Very often, there are repeatable patterns in the profits and losses of traders that could lead an observer to know when to go long that trader and when to fade them. In some cases, I have helped build alerts for traders that pop up on the screen when they are at a point where they typically have lost money in their P/L cycles. It's a different way of building mindfulness about our patterns, so that we can control them rather than have them control us.
So what are the most common patterns that appear during such analyses? Three immediately come to mind:
1) Losing money on one's largest risk-taking - We all know that we're supposed to take our largest positions when we're most confident in our views, but that logic doesn't work for all traders. Often, traders will take their largest positions after they've had a winning streak. Now they're playing with house money. Confidence begets overconfidence. Once the position sizing is largest, perhaps the market moves are most extended. Losing on your biggest bets is a great way to undo many gains with one or two large losses--not at all good for the psyche. Before you assume that you should bet larger when you have your greatest conviction, analyze your P/L as a function of your risk-taking. If your biggest bets don't have your greatest hit rate, is your confidence generating information?
2) Losing money during quiet market periods - One analysis I like for stock market traders is to break P/L down by VIX periods. How does the trader perform when markets are most and least volatile? How well does the trader transition from higher to lower volatility periods and vice versa? For daytraders, how does the trader perform during midday hours vs. early mornings and late afternoons? During quiet periods with narrow ranges, does the trader make more trades or fewer? It's not uncommon to see risk-prudent traders struggle when volatility rises and aggressive traders struggle when volatility is crushed.
3) Losing money with good market views - This one is a little more challenging to analyze, but very worthwhile. What happens to traders' positions *after* they exit their trades--particularly after losing trades? Very often, traders have a correct market view and still manage to lose money. By placing stops too close to entries and by adding to positions when moves have already extended, traders generate good ideas but execute and manage them poorly. A common variant of this problem is placing profit targets too far away during lower volatility markets. Trades start out in the money and end up scratching or with losses--a frustrating experience to be sure. Sometimes we see traders taking profits in trades that often ultimately extend far more in subsequent hours and days. That occurs when ideas are generated on one time frame of analysis, but managed (for psychological reasons) on another, leaving plenty of money on the table.
Our trading results are a great way of studying ourselves. If we are operating with cognitive biases and/or emotional disruptions, these will inevitably find expression in our P/L stream. Because we are not always objective observers of ourselves, it helps to go to the objective data of our trading to find a mirror into our psyches.
Further Reading: Metrics for Active Traders
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