The Psychology of Playing a Big Market Opportunity

 

3/30/25 - The tariff announcement on April 2nd carries a high degree of uncertainty and the selloff in US stocks to end the week was one sign of that.  Given an oversold stock market, an announcement that is more benign than expected could lead to quite a round of short covering.  An announcement that conveys elements of shock and awe could continue pressure on U.S. stocks and the U.S. Dollar.  What is important from a trading psychology perspective is that it's not necessary to *predict* what will be announced.  That is because whatever is announced will impact large market participants and create short-to-medium term trading opportunities.  In other words, successful trader identify what *is* happening and respond quickly.  They don't become caught up in what they think will happen or what should happen.  Uncertainty brings opportunity, but only when traders and investors perceive a shift toward greater certainty.     

Keys to Great Trading

 

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3/28/25 - The best trades occur when markets are trading thematically, with the themes representing the actions of the largest investors who move the most money.  I am watching the correlation between equity markets overseas (VGK, EFA, EEM) and the U.S. stock market.  Until recently, those had been moving in different directions.  If we were to have genuine trade wars, we could see a toll taken on global markets.  On the radar as a potential opp...nice example in real time of allowing a big picture to inform short-term trading.

3/26/25 - Quick shout-out:  TraderLion is coming out with a book published by Harriman House detailing the process of finding your edge in markets.  It is so important to understand markets in ways that make sense to you; only then can you have the confidence to take meaningful risk and sustain your risk-taking.  What has worked for me is a lining up of time frames, where I look at my markets (stock index futures) on three different time frames.  As I've mentioned previously, the X-axis actually isn't time; each bar on the chart represents an amount of volume traded.  So the short-term chart has bars representing relatively few contracts traded; the medium-term chart has bars representing a moderate number of contracts traded; and the longer-term chart has bars representing open-high-low-close for a large number of contracts traded.  The charts thus adjust to the busyness of the market.  I overlay the same technical indicators on the three charts and wait for signals across all three.  I then turn to my very short-term chart of the NYSE TICK to time my entry, looking for occasions when buying/selling are drying up and reversing.  I'm comfortable taking sizable risk when everything lines up, and I'm comfortable not trading when signals are mixed.  As a very bright and creative money manager taught me, so much of success comes from not needing to trade.      

3/25/25 - Yet another key to trading success:  The ability to recognize, in real time, when your market is lining up for an unusually good potential opportunity and then to be able to size up for that opportunity without losing sight of sound risk management.  Selective aggression is all about being willing and able to wait for the right opportunities and, when those arrive, being able to pounce decisively.  Very often, a meaningful part of overall profitability for discretionary traders comes from a relative handful of trading opportunities.  A key to great trading is being able to outline--in detail--the criteria for a true A+ opportunity and then having the discipline to wait for those criteria to be met and being able to go from waiting to pouncing.  In my next post, I will outline the high opportunity criteria that guide my largest trading.  

3/24/25 - Here is another key to great trading:  understanding market context.  Reading the "text" of the market--the short-term patterns that set up--is crucial to good risk/reward entries and exits, but what tells you the "context" of market action?  Is this setting up as a trend day?  Are we seeing a rotational day?  Who is in the market; how busy are we and how far could we move?  How does today's market fit into the pattern of recent trading?  Is there a theme driving trading across asset classes?  Who is setting up to be trapped:  Are buyers and sellers moving price effectively, or are we seeing signs of exhaustion? 

Great trading comes from looking beyond the market and time frame we're trading to see the bigger picture that will be driving price action.  The microscope helps us get the best price for our orders; the telescope tells us what to order and why.      

3/23/25 - What if a key to great trading is found in what you do during the time when you're not trading?  What are you doing between trades to generate ideas, to track shifts in what you trade, to track shifts in the markets that impact what you trade?  When I compared being a trader to being a sniper, I pointed out that "It's a beautiful feeling to plan one good trade, execute it to perfection, and then sit back and wait for the next opportunity.  Any performance skill, honed and executed with precision, is a kind of work of art.  I think the best snipers understand that".  

