/volatility/trend patterns shift) and over longer time frames (when intermarket patterns shift).

* It's a common observation that traders fail because they don't stick to their plans. My experience is different. Traders develop plans and trade patterns that simply don't work; they're based on randomness. When the patterns don't work, traders become frustrated and abandon their plans. So it looks like lack of discipline causes trading failure. But planning doesn't create success; sound planning does. Sticking to plans based on randomness is no virtue.

* I mentioned in my book an important law of performance: In every performance field of note--from Olympic athletics to Broadway--performers spend more time in practice than in formal performance. That is how expertise develops. The ratio of "practice" time (time spent on markets outside of trading) to trading time is a worthwhile indicator of a trader's prospective success.

* Among the predictors of trading success, a "passion for trading" is grossly overrated. The successful traders have a passion for markets, which is very different from a passion for trading. Indeed, a passion for trading in the absence of passion for markets is a fair definition of addiction.

* Some traders habitually look for tops in a rising market and bottoms in a falling one. There's much to be said for countertrend methods, but not when the need to be right exceeds the need to make money.

* An underrated element in trading success is mental flexibility: the ability to shift views and perceptions as new data enter the marketplace. It takes a certain lack of ego to form a strong view and then modify it in the face of new evidence.

* A trader I spoke with recently told me he was going to trade more aggressively by putting on more trades. Trading more frequently is not necessarily trading more aggressively, and it certainly isn't necessarily trading prudently. Trading more aggressively means allocating more risk capital to particular (sound) trade ideas. A considerable portion of traders would benefit from trading less frequently *and* more aggressively.

* Nice litmus test for any website devoted to trading education, coaching, and the like: If the site spends more time promoting the person than promoting ideas, you have a good sense for the site's priorities. Caveat emptor.

* Many traders fail because they're focused on what the market *should* be doing, rather than on what it *is* doing. The stock market leads, not follows, economic fundamentals. Some of the best investment opportunities occur when markets are looking past news, positive or negative.

* Success in trading requires the capacity for personal investment. Too many traders close out their efforts, along with their positions, at the end of the day.


What Trading Teaches Us About Life

Three Steps Toward Trading Improvement


Matt said...

Good post and has a lot of truth in it! Especially items 1, 3, 6, and 10 are very interesting and also paradox observations. A reasonable approach to trading would never allow someone to pick tops and bottoms and act against the dominant market theme. Trading can only be done successfully with an objective view on the markets.

CharlesTrader said...

Something that I still fall prey to is failing to take a small loss when the market turns against me, even though I know from experience that a small loss can be made up quickly in the next trade. I should know better, but I still sit on a loss too long from time to time.

However, when this does happen, it is like a knock on the head that helps me regain my discipline.

"The stock market leads, not follows, economic fundamentals."

Commentators on TV get this wrong also. Economic reports are past news. The market trades on expectations of future fundamentals.


Keith Shepard said...

Admittedly, I can't keep a trading journal.

I've tried a number of times. I'm not sure if I'll try again or if it would end the same. I know a journal is valuable and successful traders keep trading journals, but I can't seem to "get into the swing".

I suppose, much like working out to lose weight, it takes a certain number of days to become habit. Habit to the point of where if you don't journal, you feel like something is missing from your life.

Then again, I've never been good at transposing my thoughts from my head through my fingers and into words, so maybe journaling is my natural enemy.

Not sure.


Dr. Duru said...

I think one of the hardest of all these for me is the edict that "markets lead the economic fundamentals." For example, for most of last year, the market chose to ignore all the warning signs of the looming credit crunch by rallying sharply off lows and subsequently punching through to multi-year highs. That was a time to pick an argument with Mr. Market! So, after 2007's experience, do we believe that this next bounce is the charm, and the market is finally getting it right? Or do you form your own opinion on the true health of the economy and the height of the "wall of worry" the market can climb. Answering either question seems fraught with danger at this juncture, so I choose to stay locked onto the very short term technical signals.

Oldedit said...

Each point deserves personalization by each reader. What does this mean for me?

