Thursday, October 01, 2009

A Cognitive Strategy for Overcoming Frustration in Trading

My recent post emphasized the importance of overcoming frustration in trading. In this post, we'll take a look at a cognitive approach to dealing with frustration and its effects on trading.

Cognitive theory suggests that we do not respond to events themselves, but rather to our thinking about those events. If I get a "C" on a test after not having time to study, I might feel very good, knowing that I passed. A different person taking the same test might feel depressed with the same grade, crushed that they did not finish at the top of the class. How we process the event affects how we respond to it.

Similarly, when traders are overcome with frustration, cognitive theory suggests that it is not their losses, but their thinking about their losses that generates their stubbornness, self-criticism, and overtrading.

Specifically, traders need to process losses as self-esteem events if they are going to generate strong emotional responses. (Note: lost opportunity can be as threatening for a trader as realized losses). The frustrated trader, at some level, feels that losing is a sign of weakness or incompetence: that taking a loss makes one a loser.

It is the desire to avoid feeling like a loser that typically gets the frustrated trader holding onto losing positions and overtrading to make money back. Ironically, those very reactions make it more likely that the trader will experience catastrophic financial losses.

A cognitive approach to overcoming frustration would be to rehearse ways of thinking that make losses non-threatening. This is why, in the coaching book, I stress the idea of actively embracing losses and learning from them. When we take a loss, it means that either we did not execute our idea well or that our idea was wrong. Either can be an opportunity to learn.

If our self-esteem comes from learning, growing, and developing--not from being perfect or being the best--then we do not need to fear our shortcomings. They fuel efforts at self-improvement.

A daily program to transform yesterday's losses into today's goals achieves an important psychological alchemy: we take what has been threatening and frustrating and turn it into a potential source of pride.


carlos said...

"When we take a loss, it means that either we did not execute our idea well or that our idea was wrong."

Brett, I'm a strong believer in what you do and teach, and I own your latest book. But I must disagree with the above quote. Particularly for system traders (but for others as well), taking a loss is part of the process. No one (that I'm aware of) has a system that produces 100% winners. Losses are part and parcel of trading, and need to be embraced and accepted. As another of my favorite authors, Van Tharp, says: "At the end of the trading day, ask yourself a simple question: did I make any mistakes? If the answer is no, pat yourself on the back. If the answer is no and you lost money, pat yourself on the back twice. Good job; you followed your rules."

I believe trading without losses is impossible, and striving to achieve that is just setting yourself up for a lot of frustration.

jamesk said...

Brett, I would have to strongly echo Carlos's comment. In many approaches conservative, disciplined trader goes into the trade already accepting the loss. It's the ante that is made in conjunction with a careful consideration of the trade. The conservative trader knows going into the trade that he/she is risking X points, etc. The undisciplined, impulsive trader either goes in with that mentality and doesn't execute on it or, as the trade goes against him/her, rationalizes the trade to continually a take on more and more of a loss. The inability or unwillingness to both implement stops and to execute on them, in my estimation is a large part of what leads to the profound trading issues you have described. So, I might say, a key part of the cognitive strategy, is to develop the discipline to take the emotion--the fear/greed--out of the equation. Once those are allowed to enter, everything you have described takes over.

Charles Upton said...

carlos -

I think what Doc is trying to point out is that we ought not view these *inevitable* losses as defeats but as learning opportunities, which means we gotta break 'em down and figure out what went wrong.

It's like the old adage, "it's not what happens to you, but how you respond to what happens to you."

Losses themselves don't make you a failure(unless all of your capital goes to zero), but the stubbornness to not minimize them, accept them and learn from them.


sometimesbullsometimesbear said...

Trading without losses is impossible - Very true.

I believe, Brett, what you are trying to tell the trader is how to cope with the loss, how to perceive it, how to respond to it, and how to cope with it.

Bryan said...

Very useful stuff, especially the penultimate paragraph. Thank you.

Soberba Insônia said...

Loss means bad choice in entrance points, which in turn means you didn´t analyze thoroughly your niche of choice context plus increasing odds of success or defeat before operating.

On the other hand, to achieve this elite performance in trading and sustain it 100% of all operations you will ever do, it´s impossible.

One day you will slide (too many psychological variants to be always nicely lined up), and then come the ´take/accept WELL PLANNED LOSS´ part of the battle that doesn´t exclude you of being a good trader.

Good article, by the way, Brett.

keithpiccirillo said...

A long time ago an instructor in a class quoted this which may be applicable: "If you can't change your situation, change your outlook on the situation". Learn from your mistakes but don't dwell on them and move on.

Matt Fahmie said...

Fall 7 times, stand up 8. Losses should
Drive progression. At least they have
for me. Feeling depressed over losses
in my opinion is a defeatest attitude.
If you feel that way you will never
Succeed. One has to be willing to pick
themselves up by their own bookstraps
and review what got them there and then
take steps towards improvement. Feeling
sorry for yourself accomplishes nothing,
take responsibility and use it as
motivation to become that much better.

Gro said...

My former volleyball coach once said after a session where the team had performed badly : "so, what did we learn today ?"
This is exactly what you say in your post : we have to forget about the losses we just had and focus on what we can learn from them instead.
This is why the post-market analysis of my own trades is so important ; I generally do it the next day, once the heat has cooled off so I can objectively analyze the whole session and easily point out what went wrong (a rule was broken, a condition for a setup was not met, the trade was impulsive, I was distracted, etc...).

ArmyOfOne said...

Good article, Brett. Trading is full of irrationality. Sometimes trades that meet all the rules fail for unknown reasons. When it happens I can drive myself nuts wondering "Why?" and trying to fix something that isn't broke. The best thing I can do for myself is develop a sudden case of amnesia and move on.

Radek said...

When you followed your rules and made a loss, love it. Love it out of respect for yourself and what you do.

Expecting not to have losses is like expecting to breathe in without expecting to breathe out.