Trading Psychology Principles and Best Practices

 

*

Principle #5:  Trading is a team sport.  I recently described a number of ways in which teamwork magnifies our learning and spurs our performance.  Teaming up with other dedicated traders adds layers of accountability to our decision making; it also provides us with multiple inputs for trade ideas and ways of managing risk.  Many psychological challenges of trading occur out of frustration, due to limitations of trading in isolation.  When traders are committed to helping one another, there is no room for emotionality and impulsivity.  Ultimately, however, traders who develop their own expertise within a team provide unique and valuable input to one another, supercharging decision-making processes.  It is very rare to find elite talent that develops in isolation.  In sports, in academics, in the arts:  mentoring from experts/coaches and learning from peers supercharges performance.  Who is making you better every day?  Who are you making better every day?  It's great to learn in a community, but it takes teams to build the performance that comes from commitment.  

Principle #4:  Great trading requires the ability to invest.  A member of an Olympic basketball team will work intensively (with coaching/mentoring) on every part of their game--passing, shooting, defending, rebounding, etc.--and will spend further time to work on practicing new plays and strategies tailored to the vulnerabilities of the opponent.  They invest hours and days of practice to prepare for competition.  Similarly, the best traders invest time in every part of their game, from finding the best opportunities to refining entries, sizing, exits, and the structuring of positions.  Working with a coach/mentor adds a layer of accountability to the trader's efforts and helps traders focus those efforts in the areas needing the most work.  For the professional, much more time is spent in practice, review, and making improvements than in actual performance.  The goal is not simply to win a game or make money, but to become your very best in every aspect of what you do.  The measure of a great trader is found in what they do outside market hours.  

Principle #3:  The best trading proceeds from values, not needs.  This is related to the idea that great traders have a passion for markets, not trading.  The challenge of understanding markets engages our curiosity, fueling efforts to dig deeper and dig differently.  That is what uncovers fresh edges in markets.  The best trading teams that I've worked with are just as engaged in markets when they're not trading as when themes are active and prices are moving.  In trading, as in other performance fields, success is a function of the ratio of time spent practicing and preparing for performing vs. the time actually spent in performance.  We can only sustain such intensive, deliberate effort if we find something intrinsically rewarding in preparation:  we value the process of curiosity and discovery.

This is why trading based upon needs never works.  When we need to trade--when we need P/L--markets control us.  We're no longer engaged in a performance mode.  In trading, as in our personal relationships, deficit needs are a weak foundation for longevity.  The best relationships, including our relationships with markets, are based upon positive values.  They are expressions of who we are, not vehicles for what we lack and need.

Principle #2:  Know who is on the other side of your best trades.  Many of the best short-term trading edges come from exploiting the behavioral tendencies of others in the marketplace.  What that means in practice is, not that you simply avoid emotional trading, but that you identify the emotional trading of others and take advantage of their cognitive errors and overreactions.  We had a great example on Friday, when the SPX went down on meaningful selling pressure (as measured by the number of trades hitting bids; the number of stocks trading on downticks).  Eventually the selling pressure led to a situation where buyers came in (as measured by volume lifting offers; the number of stocks trading on upticks) and price moved higher.  From that point forward, there were continued bouts of selling that could not push the market to fresh daily lows.  The bears kept selling, even as price and volume were telling them they were wrong.  That contributed to a rebound that was every bit as potentially profitable as the prior decline.  

The people on the other side of your best trades are those slow to update their views and positions.  They are trading their ideas/biases and not truly tracking market activity and its shifts.  The open-minded ability to adapt rapidly is one of the most powerful edges for short-term traders.

