Saturday, June 25, 2016

Why Time is Key to Trading Psychology

The recent Brexit trade and its volatility has given us an opportunity to explore an important and neglected topic in trading psychology:  time.

Here's a useful distinction between novice and expert performers:  Under pressure, the novice feels threat and speeds up.  Heart rate, galvanic skin response, muscle tension--all increase under pressure for the novice.  The expert performer has trained under pressure.  Under pressure, the expert slows down and focuses.  

Put novices behind a rifle and the odds are good that when the target appears, they will speed their breathing, start to shake, and miss the shot.  Put an expert sniper behind the rifle and breathing slows, all movement stops, and the aim is true.

As a psychologist, I've experienced the same thing.  During my beginning years, I felt panic if a client I worked with reported thoughts and feelings of suicide.  Later, crisis talk made me hyperfocused.  I hung on every word.  I became more deliberate in my responses, more attuned to the person I was speaking with.  So it is with mountain climbers, professional athletes, and elite military units.  They replace fight or flight with focus and freedom--the freedom to stay in control over a situation and not allow it to control them.

OK, so what does all this have to do with the Brexit trade?

As part of my trading, I have a short-term system that provides entry and exit execution guidance.  The system adjusts entry and exit points for the market's volatility.  During Friday's trade, the volatility unit risked by the system was about three times the size of the volatility unit from the first week of June.  The same exact setup now could make or lose three times as much as recently.  It was no different from tripling trading size all at once.

But it wasn't just volatility that changed.  Time itself changed!  The system works from event bars, not chronological bars.  Each bar represents a number of ticks in the market, not a number of minutes or hours.  For all of Friday, we printed almost 200 bars.  For the first Friday in June, we printed nearly 60 bars.  

The novice is calibrated to the chronological clock and thinks in terms of standard trade sizing.  As a result, each trade is far more risky.  Under those conditions, market volatility begets emotional volatility and either the fight of reactive trading or the flight of the deer in headlights.

Calibrated to the market clock and adjusting trade sizing for volatility, the trade opportunities are the same--there are only more of them in a given trading session.  A crisis session for a psychologist is an entire therapy compressed into one meeting; it is what you do all along, only compressed.  That compression is a catalyst for focus, because each time unit carries greater meaning and significance.

The novice trader cannot adapt to changes in the market's clock.  Movement slows, the VIX falls to 12, and boredom sets in--the need to trade.  Movement picks up, the VIX nears 30, and excitement sets in--the fight and flight.  Once you define time in terms of market movement, the switch from slow markets to fast ones is like the change on a dance floor from a slow tune to a fast one.  There are times for slower and faster dancing...our job is to adapt to the market's music--not dance a given way regardless of the music that's playing.

Further Reading:  Why Trading Markets is So Difficult