The first post in this series examined how successful performance is a joint function of talent and skill. The second post focused on how traders can identify their core talents. This third and final post will address the problems that undermine our trading success and what we can do about them. The central psychological challenge for trading is that frustration and doubts over losses and missed opportunities can lead to self-doubt, and self-doubt can lead us to tinker with trading to the point of veering from our greatest talents. A classic example is the intuitive trader who has a keen sense for pattern recognition. After a period of frustration and loss, he begins to overthink his entries and exits, losing a feel for markets. This compounds the losses and turns the normal setback into an outright slump. Yet another example is the trader whose key strength is risk management and prudence of decision-making. She decides she should be taking more risk and sizes up positions, creating greater volatility of P/L, and destabilizing her emotionally. In each of these cases, it looks as though the trader is self-sabotaging. What is actually occurring is that, under conditions of stress and emotional arousal, the trader has a more difficult time accessing and acting on his or her strengths. How can we know when we're getting away from doing what we do best? Two tell-tale signs let us know when we're no longer aligned with our talents: 1) Trading becomes not fun - When we veer from personality strengths, we no longer experience gratification and fulfillment in our work. That's when we find ourselves stressed and procrastinating. Recall the key idea from the previous post: the exercise of talent brings our well-being. When trading becomes work and drudgery, we know we need to pull back and get back to what we do best. 2) Trading becomes confusing - When we lose touch with our cognitive strengths, we no longer experience a sense of understanding and mastery. We trade best when markets make sense to us, when the factors we look at align in ways we've experienced before. When we are confused, it could be the case that markets themselves are confusing: those factors aren't lining up. Often, however, our confusion reflects a shift in our processing of information. We're in the dark because we've gotten away from how we best make sense of things. That's when we know we need to step back and return to our best modes of information processing. Viewed in this way, our experience becomes a barometer of whether we're aligned with our talents or not. The single most important thing we can do when in drawdown is reacquaint ourselves with what we were doing when we consistently made money. Find when you've been most successful and have traded best and you're most likely to find--and return to--your signature talents. Further Reading: The Surprising Reason for Trading Failures
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The recent post looked at trading success as a function of native talent and acquired experience and skill. Because the exercise of talent is intrinsically fulfilling, we gravitate to activities that express our talents. This exercise is what propels us through hours, days, weeks, months, and years of deliberate practice and skill acquisition. Whenever we see unusual passionate motivation, we are likely to see the consistent expression of talent. Consider four dimensions of emotional well-being: * Happiness - Finding joy in life's activities * Satisfaction - Doing things that are meaningful and gratifying * Energy - Doing things that stimulate us mentally, physically, and emotionally * Affection - Building fulfilling relationships with others When our life's activities provide us with these four elements of well-being, we are most likely to be productive and creative. We're also most likely to be doing what we're good at. Talent is one of the great sources of emotional well-being. So if you're a developing trader, how do you know where your talents lie and what you're truly good at? The simple answer is to examine what makes you happy, what provides you with meaning, what energizes you, and what brings you fulfillment with others. Your talents are hiding in plain sight, bringing you your most positive life experiences. Look to your passions and you will find your talents.
When I worked in Chicago, a number of successful daytraders were video game junkies. They would spend hours in front of screens, trading actively, and then go home and go in front of screens and play actively! Their talent was for hand-eye coordination and quick decision making, particularly in a competitive context. Suppose I tried to turn them into long-term investors, researching the fundamental strengths of assets and creating balanced portfolios. The activity would no longer express their strengths. They would lose their intrinsic motivation. They would likely become mediocre performers at best. Conversely, a talented long/short equity manager I work with is a phenomenal detective, identifying value in places where others fail to look. His great talents are intellectual curiosity and attention to detail. If I were to try to turn him into a daytrader, he would find the activity utterly meaningless. He could never sustain a learning curve. It's no surprise that, before he started trading, he ran a successful eBay business as a young kid. He was finding value and buying and selling it before he knew what the stock market was. So often, talents can be found in the activities we choose to perform when we're not required to engage in activity. No one has to tell me to rescue cats or write blog posts. I don't have to get up at 4 AM daily to greet and feed my cats, follow overseas markets, and write my 4500th post to TraderFeed. As Ed Seykota pointed out, it's not even that I have those talents. Those talents have me. You will find your success, in life and perhaps in trading, by leveraging the talents that have you. In leveraging our talents, we have the best chance of living a life filled with happiness, satisfaction, energy, and affection. Further Reading: Finding Opportunity Amidst Adversity
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Talent is what we're born with; skill is what we acquire with practice and experience. Exemplary performance, such as that at the Olympics, lies at the intersection of talent and skill. Without the hard work of skill development, talent becomes unfulfilled potential. Many hours of hard work without distinctive talent, on the other hand, can produce competence, but rarely more. We have one great advantage in our quest for exemplary performance: talent loves to be exercised. When something comes naturally to us, when we gravitate toward activities in our free time, when we lose ourselves in the flow of an activity--the odds are good that talent is involved. Skill building is not always a labor of love; sometimes it is much more labor than love. When we yoke skill building to talent, we can find the motivation to get through difficult drills and detailed performance reviews. When skill building is attempted in the absence of talent, it is sheer drudgery, and it is rarely sustained.
