Tuesday, November 18, 2008

Stress and Performance in Trading

An excellent review of research by Mark Staal, conducted for NASA, offers fascinating windows on the variety of ways that stress can affect human performance. Examining hundreds of research studies, the author finds that stress interferes with attention, memory, decision making, and perceptual motor performance. His review questions the common notion that people perform better under moderate loads of stress than under very low or very high levels. Rather, in many spheres, there is an inverse linear relationship between experienced stress and performance.

The behavioral finance literature suggests that one reason stress might affect performance among traders is by skewing their assessments of risk and reward. Under pressure, traders may narrow their cognitive scope to only the information most salient to them (availability bias) or relevant to their expectations (confirmation bias); focus only on superficial qualities of observations (representativeness heuristic); or become more likely to take profits than losses (disposition effect). In other words, stress disrupts performance by altering normal, sound information processing.

In a unique study, Lo and Repin found that veteran traders are less likely to experience the physiological effects of stress in response to market events than novice traders. A reasonable interpretation of the results is that, through repeated experience, traders learn to psychologically normalize the stresses associated with the risks, rewards, and uncertainties of financial markets. Directed training, in which traders rehearse sound decision making under particularly stressful market conditions, could greatly accelerate a trader's learning curve. Indeed, this is a model of training central to the development of many professionals in performance fields, from military special forces to the surgical sub-specialties.

A major flaw of much trader education is that it is not applied under conditions of stress, and so cannot train the trader to perform flawlessly in the heat of battle.


Globetrader said...

That's why demo or simulated trading will not fully prepare you for real trading. Having your own money in a trade introduces stress you don't experience when the outcome of the trade will not affect you either way.

And if you trade real, you might have noticed higher stresslevels due to the high volatility in todays markets. That could be a sign, that your subcontious mind is telling you, that you need to scale down, that you actually feel uncomfortable with the risk you taking at the moment. Most likely its not your trading system which is no longer working. It's your money management system whose parameters have been violated and as we usually don't look at our money management system, you might have missed that fact. Stress is telling you, that the problem lies exactly there.
You might have noticed that your broker has increased margin rates. That's your brokers hint, that it might be prudent to scale down, to take some risks off the table.

It might also be a sign, that you should look for safer aka slower moving contracts. You might be a DAX or FTSE futures trader but unable to stomach 50 point swings, which still don't invalidate your trading signal, as they happen within one or two 10 minute bars.

Sure 50 points to the bank in the DAX is fine, but if it goes first 35 down then 50 up in your long position, you will experience a lot of stress unless you'r a real seasoned trader used to such swings.

You might decide to take a look at the ES, which nowadays moves with fairly big swings, where you can make nice money without risking that much on the individual trade. Or you go for the Eurostoxx or to Bonds to get calmer yet clearer movements. We are in a storm and to look for calmer waters is just prudent. Yes there are extraordinary profits to be made at the moment, but markets will be there tomorrow again. And your job is first and foremost the protection of your account to be able to trade tomorrow, not making extraordinary gains on trades which have the potential to wipe 50% or more of your account.

Firebird said...

I would say that demo/simulated trading can prepare you for real trading, provided that you visualize yourself trading with real money. If while you're trading you're thinking "oh, well, this is not real money" or are trading a 1,000,000 USD demo account trading 10 or 20 contracts at a time (when you have $10,000), yes, that will not be of much help.

However, if you trade a demo account of the same size as your (current or future) live account and make the effort to visualize it as your real account, if you imagine how it will feel to have 500 more or 500 less, etc. you get a really good preparation for real trading.

It also helps to drill different more psychologically demanding market conditions and/or techniques you normally wouldn't use. P.e. scalping if you're a day trader, day trading if you're a swing trader, using alternatively way tighter and larger stops, being in the market all the time and reversing instead of exiting, etc.

Best trading,


Brett Steenbarger, Ph.D. said...

Hi Globetrader,

Excellent point re: listening to one's stress as a way to attend to sound money management. Thanks--


Brett Steenbarger, Ph.D. said...

Hi Jorge,

Yes, I see simulated trading and live trading as part of a continuum of training. Simulated trading aids with pattern recognition; without success in simulation, it's foolhardy to risk capital in live trading. But once one is consistently successful in simulation, the transition to live trading is necessary to handle the real time pressures of risk and reward. Thanks--


SSK said...

Hello Globetrader, I just read your rejoinder on the other post days ago regarding grading. I agree with some of the points you make,and disagree with others. If you send me the comments that you posted as a rejoinder to me, to my site, at Daytradingfutures@tamta.net, I would post them, and write a rejoinder and link your site also.The link is titled "thoughts from fellow traders" I have another trading friend that offered insights on the same subject that soon I will rejoin. Again he offers many interesting points that I agree with, and some that I dont.

I do disagree with you on the article germane to this post. I think you may be framing the context of trading real money and the related stress in such within a personal context. I can tell you from experience, having traded 6 figure accounts in the the long bond in the past, and trading various commodities since 1997, I take my most recent work at TAMTA, which is all simulated much more serious than when I ever traded money. And believe me, the stress is just as evident, as I dont trade for the money, but rather the execution, and put it all out there live for everyone to see. Where I am now mentally (even in life in general) after applying the exercises the Dr.Brett offers, takes much stress of out the market, because you sublime your cognitive process. More control, more experience, more self awarness, better trading, less losses, more winners, less stress. Also since it is realtime, you are under pressure, if you have any desire to execute and apply the lessons the Dr. Brett recommends. I just simply dont agree with your statement, that "Having your own money in a trade introduces stress you don't experience when the outcome of the trade will not affect you either way." In my case, the outcome of every trade, (poor ones) introduces stress. That is one reason that I love what Dr. Brett offers. Exercises to reduce that stress, and refocus on trading execution, and the underlying cognitive reasons why a trader is or is not preforming. Also, as you mention, money managment protocols will limit stress with money at risk, as well as in simulation. Agian, the stress that I have encounterd in simulation is far greater, and has opened many more doors in my learning curve than at any time that i have traded real money, and that was over a period of many yrs. I would love to rejoin your other post if you could send it to me over the coming days. Thanks for your thoughts, Best, SSK

Krasimir said...


As back testing and forward testing (simulation) are stress reducers, they do not completely eliminate it in real trading environment. Stress is a pshychological response to a threat. A threat might be that one's not believing that they could be profitable in a long run (doubts in system performance or trading skills). Then it dosn't matter how much testing (back and forward) is done, it dosn't matter how small is trading (1contract, 1 share) - stress will be still present. That's why experienced traders, as Dr. Brett cites Lo and Replin's study, experience lower levels of stress. Simply, experienced traders lived thru many challenges (bid DDs, changed market conditions, system retirements, etc.) and have the inner conviction that they will survive. While novice traders haven't been thru this - they are not sure if they can cope with a big DD, or if market conditions change - and reasonably experience higher level of stress which impairs their decision making.