The artistry of great trading is found in what we are doing when we're not staring at screens and firing away.  Like the sniper, we succeed because of our focus during the 99% of the time that we're not firing.  Creative vision is what makes a work of art.  It is also what makes for artful trading.  Skilled traders have studied and experienced so many markets that they can recognize when a meaningful pattern is playing out.  What if we only traded when that creative insight came to us, when we saw--truly saw--how things were playing out?  The cost of overtrading lies not just in the P/L lost, but in the damage we inflict upon our capacity for creative insight.  Our job is not to make great trades; it's to have the wisdom and restraint to allow great trades to come to us.    

Answering Traders' Questions

 

3/21/2025 - In the previous post, we looked at a psychological perspective about why traders might give back profits after a period of successful trading.  Now let's look at more logical, structural reasons for these givebacks.  

What's important to realize is that the market's largest participants trade thematically.  That is, they look for patterns of strength and weakness across different stocks, different sectors, different equity markets, and different asset classes--and they look for reasons that explain these themes.  When the themes change for economic or geopolitical reasons, the market that you are trading can shift greatly in its patterns of volatility/volume and correlation to other instruments.  If you fail to recognize the theme driving the change, you're likely to lose money and not realize why.

Themes have changed in 2025.  Look at how the US dollar has been trading against the Japanese Yen, the Euro, and the British Pound.  Look at the the US stock market (SPX) has been trading relative to the European markets (VGK) and the rest of the world (EFA).  Look at how interest rates have been coming down, but not as much in the junk bond market (JNK).  Look at how volatility (VIX) has expanded.

The dominant theme has been anticipation of economic weakness in the U.S., resulting in a flight from many U.S. assets.  If we only look at the charts of what we are trading, we miss the broader patterns that reflect what large investors are doing.  By noticing the patterns across markets, we can create tailwinds for trading our markets.  

3/20/2025 - I received an excellent question from a reader:

"I keep going through the same problems.  I make money for a while and then go on a losing streak and give it all back.  How can I change this?"

Brett's response:  Going through unusual ups and downs in performance can occur for psychological reasons, and it can occur for logical reasons.  The key to figuring out what to do is to first identify the problem.

You'll know that the problem is psychological if you review your trading in detail and see if your trading patterns change following winning periods.  Do you trade larger after you've made some money?  Do you trade more often?  Do you expand what you've traded?  Many times, out of confidence becoming overconfidence, traders will stop doing what made them money and lose a good amount of money.

The key is recognizing that making money puts you at risk!!  This is when you can get sloppy; this is when you can overtrade and oversize.  After you've made money, you want to trade extra carefully.  You want to ask yourself, "Would I be making this trade in this way if I had just been losing money?"  By putting yourself in the mindset of risk management, you prevent yourself from becoming overconfident and impulsive.  After a winning period, double down on sound trading process, knowing how easy it is to ease up on your rules.  

And what if your losing money is not due to a change in mindset, but a change in markets...how can you adapt to that?  I'll tackle that one in the next post!

3/19/2025 - This is an additional question from the group coaching session that addresses a situation faced by many traders in the recent volatile markets:

"Recently I am struggling to focus on process because I had quite a drawdown, and it's hard to push thoughts about making money now away.  Any advice?"

Brett's response:  Every drawdown/loss should be planned.  You should always know how much money you're willing to lose on a trade, how much you're willing to lose each day, and how much you're willing to lose each week and month.  Knowing your loss limits in advance helps in two ways:  1) You can be psychologically prepared for inevitable drawdowns and still maintain a focused mindset, because no drawdown feels like "quite a drawdown"; and 2) You always give yourself room to come back.  As I mention in my books, traders I worked with in Chicago (who were very short-term) had a separate loss limit for the morning trading and for the afternoon.  They always gave themselves an opportunity to come back on the day and, on losing days, they could always come back on the week.  Any planned activity becomes familiar and cannot trigger us.  Mentally rehearsing the downside and being at peace with your loss limits prevents frustration from ever impacting our trading.

If you've taken a large, unplanned hit, returning to trading in simulation mode (take P/L off the table temporarily), regaining your rhythm and focus, and then sizing up gradually allows you to recover.  If you can't focus on the market, it's time to work on your focus.  

3/18/2025 - Here's another question that arose during the coaching session:

"What are the skills you recommend to handle our triggers?"