   

Principle #1:  The best trades come to you.  I have consistently found that, if I begin my market day with a definite idea and a desire to trade that idea, I'm likely to lose money.  If, on the other hand, I enter the day having done research but then adopting an open mind as to whether or not the market will follow its historical tendencies, I'm much more likely to place winning trades.  Really good trades are not something I bring to the market.  Really good trades emerge from being immersed in the market.  Watching and watching, listening and listening to what the market is saying leads to moments where it suddenly becomes clear what is going on.  The idea will come to me (as happened yesterday) that buyers cannot push this market higher.  That leads to a nice short trade to fade what has been happening.  

When trade ideas come from immersion in the market, we experience a quiet confidence in those ideas.  Calm clarity is a sign that an idea has come to you--that you're not simply imposing your needs, your views, your desire to trade on the market.  One of the most promising practices in trading psychology is training the brain to more consistently operate in a mode of enhanced focus.  The best trading comes, not from controlling emotions, but from building our capacity to stay in the zone.  When we wait and wait and wait and track the market and track the market over time, we are doing the very things that help train our brains.  

Success comes from active patience.  That's when the great trades come to us.     

How Teamwork Makes The Dream Work

 

5/28/2025 - What I see happening in the best training of trader talent at hedge funds is a marriage of top-down and bottom-up analyses.  Top down analyses are often historical studies of how a stock or market has behaved under a given set of circumstances.  For instance, if a company reports earnings that are significantly above consensus, how does its stock tend to behave over subsequent time periods?  Or, if interest rates make a new month-long high, how do different stock market sectors tend to behave going forward?  The top-down analyses provide a big picture of where there might be edge going forward.

The bottom-up analyses are all about shorter-term pattern recognition and how a stock or market tends to behave when price and volume meet certain criteria.  For example, if a stock trades with high relative volume and breaks above a two-day range, how does it tend to behave during the remainder of the trading session?  

The marriage of top-down and bottom-up analyses aids trading psychology because traders understand what the edge is, why it is there, and what to do about it.  That broader understanding contributes to confidence in the idea and the ability to take meaningful risk when the odds are in the trader's favor.  Great traders, like great poker player, know the hands they are playing, the odds of winning with those hands, and how to best bet those hands.

5/26/2025 - So how do teams in professional trading settings help their members trade at their best?  They do so by exchanging ideas on:  1) Why to trade (what are catalysts for buying/selling); 2) What to trade (what instruments/stocks will best exploit the reasons for taking risk); and 3) How to trade (what would provide ideal risk/reward entries; what would be opportunities to size up positions; how positions would best be structured for risk/reward).  In other words, teams don't just share ideas for entering trades.  They collaborate to get the most from those trades.  What to trade is just as important as why to trade.  How to trade is just as important as what to trade.  When teams review their trading together, they internalize lessons in making the most from their ideas.  

5/25/2025 - Below we can appreciate how teamwork helps us make the most of our talents and accelerates the development of our skills.  Teamwork also builds our trading psychology, as we are motivated to help others and serve as a role model for them.  Basic training produces soldiers ready for combat in grueling circumstances.  The right training in markets similarly produces a robust mindset in the face of uncertainty and setback.

So how can individual, independent traders gain the benefits of teamwork?  A first step in the right direction is to find a trading partner who is committed to working with you and who you are committed to helping.  A two-person team more than doubles the benefits of sound trading processes.  By performing separate research and then brainstorming findings, a trading pair can generate ideas that neither had come up with on their own.  Similarly, when reviewing performance together, the lessons learned from our partners, combined with our own lessons, can stimulate creative ideas for making trading improvements.  

Too, working as a pair improves trading psychology as each member focuses on helping the other.  That keeps everyone constructive.  The interactions tap into social motivations, keeping both members helpfully engaged.  Training programs for traders and trading communities can be great places to start the search for trading partners.  Following traders who post on social media may also lead to useful collaborations.  

Teamwork creates synergies...even when the team is two.

========  

I work with a number of portfolio managers at hedge funds.  Here are a few facts about them:  

*  All of them have a history of success in financial markets; that is why they are managing hundreds of millions of dollars or more.  

