Friday, September 21, 2018

Can Artificial Intelligence Make Us Smarter Traders?

There are some who would have you believe that trading is 80+% a function of your psychology.  All you need to do is sustain your mindset and discipline and remove your emotional blocks and you, too, can find the success of Market Wizards.

As a psychologist, a psychologist who has worked full-time with traders on trading floors, a psychologist who has consulted to trading firms across different markets and strategies, and as one who has traded himself for decades, I can assure you that there is a helluva lot more to success in markets than maintaining the right psychology.

A good way to put it is that the wrong psychology can derail anyone, but the right psychology does not substitute for insight, skill, and experience.  Psychology is necessary for success in any performance field--from athletics to trading--but it is not sufficient.

One of the most powerful observations I've encountered in my work with traders and portfolio managers is that cognitive skills and development account for as much success in markets as personality variables.  Superior traders have superior information processing skills.  Show me a good trader, and I will show you someone who--in some way--processes information more effectively and uniquely than his or her less successful counterparts.

I was part of a meeting recently in which a money management firm discussed the idea of requiring programming knowledge from all new hires.  Years ago, that could never have been a topic for discussion.  Now it is a serious proposal.

It makes sense.  When I look at the traders who have been particularly successful over the past couple of years, the majority are either entirely algorithmic or manage capital with a hybrid, "man-machine" interface.  Many make discretionary decisions--aided by signals generated by the machines.

Quite simply, machines--used properly--can process more information, more quickly than we can.  They can find patterns in multidimensional space that evade our naked eyes--and they can ensure that these patterns are not merely curve-fit.

It's not that artificial intelligence (AI) necessarily succeeds by giving us better trades.  It is valuable in giving us more hypotheses to consider in framing trade ideas.  It identifies patterns that have set up in the most recent past so that we can make an informed judgment as to the potential for those patterns continuing into the immediate future.  It vastly expands our cognitive bandwidth.  For that reason, AI can help us more quickly adjust to shifting patterns in the instruments and markets that we trade.

On Saturday, October 20th, I'll be in San Diego with the folks at Trade Ideas and several experienced market participants to discuss the potential for partnering with machines for better trading.  We'll take a look at trading processes, as well as trading psychology, and how those can make the most of increased information bandwidth.  The automobile greatly expanded our travel capacity relative to the horse-and-buggy.  So, too, in the machine age, can we greatly enhance our decision making with a superior flow of supporting information.

Further Reading:  


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Tuesday, September 18, 2018

The Power of Quiet Trading

Think of your mind as a finely calibrated instrument that can detect subtle patterns in markets--and in ourselves.  In order for this wonderful instrument to function properly, it requires no interference whatsoever.  If you place electrodes on a person's head to detect brain waves, the slightest movement of the head can throw the readings off.  Similarly, when our minds encounter interference, they no longer can read the subtle cues of conversations--or the subtle patterns of price behavior.

Perhaps the greatest trading psychology flaw one can have is the tendency to experience quiet as emptiness.  Instead of experiencing quiet as peace, people can experience it as boredom or as a void.  So they rush to fill their voids with self-chatter and aimless action.  Just watch how quickly we turn to our cell phones when a quiet moment occurs.  All that activity trains us in a sense: it trains us to be unable to make full use of our finely calibrated instrument.

The most recent Forbes post examines research relevant to the quieting of our minds.  One line of research reaches an astounding conclusion:  that it is in the quieting of our egos that we gain access to our greatest strengths.  I encourage you to check out the post and the research links.  If this line of thought is correct, then all the trading patterns/setups and all the self-help techniques designed to instill discipline and remove our blocks are of limited value.  If we are not in the right (flow) state to detect subtle patterns, we quite literally will end up trading noise.

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Thursday, September 13, 2018

The Right Way to Trade With Confidence

Here's an idea I've been discussing with a few of the traders at SMB who are increasing their confidence--and their size--in many of their trades:

When you have *real* confidence in your trading, you're not threatened by the possibility of being wrong.  All of us are fallible, and if we are secure with who we are, we can accept that.  True confidence means we have the inner strength to deal with setbacks as well as successes.

When we have big confidence in a trade, that is when we want to double down on our planning for the possibility of being wrong.  Too often, traders become confident in an idea and stop looking and planning for alternate possibilities.  We want to use confidence to trigger our awareness of fallibility, so that we are aggressive in the trade AND aggressive in planning an exit if the trade doesn't work out.

The holy grail is to have conviction *and* open-mindedness.  We can size up a trade at the same time that we intensively review our exit strategy.  Aggressive and nimble...just like the sniper.