Brett's response:  Notice that the trader recognizes something very important.  Our problems are not just negative trading behaviors (such as going on tilt), but whatever triggers those negative behaviors.  If we can control our triggers, we can prevent problems like overtrading from occurring in the first place.

The very first step is recognizing the trigger as it is occurring.  For instance, we might wait for a perfect entry on a trade only to see the market make its move without us.  That triggers frustration, and the frustration can lead to chasing the trade and executing at a really poor level.  We can only identify our trigger patterns by studying our preventable losing trades and dissecting how they occurred.  In the above case, what sets up the poor trade is not just the frustration, but the perfectionism that precedes it.  Very often, our excessive expectations set up our excessive frustrations.

By working on our thinking patterns as we're trading, we can ensure that we're going into trading with realistic expectations that won't frustrate us.  For instance, my first entry on a trade is always small and at a good level, not necessarily a great level.  "Good enough is good enough" is the mindset I rehearse.  I have favorable reward to risk and that's good enough for an entry.  If the position moves against me, but not to my stop, I'm prepared to add another clip at a more favorable level.  If the position moves immediately to my target, I've made a decent profit.  

Note that these kinds of thinking patterns can be mentally rehearsed before the market open and during trading reviews.  The best way to handle our triggers is to identify what sets them off and create new patterns of psychological win/win.

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3/16/2025 - In this series of posts, I will address questions that traders posed during my recent group coaching session with Agnieszka Wood and Alex Serzhanovitch.  If you have trading questions you would like me to address, please feel free to reach out to me via Twitter/X.

The first question is:  "Given that markets constantly change, how can traders develop the psychological flexibility needed to adapt their strategies without falling into emotional overreaction or hesitation?" 

Brett's response:  This is a great example of a situation where improvements in trading process can create improvements in our trading psychology.  Basically, what active traders need is real time information that tells them that their market is changing.  The professional traders I work with at hedge funds monitor real time price change, of course, but also real time market volume and volatility and real time correlations.  Very often, shifts in volume/volatility and correlations precede shifts in trading direction.  A simple example would be a stock that moves out of a range to the upside but then stalls on low volume.  If this was a valid breakout, one might expect short-term participants to take advantage of the move, resulting in increased volume and volatility.  One might also expect that, if the stock's upside breakout was valid, it would be accompanied by similar moves in other stocks in the same sector and perhaps by similar moves in the overall market.  By monitoring this real time behavior, traders can become highly flexible in jumping aboard moves or fading them.  Once the market changes are perceived and understood in a broader context, the trader can quickly adapt.  

Recently, the market made an intraday high but many sectors (including small caps) lagged significantly.  This was very helpful information in fading the strength.  Practicing trading with small size while making these observations and adaptations provides the experience that leads to confidence.  How the market moves is just as important as the moves it makes.  

What Kind of Trader Are You?

 

3/16/2025 - Thanks to a very smart market strategist for this quote: "Following your passion is a very “me”-centered view of the world. When you go through life, what you’ll find is what you take out of the world over time — be it money, cars, stuff, accolades — is much less important than what you’ve put into the world. So my recommendation would be follow your contribution. Find the thing that you’re great at, put that into the world, contribute to others, help the world be better and that is the thing to follow." — Ben Horowitz, “Don’t Follow Your Passion” advice to the Columbia class of 2015.

3/14/2025 - There are five key personality traits that spell the acronym OCEAN:

*  Openness to Experience - Our curiosity, creativity, and openness to new ideas;

*  Conscientiousness - Our attention to detail and process-based organization;

*  Extraversion - Our interest in social interaction; also relates to risk taking;

*  Agreeableness - Our ability to get along and work well with others; relates to teamwork;

*  Neuroticism - Our tendency to experience negative emotion and stress

These traits are basic to who we are.  Our job is to find the ways of trading that best play to our personality strengths.  A great way to see how your personality contributes to your trading success is to study your best trades and how you succeeded.  Across many winning trades, you'll see how you best engage markets--and that says a lot about who you are.

