Saturday, February 14, 2009

Why Can't I Follow My Trading Plans?

An experienced trader writes to me:

I wondered if at some point you could re-address or provide links to
brief solutions for not staying committed to one's daily plan. Today
was an excellent example. After a breakeven morning with two decent
ideas which didn't pan out, I crunched some numbers which suggested
that the late afternoon, specifically the last hour, could be weak as
much as 1% down by the close and at worst maybe about .5% against me
(lower probability). I went short ES @ 829.50 around 2:45. The mkt
floundered around and by 3:53, I think, it's not going to happen today
and I don't feel like going home with a loss if the big boys try to
squeeze them at the end of day. So I cover with a 1/2 pt loss and
within 2 minutes the market begins to slide, cracking 10 pts by EOD.
Let's just assume the idea was randomly good or bad, I can still
estimate thousands (if not tens of thousands) of dollars in
opportunity cost over time, i.e. selling a winning trade @ 330 pm
instead of at the close per entry time plans for time and/or price.

All of us have experienced the frustration of bailing out of a trade prematurely, only to see it go our way. What makes it so difficult to stick with trade ideas and plans?

I'm going to use more than one post to address this question, because it lies at the heart of trading psychology. Indeed, it was my own experience as a trader--seeing that I was making all of the common mistakes that traders make, despite my background in psychology--that led me to write my first book in the area and examine the role of consciousness in decision-making.

The gist of what I described in the book was that, when psychological impediments to good trading occur, it is because the state of mind and body that we're in when we're executing or managing the trade is different from the state in which we formulated the trade idea.

From this perspective, all of the brief therapy techniques that I discuss in my subsequent books--cognitive, behavioral, dynamic, solution-focused methods--have the same purpose: to create consistency in our conscious awareness, so that we view markets through one, clear set of lenses throughout a trade.

What derails traders is that, at some point, we switch perceptual lenses and view the trade through the lens of profit/loss (P/L), not through the lens of probabilities, risks, and rewards.

That appears to be the case with the trader above. The key to his dilemma is that he had a breakeven morning, with two "decent" ideas that didn't pay him out. That set the stage for frustration. When he contemplates the third idea leaving him in the hole and says, "it's not going to happen today and I don't feel like going home with a loss", now he is P/L focused, not market focused. He is managing his feelings about the day's trade, not the trade he has on.

Performance anxiety occurs whenever our concerns over the outcome of a performance interfere with the process of performing. If our P/L focus exceeds our plan focus, we will tend to act impulsively to allay our P/L concerns, thereby violating trading rules and plans. Under conditions of frustration and anxiety, our perception becomes tunnel-visioned: we act to reduce our distress, rather than to maximize our opportunity.

Below are links that address this issue from different perspectives. In forthcoming posts, I will elaborate on solutions that aid in consistency of thought and action.