Can anyone succeed as a trader? Of course not. Not everyone succeeds as an athlete, and not everyone can succeed as an opera singer, surgeon, or graphic artist. Performance follows from talent and intentional efforts to cultivate talent to its fullest. Without the right kinds of bodies, we won't be Olympic sprinters, wrestlers, or swimmers. Without the right kinds of minds, we won't be chess grandmasters. Raw material matters. It may not be sufficient for greatness, but it is necessary. Show me a great trader, and I will show you at least one great talent. Great traders play to their great talent; they maximize their strengths. Show me a great trader, and I will show you a passion for his or her work. Why? Because talent loves to be exercised. A great talent is like a great horse. You can't keep it in the stall indefinitely. You have to let it run. Great talent loves to run and run free. The result is unusual productivity. But only if the talent is awakened and refined by skill development. Trading success comes with greater difficulty in recent years, because the machines have at least two sources of talent: processing speed and processing breadth. Machines can "think" faster and can integrate more information than those relying on the unaided mind alone. What person can trade dozens or hundreds of strategies across multiple time frames and multiple assets to create smooth profit/loss curves? Little wonder that asset management firms relying on such processing power have amassed hundreds of billions of dollars of assets. Markets work by the golden rule: those who have the gold, rule. Market movement is a function of capital flows, and those who have the greatest capital are in a position to most influence those flows. Great size comes at the expense of great maneuverability. When you have hundreds of billions of dollars, you cannot easily sell out of your holdings without greatly disrupting markets and getting very poor prices as a result. Large money managers have to build and trim positions over time, and that building and trimming leaves footprints. Among the traders who are succeeding in the current environment are those who possess the talents and skills to read those footprints. Opportunity does exist in the trading world, but it is a different opportunity set from the one I encountered when I first began trading in the late 1970s. But you cannot exploit those opportunities if you don't understand your strengths, how to exercise them, and how to refine them with skill development. How can we know what we're truly good at? That will be the focus of the second post in this series. Further Reading: Creativity and Greatness in Trading
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While it's true there are no elevators to success, having the right resources and making wise use of them can at least provide an escalator. Here are some resources that might make your ascent just a bit less steep: * Trading methods: The Become Your Own Trading Coach blog archives the best of past TraderFeed posts.
* News and blog feed:FinViz News updates in real time. * Learning markets: The SMB training blog covers topics related to how they train new traders. Check out this one on reading the tape.
* Keeping on top of finance and more: No one archives the best of the financial web as well as Abnormal Returns.
Here is a little-appreciated principle: Accompanying every dream is a fear. Very often, the greater the dream, the greater the fear. The fear manifests itself in many ways, not always as outright anxiety. Sometimes the fear shows up as excuses that keep us from moving forward. Sometimes the fear takes the form of procrastination; sometimes it shows up as a fatigue and a suppression of our drive. Yet other times, the fear is a direct fear of failure, hesitancy to take risks on the way to reward. Why do we fear at the same time we dream? It's not that we're sabotaging ourselves, though continually giving into fear can end up derailing our quests. No, the fear shows up whenever there is uncertainty and change--whenever we prod ourselves out of our comfort zones. Any worthwhile goal entails a shift from the status quo, and those shifts take effort. They are not comfortable. Fear is our conserving force, tethering us to what we know and where we're safe. Fear preserves the status quo.
In many respects, this is adaptive. If we were wired for easy and continual change, we would find it difficult to navigate life's many routines. Instead, we're wired for habit patterns, and those make us more efficient. They allow us to get things done, while saving finite willpower resources for challenging situations. Once we exit our habit patterns, we extend ourselves and we expend resources. We introduce uncertainty and the unknown. And that's when fear kicks in.
