Saturday, December 23, 2017

Trading Psychology Challenges - 12: Self-Awareness

In my recent podcast for CMC Markets (see Episode 7, and check out other interviews with Linda Raschke, Jack Schwager, and more), I describe a technique that I use when a trader falls into overconfidence after a winning streak.  We use guided imagery to visualize a scenario in which the most recent period was a losing one.  Would the trader still put on the trades being contemplated?  If so, would the sizing be the same?  

A simple exercise such as this is a way of instilling a degree of self-awareness for the trader who may fall victim to recency bias.  We tend to overemphasize recent experience, extrapolating it into the future.  This can make us underconfident after losses and overconfident after wins.  When our performance reverts to its mean, we are undersized when we're due to make money and oversized when we're due for a P/L pullback.  Reactive variability in our trade sizing and overall risk taking is a major cause of lagging performance.

Self-awareness means that we step outside ourselves and think about our thinking and observe our feeling states.  When we coach ourselves, we are by definition in a state of mindfulness, as we stand above our behavior patterns and exercise a higher degree of choice and self-control.  This is one of the great advantages of trading journals.  When we write about our performance, we can stand apart from performance and take a coaching perspective.  

This is a very important performance principle:  When we work on self-awareness outside of our trading, we build the mindfulness skills that eventually kick in during our trading.  Coaching ourselves before and after market hours eventually leads to ways of thinking and behaving that creep into our real time trading.  One of the key indicators of trading success among developing traders, I've found, is the ability to recognize trading mistakes and turn them around during the course of a trading day.  It is very difficult to fall into a trading slump if you're aware of problems and actively coaching yourself about those in real time.

So how can we move from being reactive to being proactive?  How can we reduce mindless trading and trade in more self-aware ways?

Here is a routine I've found to be particularly helpful:

Divide your trading day into three segments:  premarket/pretrading; middle of day; and end of day.  During each of these segments, you are going to engage in a routine that involves self-awareness.  Before the trading day starts, you are actively reviewing your previous day and your plans to continue doing what you did well that day and correct mistakes you made.  You are reviewing market activity and generating a number of what-if scenarios that tell you what you want to do under a variety of possible conditions.  

Midday you are taking a trading break and refreshing your focus/concentration.  You're also stepping back from following price action and updating your scenarios to identify potential opportunity in the afternoon.  Midday is also a great time to once again review performance, learning from what you did right and wrong in the morning.  It is during this midday break that you can interrupt any negative patterns that may have entered into your trading, so that you can perform better in the afternoon.

At the end of the day, you actively review the day's performance and set specific goals and plans for the next day.  Those will become part of tomorrow morning's review.  In this end of day review, you'll assess whether you focused on the right areas of opportunity, whether you trading that opportunity well, and whether you did a good job of identifying new opportunities.  It is this end of day review that allows you to learn from experience, reducing the odds that today's mistakes will bleed into tomorrow.

Notice how this truly is a self-coaching process.  Just like a basketball or football coach will work with a team before a big game (preparation), during the big game (halftime and time outs), and after the big game (review and practice), you are working with yourself before, during, and after performance.  This builds your self-coaching skills; it turns mindfulness into a daily activity--which means it eventually becomes a positive habit pattern.

This could be the greatest report card you could ever give yourself:  Does your daily process systematically make you better?  If you repeat today again and again, will you build skills and develop positive habit patterns, or will you languish in mediocrity and inconsistency?  Does your daily routine make you more self-aware and self-determining, or does it leave you vulnerable to cognitive biases and emotional impulses?

Further Reading: