Sunday, May 03, 2015

Process-Driven Trading: Trading With Quality

We often hear that traders should be process driven and strictly follow their process as a way of avoiding psychologically-driven biases and poor trading practices.  This draws upon an analogy between trading and the running of a manufacturing or service business.  In the business setting, you are looking for consistent, high quality.  Variability of output = low quality.  For example, if you're manufacturing a drug, you want the production process to turn out the same pill all the time.  If you're a delivery service, you want consistent on-time delivery--and you standardize each step of the process to make sure that happens.

Essential to process-driven quality control are two ingredients: 1) measurement of outcomes and 2) identification of the activities that consistently generate those outcomes.  In the world of medicine, that has led to a focus on outcome research and the creation of evidence-based treatment protocols that standardize best practices.  If you receive surgery from an evidence-based treatment center, many of the decisions that are made, from the amount and type of anesthesia to the sterility of the operating room and the method of incision, will be laid out as protocols and derived from rigorous, controlled outcome studies.

When traders say that they are "following their process", what they should mean by that is that they have intensively studied what makes them money and what does not; identified their best trading practices; codified these best practices as protocols to follow; and then tracked their fidelity to these evidence-based practices.

In other words, a trader who is truly process-driven should demonstrate:

1)  Reliability - They do the same thing in the same situation each time;
2)  Validity - What they do is known to result in greater positive outcomes than following other procedures.

Most traders who speak of being process-driven do not truly track reliability and validity.  When they talk about being process-driven, what they mean is that they follow a routine.  Routines are necessary for quality control, but hardly sufficient.  Rowing a boat in a consistent manner doesn't help if you're headed in the wrong direction.  If traders don't track outcomes, identify the practices that generate favorable outcomes, and *then* ground routines in those practices, they are not trading with quality.

Trading with quality means putting as much time and effort into studying trading performance as studying markets.  The process-driven trader doesn't simply define a routine and follow it blindly.  Rather, process-driven trading means that you identify and understand what works and then systematically become more consistent in executing that.

Would you fly an airline that operated with the same quality control as you demonstrate in your trading?  

It's all about doing things right and doing the right things.

Further Reading:  Quality, Minds, and Markets