Monday, February 17, 2014

Adapting to Change: The Greatest Challenge in Trading

Here's why I'm writing a new book on trading psychology:

The status quo says that problems in trading performance are the result of emotional disruption, lapses of discipline, and failure to consistently act upon one's edge in markets.

That analysis simply does not match my experience, either as a coach or as a trader.

Successful traders don't suddenly morph into inconsistent basket cases.  And when you see multiple talented traders lose money at the same time, it's impossible to believe that an epidemic of lapsed discipline has suddenly struck the trading community.

Rather, what happens is that the edge that had been present in markets no longer exists.  Markets continually change--they shift in their patterns of trend, volatility, correlation, etc.--so that what once worked no longer yields reliable results.  The momentum trader makes money until volatility shrinks and we move into choppy, rangebound trade.  That brings frustration and emotional disruption, but the cause of the negative emotions is a failure of adaptation to markets--not a failure of discipline or rule-following.  Indeed, doubling down on following rules that no longer work can only cement further losses and frustration.

To be sure, once emotional upset enters the trader's experience, it can interfere with future decisions.  But no amount of psychological stress management will create needed adaptations to changed markets.  That can only be accomplished by treating losses as potential sources of information--as signals that alert us to altered market regimes.  

Once you view drawdowns as information--not merely as failures or as stresses--the door opens to a deeper understanding of markets and ways in which we can take our trading to that proverbial next level.  The challenge is not simply to learn trading; it's also to unlearn and relearn it when markets present different, fresh opportunity sets.

Market Structure and Adapting to Change


Tappy said...

Good points. Art DeVaney has similar thoughts as well. "There is no failure, only feed back"


Andrew Menaker PhD aka PopDocTrader said...

I completely agree regarding the need to continually adapt to changing conditions as one of the key challenges facing traders.

It's no coincidence that adaptation not only drives better trading, it's also what drives human evolution. During the hunter-gatherer phase of human history we were not bigger, faster, or stronger than other predators. Humans survived and thrived due to the ability to adapt to changing conditions.

Loss as information or feedback is key. But I would also add, in my experience, there is a connection between psychological stress mgt and adaptation. When stress mgt or emotional mgt is firmly in place it increases the odds of adaptation.

The brain is expensive. For example, it only makes up 2% of body weight, but it uses up about 25% of the body's glucose and a significant amount of oxygen. If a person is consumed with intense feelings, there is less chance the brain will be able to respond to the situation adaptively.

Andrew Menaker PhD

RAZOR said...

Observe, react, adapt, evolve......

the four words above every page of my personal trading journal.....

Mark Wolfinger said...

Dr. Brett,

Looking forward to the new book. The premise discussed in this post makes me want to learn more.

SSK said...

Hello Brett, My comment is to big for the blog, so I will do part 1, and part 2. PART ONE… Thanks for all the interesting links over the weekend…this is an interesting post, and in my experience very relevant. In my case, I have had the opportunity to simulate in at least 3 different market types over the years since the high volatility times starting in the 07-08 market, the 09-11 grinder up market where the vix was settling down, rotating markets through 2011-2012, and then the 2013 grinder up low vix environment, etc. I was also trading the bonds and commodities and currencies for real cash in the mid to late 90’s until around 2001, so I was around the mania during that time too. I now digress a bit; Then I took three years off to design and build a masterpiece of a house. No subcontractors, just me and and a friend or two or three at times. Between running the business, building the house, and now taking care of a deaf and cognitively deficient uncle in law, growing and many other interests and things, I stay very busy. Studying many things including market related issues, the ability to focus here and there over a year or two, then taking some time off in a more formal way, while still keeping up with markets in a passive way, has given me a chance to sublime process. I have had the opportunity to test many different creative expressions in the market, and work on other weak points of my personality in the real world, but I digress again a bit.

SSK said...

PART TWO; The point I was trying to make was that compared to a strict quant type approach to trading, where programming is always changing based on new market patterns, I would posit if all other cognitive functions of the mind and the functions of the body (relating to the stress response and how one both deals with it, understands it, and relates to it) are homeostatic , I would say that long term exposure to a well thought out process, within a framework of simulation, would let the brain do what a programmer could do, but with better and quicker synthesis or you might say, a streamlined simpler approach. This could be better related possibly to the timeframe of a day trader, one that has a need to see nuances on shorter intervals , being in and out over 30-90 minute intervals (the caveat being with yrs of exposure and structured process , admitting that is not practical for most). The things you speak about, and have programed like the cumulative NYSE tick etc, or other statistical programs like “x” number of days for this outcome or that, serves an interesting purpose in analyzing the market from a different time frame perspective. It seems that for the purposes you use them, they may not be as affected from short term moves, or changing market patterns, (through a smoothing out effect over time) hence not that germane to the point of your post, (and I understand since this area of programming is not an area of expertise, or a strategy that I have personally deployed, so I may in fact not know what I am speaking of at all! LOL) though it seems to be my personal experience, (the caveat being that I am in a unique situation and can to take years on and off to work this mission. I am able to enjoy both academic and analytic work, psychological work, with real world application in trading and in life over time. At times it is more formal and intense, at other times more passive, (like when you were on vacation), yet still productive and creative leading the brain to a synthesis. Like you said in your other post about your vacation and your epiphany on the beach, the down time leads to many other views through different lenses of the markets, in both a macro and mirco type of setting. That includes seeing and relating to many of the variables you mention in your post. I guess I am just really lucky that I am not rushed in the process to only make cash, and can enjoy exposure to many different markets, and creative exercises, while creating a large dataset for review in different markets while gaining experience, and trying all sorts of new things without any baggage you might say.. My personal experience really relates to what you see in the real world of traders performance, because I have seen the need, and the ability of the brain to adjust to different markets without any indicator outside of understanding Market Profile and a few other neat indicators through Market Delta and the tick, and some other basic trading tenets. Both myself, and my trading buddy have seen our edge succeed in different markets, where the changes are more centered around tactical execution based on the ATR and Volatility. The mind as you have said many times, through exposure, experience and repetition to patterns is a great quant gadget in itself, adept at successfully adapting over the years through lots of different exposures to different markets through the simulated process. As you well know tactical execution is a whole other realm and can be very complicated due to personal strengths or weaknesses. Thanks so much for your insights, really cool, it’s nice to think out loud…Soon I have a desire to put my trading ideas back in print after a passive observation of the market over the last year or so, (even though passive is relative, since a buddy of mine both deploy the same edge in the market place and speak about and review the market daily. Maybe some day I will learn to use a few less comas and parenthesis in my writing, lol!! Thanks again, Best, SSK

Michael said...

Dr. Brett,
Looking forward to reading your new upcoming book. I have enjoyed and benefited from each and every one of your previous trading books.


Vikas said...

Question is, at what point does a system follower say "OK, the system needs to adapt here, the markets have changed", and when does one stick to it through tough times. Or maybe your article is not about sticking or stopping systems at all, but about analysing if things are the way you expect them to be, and adapt if not.

Y Mender said...

Thank you Dr. Brett fir the helpful post.

While research and development for continuous improvement of one's trading should be part of trading practice, the performance of trading could serve as a very good indicator of when the system needs to adapt. In its simplest form, if the trading metrics show evidence of consistently profitable performance, more than one possible cause could be driving successful trading: 1) the system is adapting, by design or coincidence, to changing markets; the markets have not changed (an unlikely situation in the long-term); the trader's superior trading skills are compensating for a system that has not adapted, or ....

Thank you