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3/13/2025 - Key question:  Are you a generalist in your trading, trading multiple markets and strategies, or are you a specialist, who does one or two things really well?  I work with portfolio managers who are generalists, covering world economies and markets and finding themes and opportunities, and I work with PMs who are specialists, finding opportunities in rates markets in terms of directional movement (due to shifts in economies and central bank policies) and relative movement (due to abnormal movements in one part of yield curves vs. others).  Are you a broad thinker?  A deep thinker?  How are you wired that makes you special as a person and as a trader?

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3/12/2025 - Here's another issue for trader self-assessment:  How do you best process information?  Are you spending the majority of your time in the information processing modes that work best for you?  Many traders process information through social interaction:  talking ideas and hearing ideas.  Trading in isolation isolates them from their strengths.  This is why being part of a team and prop firm like SMB, where there is constant interaction on the trading floor, can be so valuable.  Note that the training classes at SMB conducted by Jeff Holden are via Zoom and feature presentation, discussion, and chat.  Research in psychology is clear:  processing information more actively and in more ways leads to deeper, more effective learning.  If you process information best by reading, then read many things and even read aloud.  If you process information best visually through charts, then have a chart review process and others you share charts with.  Make it active.  Make it interactive.

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3/11/2025 - PM - Here's another thing to think about re: the kind of trader you are:  Do you have a sound, well-thought out, tested process for making money in markets that you sometimes fail to follow or do you need to refine your processes for generating ideas, sizing positions, managing risk, etc?  In other words, do you need to do a better job of following your ideas or do you need to generate better ideas and trade them better?  Is your psychology interfering with your trading, or are your trading weaknesses interfering with your psychology?  It's difficult to make improvements in trading performance if you're not clear on what needs to be improved.

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3/11/2025 - AM - Before I respond to the questions of those who attended my recent webinar, I would like to share the fruits of a discussion I had with an experienced and insightful trader.  The basic idea is that we experience emotional disruptions in our trading, not because we lack discipline or are overcome with greed or frustration, but because we are trying to trade in a way that doesn't leverage who we actually are.  When we don't play to our strengths, trading can be frustrating and unfulfilling.  The best path to wealth in trading is to draw upon the wealth of talents, skills, and interests we bring to markets.

There are basically two types of traders.  The first generally trades very short-term and places many trades per day.  This fast trader excels in pattern recognition and also excels in the ability to maintain high levels of focus and flexibility of perception within and across trading days.  Often these traders are quite competitive and love finding and pursuing opportunities that set up on the screens or in the order books.  For instance, the fast trader will notice volume expanding on a break out of a short-term range and may quickly jump aboard that move, with the idea of stopping out on a return to that range.

The second type of trader typically holds for longer periods of time:  intraday or multi-day/week swings.  The ideas being traded are typically less about short-term pattern recognition and more about themes that are emerging within and across markets.  For example, the bigger picture trader will see selling in stocks at the same time that there is buying in bonds, driving yields lower.  The trader identifies this as the start of a risk-off theme in the market and might buy defensive stocks and sell growth shares.  The intellectual challenge of finding and exploiting themes is a major motivator for these traders.

When the fast trader attempts to trade longer time frames, the near-term pattern recognition (a strength) can actually pose distractions.  When the bigger picture trader attempts to trade short time frames, the intellectual curiosity/creativity of finding themes (a strength) can actually interfere with timing.  In other words, problems with our trading may not occur due to our weaknesses, but because of a misapplication of our strengths.

What we do well and what speaks to us is our surest path to success.

Further Reading:

Mastering the Positive Psychology of Trading

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Identifying Themes in the Stock Market

 

3/9/2025 - The most effective way to work on your trading is to identify themes in your P/L.  Suppose you break down your P/L by market condition:  rising markets, falling markets, range markets, volatile markets, quiet markets, etc.  Suppose you break down your P/L by *what* you are trading and by the patterns you're trading.  Suppose you break down your P/L by time of day, by whether you've been profitable or not at the time of the trade, by the trade size, etc.  What will happen with these breakdowns is that you'll identify patterns in your trading:  what you're doing well, where you're falling short.  Before you can work on what's wrong with your trading it's important to diagnose what is working and what isn't.  Many times the answer to trading problems is to eliminate what isn't working and do more of what you do well.  An analytical journal such as Edgewonk can be very helpful in finding the themes in your trading.  

