Wednesday, April 01, 2009

When Trading and Trading Losses Spiral Out of Control

A frustrated trader writes to me, "I was searching for something that would aid me in making decisions in trading the index on a 3-10 day swing basis, but I am failing again and again. I think I have failed more than 10 times and swore 10 times that I will not trade again. But I come again with new money and donate it. Can I stop it??? You are the only person who can help me in stock trading in real terms."

Every week, I receive emails similar to this one. Traders have lost money, are desperate for success, and seek my assistance. We hear many breathless stories, promoted by the industry, of those who have made it big or who seemingly effortlessly trade for a living. What we don't see is the tragic financial and human toll among the 80+% of people who do not succeed at trading. I give major credit to the trader who wrote to me, for the honest self-appraisal.

What advice can I offer the reader? Let's take the reader's words in turn:

* "I was searching for something..." - I wrote the trader performance book to better understand how traders progress from being novices to becoming expert. What I found is that much of trading expertise is the result of long hours in front of the screen, properly structured, internalizing patterns of market strength and weakness. The key to trading success lies in the cultivation of our own pattern recognition (and our ability to act on patterns); not on a search for external answers or grails. There are no gurus with answers.

* "Trading the index on a 3-10 day swing basis..." - The reader is competing against many hedge fund portfolio managers at that time frame. To succeed at that time frame, you have to be good at picking up catalysts for multiday price shifts (significant news items, shifts in central bank policy, etc.), and you have to be good at picking up intermarket themes (how interest rates and currencies affect stock markets; how markets overseas affect the U.S., etc.). If you don't have a handle on those patterns, your odds of success are vastly diminished, as markets will move without your understanding why.

* "I have failed more than 10 times and swore 10 times that I will not trade again. But I come again with new money and donate it. Can I stop it???" - This is not a problem with trading. It is a problem with addictive behavior. When people engage in activities that are designed to bring a "high", experience painful consequences, but cannot desist from the activity, that is the hallmark of an addictive pattern. Please evaluate yourself honestly and check out this trading addiction linkfest if you think this problem might affect you.

* "You are the only person who can help me." - This blog, the Twitter posts, and all my books will not be helpful if you don't possess self-control. Addictive patterns of behavior rob us of self-control. The one piece of advice I can give is to seek professional help from a psychologist experienced in working with addictive behaviors and then, if you're still interested in trading, build your learning curve in simulation mode before risking any further money. Only when you're consistently successful in simulated trading should you put your capital--and your emotions--at risk. Simulated trading is the not the same as live trading with real risk/reward, but if you can't make money on paper, you surely won't make it when the pressure is on.

If trading is your path, the learning curve should not be a tortured one. You need a certain degree of well-being to sustain the motivation and concentration needed to sustain your learning. Most of all, you need self-control to develop and follow trading strategies that build upon your pattern recognition. Before you work on the markets, it may be necessary to work on yourself and regain that self-control.


The Stock Speculator said...

This trader needs a set of loss rules. I guess he needs self control first, but loss rules would help.

Lose X amts of trades in a row, cut trade $ levels in 1/2.

Lose another X trades while on limited trading, cut trade $ levels in 1/2 again.

Lose another X trades, not trading for X days, weeks, etc

Cryptic said...

Is there a free resource where I can obtain TICK data?

Damien said...

This trader needs to buy Dr. Brett's new book "The Daily Trading Coach." Then, give it a once over during the weekend when markets are closed. If the amount of effort from the exercises in the book seems overwhelming or scary, trading is not for you. And that's OK! We're not all meant to be traders (which is much like being a pro poker player). Like all well paying careers, it seems sexy to outsiders, but it's less glamorous in the trenches.

The Energy Standard team said...

Good post!

I believe such traders could also benefit from some basic truths:

- If you lose and get anxious to jump back in to "take back" the profit, don't. Clear your head first.

- Don't find a model (3-10 day trading rule) and try to fit it to data. Read the data, and build a model around it.

- There is no substitute for independent thinking. If you're trading on somebody else's models/rules, what do you do when the market breaks the model? You freeze or panic, because you were just following orders and there were none.

This is a great blog, keep posting!

Mark Wolfinger said...

Excellent post.

Real-world situation that applies to many rookies.

S Benard said...

My best friend, who lives down the street, is a fellow trader. He has a successful (non-trading) business, but he dreams of dumping it to trade full-time. He has lost more than $250,000 in trading. He just keeps doing it again and again. He has tried numerous black boxes (tradebots), including about 6-8 in the past six months. All failed and lost money! The last automated system traded positive for one WEEK on a demo account, and I told him to follow it for at least 2 months. He didn't listen. He sent them some money, and while he was on vacation, it went negative and his lost his entire account.