So how do we overcome fear and clear the path to our goals?
Here is where the Naomi Principle kicks in: we can best overcome negative emotional experiences by tapping into stronger, positive ones. Imagine if we encountered a person whose sole mission in life was to keep us from achieving our dreams and thwarting our fulfillment. We would actively avoid that person; we would actively confront that person; we would take every action to minimize their impact upon us. They would become our enemy. We would find ample motivation to not allow our enemy to win. In short, our positive desire to fight for ourselves and win our freedom would overcome any fear or uncertainty we might experience. When we visualize fear as that person standing in our way--as our enemy--we can summon that will to fight for ourselves. It's easy to give into procrastination, but if we clearly identify that procrastination is just another face of the enemy--just another form of fear--then we can ask ourselves, "Who do I want to win today: me or my enemy?" It's much harder to avoid that workout or prematurely bail out of that trade if we replace flight mode with fight mode. Anger, channeled as the will to defeat an enemy, is a more powerful--and more positive emotion than fear. That's what moves athletes and soldiers forward on the field: the desire to not let the opponent get the best of you. When our dreams are bigger than our fears, we will fight for those dreams. No amount of reasoning, journal writing, or analysis ever got someone past a fear. Only fight beats fright: we achieve our dreams when we truly fight for them. Further Reading: What It Means to be Free
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A worthwhile lens for viewing your trading processes is that of emotional intelligence. The above graphic depicts four aspects of emotional intelligence that are central to trading: 1) Self-awareness - Are you able to stand apart from yourself and observe your strengths and vulnerabilities in real time? Emotional self-awareness means that you observe and understand your emotional responses to market situations, and don't automatically get caught up in those. Self-awareness also means being fully grounded in one's "edges" as traders and not straying from those. 2) Self-management - Are you able to channel your thoughts, emotional responses, and behaviors in a constructive manner? Self-managing traders set goals that guide their activity through the day. They also behave in a rule-governed manner, whether it is with respect to entry/exit execution or risk management. Self-managing traders are ones who continuously review performance, learn from it, and place the lessons into subsequent practice. 3) Social awareness - Are you able to read participation in the marketplace? Can you pick up cues from volume, volatility, the co-movement of instruments and assets, and responses to news items that tell you whether buyers or sellers are dominant. The socially aware trader is keenly attuned to market flows, digging beneath the surface to figure out who is in the market, what they're doing, and the price levels at which they're acting. 4) Relationship management - Are you networking with others to make yourself better? Successful trading is a team sport, even when the trading is solo. There is simply too much information relevant to markets to process and stay on top of at all times. Successful traders filter out noise--the conversations, emails, and messages that contain little value--but actively filter in colleagues who have valuable perspectives. Very often, fresh inputs from those colleagues lead to fresh insights and trade ideas. Beneath every great individual performance is a well-functioning team, either real or virtual. How well are you managing yourself and your trading relationships? How well are you sustaining a high level of awareness of yourself and of market participants? It's not a far stretch to imagine giving yourself a daily report card simply on these four dimensions to ensure that you're trading in a truly emotionally intelligent fashion. Very often, failing to monetize smart trading ideas is the result of a lack of emotional smarts. The good news is that, with practice, we can learn to be emotionally smarter: better at sustaining awareness and managing our resources. Further Reading: Social Intelligence and Trading
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I recently wrote about the greatest weakness displayed by losing traders. Under conditions of drawdown, the winning trader becomes more grounded in his or her strengths. The losing trader veers from those strengths. To successfully deal with a drawdown, you want to reacquaint yourself with your best trading: focus on the best trades, double down on your best practices for preparing for the day and keeping yourself in the right mindset. The great risk of drawdown is that the losses in trading create lost confidence and lead you to abandon what has worked. Smart traders know that the same process needs to happen after winning periods in markets. A string of winning days can lead to overconfidence and sloppiness. It's when you're winning and feeling on top of the world that you once again want to double down on those best practices and best trades. Losing money is not the only risk. The greatest psychological risk traders face is losing perspective. It's when you lose perspective that you want to rediscover the trader that you are. Further Reading: Self-Regulation and Trading Performance