3/7/2025 - So what is the dominant theme in the current market?  Many traders would point to the fall in U.S. stocks and, yes, that has been significant.  I would argue, however, that the more dramatic and potentially troubling theme is the recent decline in the U.S. Dollar.  (Note, simultaneously, the steep rise in the Euro and the British Pound.  The Swiss Franc has been rising, as has the Japanese Yen).  I find the Barchart site helpful in tracking all this.  If you are a money manager, asset allocator, investment bank, or sovereign wealth fund, there is no more direct way to vote for or against an economy than through investment in (or divestment of) that country's currency.  The prospect of tariffs and layoffs, combined with the recent sense of rapidly changing decision-making, may be  undermining confidence in the U.S. economy.  The fall in Treasury yields accompanying the fall in the Dollar suggests economic weakness and the eventual possibility of a cut in interest rates from the Fed.  See also the weakness in stocks sensitive to discretionary consumer spending.  The challenge of change--personal as well as economic--is to make it both powerful and sustainable.  

3/6/2025 - What portfolio managers typically understand and individual traders often miss is that volatility is an asset class.  There are ways of trading volatility (especially through options structures), just as there are ways of trading directional price movement.  What's more, not only has volatility ($VIX) been ramping up lately in the US stock market, but also the volatility of volatility ($VXX).  In other words, volatility itself has been moving around quite a bit.  That is leading to large whipsaws in the market.  It's important to identify themes in the stock market, it's important to identify themes in individual equity sectors, and it's also important to identify themes in volatility.  The "setups" that work in a low volatility market are not necessarily the same as those that apply to a higher volatility market.  The patterns we look for in a stable volatility market are not those that necessarily apply to a shifting volatility market.  We need to identify all the themes occurring now, study how markets have responded to those themes, and create what Mike Bellafiore calls "playbooks" that apply to the market we're in. 

3/5/2025 - A key trading skill is identifying themes early in their unfolding.  Once the theme is obvious and well-subscribed, it is often subject to reversal as the latecomers are squeezed from their positions.  Yesterday I heard a lot from traders about the market weakness, concerns about recession and inflation, etc.  Just a couple of days earlier, the discussion was much more about buying weakness, playing for the bounce, etc.  No question, we have seen expanding weakness in the U.S. stock market.  Small caps (IWM) and consumer discretionary shares (XLY) have been particularly weak.  Indeed, yesterday we had well over 2000 stocks on the NYSE make fresh one-month lows.  When that has happened in the past, results have been mixed in the near term, but relatively strong 20+ days out.  Most notably, the near term results (3-5 days out) have been very volatile, with large gains and large losses.  Also across the NYSE yesterday, we had fewer than 20 stocks close above their upper Bollinger Bands.  That absence of weakness has been associated with favorable returns (bounces) over the next few days.  What all this is telling us is that market themes have a shelf life.  When they become obvious, that is when continuation becomes less certain.

3/4/2025 - One thing I've learned from working with portfolio management teams for many years is that they think thematically.  They don't just look at individual charts and decide upon entries and exits.  Rather, they scour a variety of markets and see how they are moving relative to one another.  In the patterns of strength and weakness, themes emerge that are very relevant to economic growth, stability, and weakness.  The first way of identifying themes is in the relative movement of various stock market sectors.  For example, take a look at the consumer discretionary sector, XLY.  It topped out in mid-December, well ahead of the overall SPX index.  Note how the raw materials sector, XLB, topped out even earlier and is well off its October peak.  Energy shares (XLE) are off their late 2024 highs, as are the industrial stocks (XLI).  Just during the first part of the year, we've seen the defensive consumer staples sector (XLP) outperform the formerly hot technology sector (XLK).  All of this suggests a reduced emphasis on economic growth.  

Notice how there is a pattern to all this:  First we see reduced participation when the broad index makes marginal new highs and then we see *changed* participation as bear market activity commences.  The relative action of the stock market sectors tells us whether the themes dominating investors are related to growth or defensiveness; whether we're seeing broader participation or reduced participation.  Charts can be very helpful in identifying points to enter and exit when you get to the point of executing your trades.  But it's themes that provide the most reliable information re: *what* and *how* you should be trading.

Further Reading:

Understanding Market Themes From Sector Breadth

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