(The company that offers this system called ME yesterday to try to sell it to me, and I told them 1) I don't believe in black boxes, and 2) I don't trade ANY system that I don't know exactly how it works. I didn't know it was the same company until my friend told me last night.)

He just keeps losing money, but he keeps throwing more and more money into it. Meanwhile, he hasn't a penny of retirement savings. He is even considering selling his business to put all his money into "the market".

I have tried to teach him how I trade, but he says that he doesn't "like" the way I trade. He wants to do it his way. I've looked at his trading method, and it's a lower. But he keeps doing the same thing again and again, despite the losing pattern.

He has two failed marriages, and he admits that at least one of his wives divorced him partly over the amount of money he has lost in "the market", as he calls it (he ignores that there are many markets). To him, its just THE market. He has even incurred debts -- about $10,000 over the past year -- to buy more trading systems or to attend seminars. Then, he took out a home equity loan to pay off the credit cards, after which he then charged them up again within a year.

After reading this blog post, Dr. Brett, I am beginning to wonder if my buddy is suffering from the addiction you've described. Now, I'm wondering what to say to him to help him to wake up. Unfortunately, while he's my best friend, he doesn't really listen to the warnings by me or his older brother. I have no idea how to help him.

This post has hit a raw nerve for me, because I've been his closest friend for the past year, and he just keeps right on trudging down the same path.

Is it possible that he just doesn't have the temperament for this business?

Nikesh Goyal said...
This comment has been removed by the author.
Curtis said...

Here is the best advice I have on swing trading:

* Do research over the weekend. This is when you will have time to process all information. Do not get overactive throughout the week.

* Read Bloomberg and read marketwatch. Both are invaluable. Don't read for the news though. Okay, here is a key secret. You have to weigh in your mind who are idiots and who are smart. Decide what will be contrary and what will be confirming.

* Learn to see momentum on candlesticks. Spend at least several months watching prices only. Prefer price to indicators. Do a few hundred hours of running studies though, sure.

* Read as much as possible including books noted and Gary's "How I trade for living book". You have to read this book about 4x to get it but once you get it then you'll find it is very powerful.

* Question everything.

* If you're right then you probably picked up on something relevant. Good, you should get a good move in your direction. Be fast and don't delay.

* Always use a stop. Stops are generally losing but they'll keep you in the game.

* Don't be afraid to exit a position and re-enter in the same position or sit out completely. Always make your trades with clear mind. Always when unclear exit and re-enter with clear mind even 2 or 3x.

* You blow up 10x you are not ready for leverage. Trade without leverage until you win consistently.

* Separate opinions from data driven analysis. Remember most pundits haven't looked to see what market is really doing. They are blind. Get a feel for those who are using market generated information versus those basing on opinions.

* Imagine a world class trader sitting over your shoulder. Are you doing what you're suppose to be doing or something stupid?

* Don't expect to win. Plan to lose.

rinse said...

to SBernard --
No offense,...but you are only "beginning to wonder"?
That is DEEEP addictive behavior.

rinse said...

Also, thank you for these stories as I need to be on high alert to my own addictive nature, and the possible consequences.

etoke said...

*****"Trading the index on a 3-10 day swing basis..." - The reader is competing against many hedge fund portfolio managers at that time frame.*****

I believe this touches on a very important subject. It appears that a lot of novice traders start their trading activities using this time frame, probably in search of a method which can use price targets and stops in order to 'automate' their trading while pursuing other activities, such as an existing job. This is possibly one of the hardest time frames to trade for the reasons you mention.

It has been often said that one is "not trading the market but trading other traders". Choosing your opponent must be given consideration.

Thank you once again for your insights and high quality content, Dr. Brett.

Zen said...

Overtrading and losing a decent chunk of money don't necessarily signal addictive behavior... sometimes these are just rookie mistakes that many of us have experienced.

Brett Steenbarger, Ph.D. said...

Hi Cryptic,

I'm not aware of any free sources for NYSE TICK; maybe readers know of some. I've never used free market data, so I'm not familiar with what's out there--


Brett Steenbarger, Ph.D. said...

Hi S Benard,

Yes, I think your friend needs to hear the message and is most likely to hear it if it's delivered in a caring way. Not all have the temperament for trading--


Brett Steenbarger, Ph.D. said...

Thanks, Curtis; great advice!