Further Reading:


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Saturday, September 08, 2018

Six Characteristics of Successful Traders

I've seen traders succeed in very different markets, over very different time frames, and with very different strategies.  Here are common elements I've noticed among the most successful traders:

1)  Capacity for Sustained Focus - Quite simply, the successful ones process more information--and sustain the search for unique information--better than their peers.  This enables them to see what others do not;

2)  Originality and Creativity - I have never met a successful trader who traded in the ways that trading texts describe.  There is always something unique to the successful trader, and very often it's looking at unique information or looking at common information in unique ways;

3)  Learning From Mentors - There may be completely self-taught genius traders, but the best that I have met have learned from other successful traders.  Indeed, it's common for the great trader to have multiple role models and synthesize lessons from each;

4)  Emotional Resilience - Some traders bounce back from losses and setbacks better than others.  The successful ones actively learn from the setbacks--and then move on.  The less successful ones fail to learn from their experience and often fail to move on;

5)  Attention to Detail - In football, it's often the blocking and tackling that ultimately wins the game.  In basketball, it's running the plays and the defense.  Less successful traders focus exclusively on "setups" to get into trades.  Successful traders develop rules and processes for sizing and managing positions to maximize reward relative to risk.

6)  Always Working on their Game - As Merritt Black at SMB Futures recently noted, the intensity and consistency of the review process is very positively correlated with success.  Just as in sports, the successful traders review markets, review their trading.  They are studying "game film" to prepare for the next contest.  They aren't focused on getting rich; they're focused on getting better.

Quite simply, the best traders start with distinctive strengths and then cultivate those through rigorous tracking of performance and learning.  There is a winning process long before there are winning outcomes.

Further Reading:


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Wednesday, September 05, 2018

The Psychology of Trading Without the Ego

A surprising amount of poor trading comes from trading our egos, not from actually trading markets.

When we focus on predicting market moves and trading our views with conviction, trading rapidly becomes a game of the ego.

When we declare that we have a certain trading "style" and we wait for market conditions to accommodate our style, trading becomes ego-based.

When we obsessively watch screens and focus on each move of P/L, trading turns into an ego game.

We can use every technique under the sun to instill discipline and overcome emotions, but if we pursue trading through the ego, we will be vulnerable.

An analogy I've used in my books is the good dancer on a dance floor.  The good dancer doesn't just dance his or her style regardless of the music playing.  The good dancer does not start dancing ahead of the music, anticipating the next tune.  The good dancer waits for the music to start, catches the beat and tone, and dances accordingly.

In my recent trading, I've been taking ego out of the picture.  I examine a stable lookback period in the recent market and identify two things:

1)  Has there been a dominant trend over that period?
2)  Have there been one or more dominant cycles over that period?

If I can detect no clear trend or cycles, I don't trade.

If there is no trend, but a dominant cycle, I trade the hypothesis that this cycle will continue into the immediate future unless I see clear changes in market volume, volatility, news events, etc.  That has me buying prospective cycle lows and selling highs.  In that regime, I look like a value trader.

If there is a distinct trend, but no clear cycle, I use the first pullbacks/bounces in the NYSE TICK to enter and ride the trend, again unless I see clear evidence of changes in the market's trading.  In that regime, I look like a momentum investor.

If there is a distinct trend *and* one or more dominant cycles, then I am using the cycles to guide entries and exits in the direction of the trend.  In that regime, my execution is counter-trend (value), but the overall idea is trend-based (momentum).

We suffer when we expect markets to trade the way *we* want them to trade.  There are valuable tools that help us identify cycles and trends.  That enables us to enjoy the market's dance music--and profit from it.

Further Reading:


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Monday, September 03, 2018

Becoming Truly Accountable For Our Trading Account

We have trading accounts, but how truly accountable are we for those?

What percentage of us routinely keeps informative data on our trading results?

What percentage of those traders keep regular journals to turn the trading data into actual goals and plans?

What percentage of those traders then tracks their goals and plans and holds themselves accountable them going forward?

Put it this way:  If you pursued greatness in any professional sport, how likely would it be to find success if you worked as hard at that sport as you currently do at your trading?

Could it be that the majority of traders fail to find success, not because they trade the wrong "setups" and styles, but because they pursue performance in ways that could not work in any performance field?  

In an excellent post, Bry Gomez from the Caylum Trading Institute points to a study from the American Society for Training and Development (ASTD) in which the probability of reaching a goal was studied as a function of the level of accountability for that goal.  Simply formulating a goal led to a probability of success of 10%.  Having a concrete plan for reaching the goal raised the odds of attaining the goal to 50%.  Having a specific person to whom you are accountable for the goal--and a specific time set to review performance with that person--led to an achievement rate of 95%.

In other words, it's not simply about having good intentions or even having good goals.  It's about leveraging the power of human relationships to become fully accountable for achieving those goals.  Creating daily report cards of performance and sharing those with peers becomes a best practice that can greatly improve performance, as Mike Bellafiore has observed in the development of traders.

We find our potential when we make life a team sport.

Further Reading:


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