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What does it mean to be daring and different in trading financial markets? It means being willing to look at new information and appraise markets in new ways. Fresh insight comes from examining new data. I recently wrote about three questions to ask about any market. That post became far and away the most popular post ever on TraderFeed: number one out of over 4500 posts. Why? Perhaps because looking at markets as auction processes and focusing on who is actually participating in the market and what, specifically, they're doing takes a daring step back from the normal routines of looking at charts and following the news. One of the most powerful ideas I've worked with is relative volume, tracking when market participation is waxing and waning. Most of the time, high or low prices will shut off an auction. Buyers will refrain from buying if prices get too high; sellers will hold off on selling if prices are unattractively low. When price extremes shut off an auction, relative volume starts to fade. Those price extremes represent important information: they tell us where supply and demand are imbalanced. Should we later move through those prices with ease, we know that there is fresh participation in the auction. That is important information. At other times, however, high or low prices may actually stimulate further auction activity. Buyers are eager to acquire inventory; sellers are desperate to unload theirs. That's when we see relative volume stay high, even as markets are moving directionally. That's how trends are made. Within the volume that does transact, we can see whether those transactions result in net upticks for stocks or downticks. I track this across all listed stocks. That tells us a great deal about the relative activity of buyers and sellers at the auction. Think of markets in a sixfold grid: high, medium, and low volume and high net upticking, balanced upticks/downticks, and high net downticking. A low volume market with high net upticking will grind higher; but not necessarily move all that far. A high volume market with high net upticking often trends significantly. Low volume markets with relatively balanced upticks and downticks tend to be rangy, slow markets. As the auction proceeds, we update our views on volume and net activity. We assess who is in control and to what degree. We watch critical price levels that have represented past value and past auction extremes and see how markets behave at those points right here, right now. All of that is information readily available to all of us...but only if we dare take our eyes away from the pictures on our screens and stories in our heads. Further Reading: Creativity and Innovation in Trading
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People often have an interest in psychology because they wish to make changes in their lives. They see that their trading could be better; they want to make improvements in their relationships, or perhaps improve themselves in some way. The challenge is getting from here to there. How do we make meaningful changes in our lives? Research into counseling and psychotherapy is a little-appreciated treasure trove of information on how people make life changes. What does this research tell us about ways of making significant changes in reasonable amounts of time? Here are five important principles: 1) Focus your change efforts - Sometimes we are frustrated with how things are going at work or at home and we want to address and change everything. That's a mistake. Setting smaller, targeted goals and creating a series of small wins is much more effective in catalyzing an ongoing change process than tackling everything in diluted fashion. When goals are concrete and measurable, it's easier to appreciate when you're making progress and when you're not and taking appropriate corrective steps as needed.
2) Make your change efforts active - Too many people approach psychological work the way they approach religious worship: once a week they devote their efforts and pretty much forget things the rest of the time. That doesn't work psychologically or spiritually. Any goal worth pursuing is worth pursuing daily, and it helps (as part of the aforementioned focus) to have daily activities that move you toward your goal. If you want to get into shape, you work out daily and maintain a daily diet. If you want to improve your trading, you work on improvements that can be implemented each day. When the change process is active, changes are more likely to become part of you.
3) Make your change efforts sustainable - It's tough to sustain an active change process if that process is onerous. The most effective changes we can make are ones that become habit patterns. Yes, we often have to motivate ourselves to get over the hump of old habits and engage in new behaviors, but eventually we want to move past motivation. We want those new behaviors to become routine. This is most likely to happen if our change efforts are sustainable: enjoyable to pursue and doable. If our efforts at change are frustrating, we'll likely abandon them. The psychology research is clear: it is easier to initiate changes than to sustain them. Goals must be engaging and achievable. Small wins, over time, sustain the sense of being a winner--and that energizes future goals. 4) Begin with changes you're already making - This is the essence of the solution-focused approach, where we change by building on existing strengths and positive patterns. If you want to improve your trading, study your best trading and identify what you do when you trade well. If you want to improve your marriage, focus on what you and your partner do when you're happiest and closest. We tend to forget that we make subtle changes in how we approach situations from day to day, week to week. Some of those changes lead to positive outcomes--or at least avoid the negative ones. By identifying what we're already doing that is working, we create goals that not only are doable but that are truly part of us. 5) Emphasize changes that are meaningful - Yes, small, achievable goals work best and consistency in implementing work toward those goals is essential. Typically, however, what drives us to work on change is an inspiring vision and a sense of meaning and purpose. If my overarching goal is to achieve a trading track record that will attract the capital of investors, that adds a measure of significance to my daily work toward goals. Keeping such overarching goals visible is important, even as we work diligently on the details of performance. That is why athletic coaches inspire as well as teach. They focus their teams on practice and drills--but they also remind them that a championship lies ahead. No great things were ever accomplished within people's comfort zones. By definition, change means breaking from routine. Perhaps the most important change we can make is make the challenging of our comfort zones a daily habit. There is never stasis in life or in trading. We use it or we lose it; we extend our capacities or we allow them to atrophy. At its best, change itself becomes a lifestyle.