Substantive journal: I bought xyz because fundamentals and technicals were strong. PnF obj was y and I'll sell if stock falls 7%. Take profits at + 25%, 50%, etc. My blog is my journal.

Market conditions require that I trade small positions because increased volatility boosts risks as well as oportunities. I've got to take profits faster and definitely not buy and hold in this market.

Practice is not only picking, buying and selling, but also analyzing, waiting, watching.

I've been passionate about markets for 40 years; I trade relatively infrequently. Swing trader who holds some positions for long-term gains. I take small losses quickly.

Look for evidence of major bear or bull markets and trade accordingly. Picking absolute tops, bottoms won't work for me.

Mental agility. I read charts, commentators and wait awhile before deciding what the overall market is doing. On stocks and options, it's the technicals and news. When a company misses

Trading aggressiveness. How many stocks, options, futures, can one person track and trade at a time profitably? I'm most comfortable with fewer than 10. Then the question becomes, how large is your position in each trade? Do you go into each trade full bore or work your way in as the trade succeeds? I'm talking swing trading, position trading, not day trading. It's not about just dollars, it's also about percentages of your trading equity.

My blog is about stocks and issues, not me. So I guess I pass this one.

It's important to focus on where the market is going, not where it should be going. If it's not going where you think it should be, trade as a contrarian and see how good your should is. One way to trade with a market is to buy bull markets and stay out of bearish ones if you're uncomfortable shorting stocks, buying puts, etc.

Do traders end their investment when they close their positions at the end of the day or whenever? Yes, they can sleep without worrying about their positions overnight, but they also sleep invested in cash, which also is a position, isn't it?

I'm going to link to this post and post these comments on my blog so I can refer back to them.

LiggerPig said...

"I almost never see journal entries devoted to figuring out markets."

Outside of your excellent work, I've read very little on what I should write in my journal. Some of the books from the world's best traders contain little more than cursory hints. I'm left wondering, what were these great traders thinking as they held positions against the market, for instance?

In the case of traders using systems I imagine they concentrate on their entries, exits, stops and how they managed the positions?
For the rest of us, I would like to think journal notes are going to help us repeat winning behaviour or find ways to improve our steps to success.

When you look at many of the stock trading blogs, I agree, you will see a lot of references to p/l and comments, often negative, about a trader's overall day. Read more from the same traders and you see that they're repeating the same comments that were written a month earlier, only now they're choosing to reduce the size of their trades.

One of the things I found helped me was not to look at profit and loss, particularly when I was in a winning trade. To this day I jump out of winning positions all too easily, but at least I can look at my journal and find out why.
My trading improved the day I began to think in terms of ES points, and not p/l.
I find I write too much, to the point I was updating my notes to the detriment of my positions LOL.

It would be great to read journal entries from a pro-trader devoted to figuring out markets.

Bill aka NO DooDahs! said...

Brett, a "blogging cross-talk" response.

John Forman said...

Here's another cross-talk of sorts:

The Secrets of Trading Success

Brett Steenbarger, Ph.D. said...

Thanks for the excellent perspectives on the post--


Derry Brown said...

Hi Brett, Nice post, well done.

"So it looks like lack of discipline causes trading failure. But planning doesn't create success; sound planning does. Sticking to plans based on randomness is no virtue."This is very true and I think that through keeping statistics and/or back testing a system one can know what to expect when the law of averages is allowed to play out. If the results deviate widely from these historical statistics then that is a good indication the system is now unsuitable in the current market or is (as you say) just based on randomness.

"It takes a certain lack of ego to form a strong view and then modify it in the face of new evidence."Very well said, there is no room for ego in the market! She takes particular delight in humbling all who enter her domain thinking they are clever and any punishment is usually in direct proportion to the size of ones ego. By resisting fear and greed, having NO ego, absolute certainty and infinite patience one can remain detached from the outcomeThanks for sharing!

P.S - Here are a series of articles I wrote about trading psychology and how it shapes the market:

Part 1 - Trading Psychology
Part 2 - Trading Psychology - Herd Mentality
Part 3 - Trading Psychology - Group Intelligence