Sunday, February 14, 2010

Training Traders: The Role of Simulation in Supercharging Learning

A recent research report suggests that computer simulations can be as effective as direct observation in education. Simulations have long been used in medical education to help students learn the skills of physicians. Simulations are also standard in training airline pilots and in preparing for war scenarios. By trying out moves against a computer, developing chess players can work on various aspects of their game.

When I directed a training program for new traders at a prop firm, we found that simulated trading using live market data was especially helpful in preparing traders for shifting market conditions, dealing with uncertainty and risk, and making rapid decisions. Interestingly, we also found that when simulations were graded and reviewed by an instructor, they also incorporated some of the performance pressure faced during actual trading. If a trader knows that he has to sustain profitability in simulation mode before trading live, the simulation begins to simulate the emotional elements of trading.

Simulation, however, entails several advantages over live trading for training purposes:

1) Simulation allows traders to make mistakes and try out tactics without losing money early in their developmental processes;

2) Simulation allows for more focused learning, as traders can replay aspects of the day to rehearse trading under specific conditions;

3) Simulation provides standardization in learning, as trading days can be archived and traders can practice trading specific kinds of market conditions from the archives;

4) Simulation enables traders to get more learning into a day's period than would be possible during live trading, as many days' worth of experience can be concentrated into a single training day.

5) Simulation offers an objective test of traders' skills. If a trader cannot be successful in simulation mode with live market data, surely he will not succeed under the more strenuous conditions of having real money on the line.

A number of trading platforms and programs offer a "replay" mode that can serve as simulation-based learning for traders. By replaying challenging periods in the market, traders can observe mistakes that they made and correct them before the next day begins. That supercharges learning.

In my book Enhancing Trader Performance, I devote considerable space to the topic of simulation. My conclusion: "Research and experience suggest that the single most important investment you can make in your trading development is the acquisition of software that will allow you to develop your own training program and drill the skills that are central to your trading niche" (p. 100).

The great weakness of most "training" programs for traders is that they provide information, rather than develop skills. Information is necessary but not sufficient for the cultivation of expertise. Learning about chess or about surgery will not, in itself, create a chess champion or an elite surgeon. We can learn a great deal of information about football, but remain unable to master the game.

There is a very straightforward formula for success across performance fields: find the performance area that best matches your interests and talents; engage in structured practice under safe conditions to master the skills that are components of success; engage in realistic practice to assemble those components into actual simulated performances; and then tackle real-world performance situations with ongoing feedback and efforts at improvement.

Traders don't fail because they lack the right setups or because they weren't born with the right trading personality. Traders fail because they do not survive their learning curves: they put their capital at risk long before they have developed necessary skills and expertise. Simulation-based learning is a way to accelerate that curve and reduce the costs associated with the inevitable mistakes made by learners.