How can you make yourself a better trader, right here, right now? Per Coach Knight's observation, take a hard look at your trading results and identify the one kind of market you most hate, the one that is hardest for you to make money. Perhaps its a quiet market with little movement; perhaps it's a market that has already moved quite a bit. Perhaps it's a particular asset class or time frame. Identify where you really are a poor trader with no edge. That is what you're meant to work on. You work on your weak trading not because that's where you should put your eggs in the future, but because the weak areas of trading reveal the vulnerabilities that eventually will dog you in your bread-and-butter trading. The chain of your trading success is ultimately only as strong as its weakest link. But, wait, you say: Aren't we supposed to be focusing on our strengths and making the most of those? Of course you want to build on your strengths, and that is your path to growth. The creative challenge of making yourself better is to figure out how to leverage your strongest trading to improve your greatest areas of weakness. Somehow, in some way, your best trading holds the key to what you need to be doing in the markets that give you the most trouble. I don't mind sharing that I took a bit of a butt-kicking this past week in my trading. Nothing dire--each loss was small--but most my trades lost! My win rate on trades so far this year has been close to 70%, so a week like the one past stands out as a fail. So what went wrong? My strength lies in synthesizing data: looking at many measures of market strength/weakness and buying/selling and organizing my observations into a cycle-based conceptual framework. It's when multiple measures of flows come together and fit into a pattern that I'm most likely to place winning trades. The key to such trading is waiting for everything to line up. I don't find good trades; they come to me when I'm patient and maintain an open mind.
So what happens in a slow market such as we've had in US stocks? Everything moves s-l-o-w-e-r and it takes l-o-n-g-e-r for things to line up. But did my trading slow down? Hell, no! I simply moved to faster time frames and looked for things to line up on a near term basis. In other words, I adjusted my trading so that I could trade; I didn't adjust for opportunity!
Look, I've been trading since the late 1970s. I have a doctoral degree in psychology, and I've worked with more traders than I can count. I literally study markets every day. And still, at times, I can trade like an imbecile. Weaknesses break through, whether they are shortcomings in my psychology or my trading methods. Good trading is not about always trading well; it's about identifying and addressing weaknesses quickly and drawing upon strengths to remedy those. Guaranteed, this weekend I'll be studying my best trades and then seeing how often those patterns set up in slow markets. That will guide my trading this week. Every setback has a purpose: to make you stronger. But that can only occur if you're willing to look setbacks in the face, accept them, and learn from them. Further Reading: Trading With Your Brain--And Your Gut
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The most common reason traders encounter problems with discipline pertains to willpower as a limited resource. Reading, following prices, conducting analyses, and managing risk all day taxes our capacities for focused concentration. Like any muscle, our willpower can become fatigued. That's when we lose focus, and that's when we are most likely to take action in ways that we did not plan or intend. An up-and-coming trader recently pointed out to me that he understands physical exercise and what he can get out of it, but has trouble understanding the benefits of cognitive exercise, such as meditation. As it turns out, brain training is critical for success for anyone who is in the business of decision-making throughout the day.
There are two enemies of trading success: distraction and arousal. Distraction occurs when our focus wavers--either because of fatigue or overuse--and we have trouble filtering out extraneous information and concentrating on essentials. Arousal occurs when our bodies go into fight-or-flight mode, generally in response to a perceived threat. At such times, our bodies are primed to act when, very often, what we need to do is think, plan, and respond in measured fashion.
The purpose of cognitive exercise, such as meditation and biofeedback training, is to provide us with greater control, so that we're less likely to fall victim to distraction and hyperarousal.
There are three primary purposes for brain training: helping us relax in performance situations; helping us build our capacity for concentration, and helping us build our resilience to stressful situations. The most common goal of brain training is the achievement of a state of calm focus. In the calm, focused state, we sustain a physical level of relaxation while we are in a heightened state of concentration. When we remain in such a state for a period of time, we experience that as being "in the zone." That state of flow is associated with creativity as well as superior decision-making and emotional well-being.