*  None of them discuss with me emotional, impulsive trading, FOMO, revenge trading, etc.  The issues that trouble beginning traders are largely irrelevant to experienced, profitable market participants.  Through their training, they have learned to operate by clearly defined processes.

*  All of them work in teams.  The best teams consist of members who have their own unique strengths.  When everyone on a team is better than everyone else in some area, then everyone can make everyone better and the whole is much greater than the sum of the parts.

*  The best teams work as hard on their teamwork as on their markets.  They constantly look to improve what each person looks at, how they look at it, and how they communicate.  They work as hard on team goals as individual goals.  They review team performance every bit as much as they review their own individual performance.

*  The best teams work hard on maintaining a positive, supportive culture.  They take time outside market hours to play and celebrate, as well as to meet and plan.  The best team members support one another and motivate each other.  When I have observed teams at hedge funds and prop firms like SMB, for example, I've invariably noticed that they enjoy their interactions.

Being part of a trading community is helpful, but it does not substitute for being part of a committed team that coordinates trading efforts day in and day out.  Show me a performance field where people earn their livings from stellar performance and I'll show you a field where performance is a function of teamwork.  Even the Olympic athletes succeeding in individual events train as a team and benefit from the teamwork of mentoring and coaching.

Read this carefully:  A lack of discipline in trading comes from a lack of teamwork in training.  No one becomes a disciplined, elite soldier on their own.  It takes teamwork to make our dreams work.

.

The Truth About Trading Success

 

Well, my latest trading companion is doing quite well, as can be seen from her picture at her 6-week birthday.  It's amazing how personality comes out even at that early age.  There is much that we inherit that helps shape our cognitive and emotional functioning.  This shapes our talents, many of which appear surprisingly early in life, influencing our development.  We are wired so that the exercise of our talents is inherently enjoyable.  In that way, we pursue what we are good at and what speaks to us, leveraging our talents with acquired skills.

Back in 2010, I explained to a number of companies that solicited my involvement that the reason I didn't want to partner with them was that they are cheap whores.  Can you imagine promising eager young people that anyone who works hard enough (and who makes use of your exclusive services) can become a successful professional basketball players, Hollywood actors/actresses, ballet dancers, or chess masters?  The idea is absurd, because we recognize quickly that no amount of classes or coaching can substitute for raw talent.  The reason elite performance is elite is because it leverages rare talent and the mentored building of superior skills.

The worst of the worst in the trading world are the services that breathlessly promise traders a path to being successful.  They appeal to the egos of vulnerable people and their desperate need for success and then explain that failure is a function of emotional trading!  Well, the reason the trading is emotional is because the traders so desperately need to feel like successes.  They are not leveraging talents; they are needy.  They overtrade and fail to manage positions well because they are trading for ego and self-worth, not for truly professional reasons.

The truth about trading success is that it only comes by leveraging what we have already been successful at, because that is where we find our talents and passions.  We cannot trade to become successful.  We can become successful at trading by drawing upon our previous successes.  But, of course, not all of life's talents translate into trading prowess.  It's interesting that most people would readily recognize that not everyone can make a living from sports performance or artistic activity.  They have trouble accepting that with respect to trading, however.

A desperate need to be successful is not a passion for an activity.  The ones with real passion and talent are just as motivated to study and understand markets as they are to trade them.  One of most important questions we face is:  What do I do superlatively well, and how can I express those talents in my relationships, in my career, in my personal pursuits?  Life's goal is to grow into the very best version of who you already are.

So we'll let little Nomi, the six-week old kitten, figure out what she loves doing and then structure her environment so that she can do lots and lots of what she loves.  As the saying goes, "If you meet the Buddha on the road, kill him!"  Our enlightenment--our path--is to be found within, not by following would-be gurus.  Your talents are your trail and will lead you to mentors who can teach you skills.  When we pursue our talents, we'll always have a positive life P/L.