Biofeedback devices and programs, such as Wild Divine, provide users with constant feedback about their achievement of the flow state, so that they can figure out what they need to do to stay in the zone. Video game interfaces, where winning is based upon staying in the zone, make it easy and fun to practice mindfulness and self-control. When we sustain the calm, focused state for longer and longer periods of time, we achieve deeper and deeper levels of stillness in our minds. Very often, when meditation doesn't seem to work for people, it's because they haven't spent enough time with it to achieve their second wind of consciousness. Once in that state, we achieve a clarity of perception and awareness that is exceedingly helpful for real-time pattern recognition and decision-making. Sustaining calm focus for increasing periods of time and during periods of increasing distraction and challenge is the cognitive equivalent of going into the weight room and building our physical strength. What we're building is our willpower: our ability to act with intentionality rather than randomness. Brain training is so much more than simply going into a quiet room to take deep breaths and relax. When approached in true training mode, it is our way of building our capacity to enter and operate in the zone. Training to sustain calm focus and build our capacity to stay in the zone is the most basic exercise in the cognitive gym. In the next post, I will outline more advanced exercises that can move our trading forward. Further Reading: The Power of Implicit Learning
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Can successful trading be taught? Consider this excellent post from Bella at SMB, describing what the folks at SMB have learned from the training and mentoring of successful traders. That post rings true for me, because I personally know (and have worked with) most of the traders Bella speaks about. I have observed their development and can vouch for the qualities that have made them winners.
What is clear from my observations and experience is that patterns that have a positive edge in trading can be identified and taught. What is also clear is that learning those patterns doesn't become successful trading until those patterns are truly internalized. The many hours of study and performance review serve one important purpose: taking a pattern that is "out there" and becoming so familiar with it that you learn to feel it internally. Consider raising a child from birth. At first, you're a clumsy parent, trying to figure out what the baby needs, reading through parenting guides, and reacting and overreacting to every cry. Gradually, you begin to read your baby...one cry is different from another...one kind of holding and rocking works, another doesn't. As you gain intimate experience with that child, you develop a feel for parenting. You get to the point where you can anticipate your baby's needs in real time. There is no way of achieving that kind of parenting skill and success without having plenty of baby time. It's not uncommon to see fathers struggle with knowing what to do with their babies simply because they have been so busy at work that they haven't spent the kind of intimate baby time that gives them a feel for their child's needs. It is very similar in markets. Screen time is what gives us the intimacy with patterns that enables us to internalize them. You can teach a pattern to three different traders and you can teach parenting skills to three different parents. Ultimately, it will be the trader and parent who cultivates repeated, intimate experience that is most likely to turn the information from teaching into lived performance skills. Bella says something interesting in this regard: it is not unusual for a trader to not be successful in their first year. It is often several years before the new trader can become a meaningfully profitable trader. Deliberate practice takes time. The best traders find a trading niche that exploits their talents, derive a passionate interest from their work as a result, use that passionate energy to drive their practice and review, and accelerate their learning curves as a result. But there always is a significant learning curve, with plenty of bumps along the way. Medical school is a structured training process, honed over years of research and practice. The new medical student starts with classroom learning (anatomy, physiology, pathology), moves to learning interview skills (how to take a history and physical), then moves to shadowing and assisting practicing physicians across different specialties, then takes on more responsibility within a specialty of their choice under close supervision and mentoring. No one expects a first year med student to conduct a surgical procedure; by the end of their undergraduate training, they are actively working in the OR as part of a surgical team. What I've seen among trading firms that are successful in growing talent is that they operate very much like medical schools. They teach information, they embed new students in teams and encourage learning from a mentor, and they encourage students to specialize in areas that speak to their interests and talents. That is the process that Bella describes, and it is an excellent example of how talent can grow through properly structured apprenticeship. Further Reading: Can Individual Traders Succeed in Today's Markets?
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Lately I've encountered considerable hand-wringing as to whether individual traders can succeed in markets increasingly dominated by meddlesome central banks, high speed algorithms, and large amounts of capital in concentrated hands. To be sure, the proportion of individual traders that makes consistent money is not high, particularly in the daytrading world. Of course, much the same could be said of the proportion of young athletes, actors/actresses, or writers that succeed in professional careers. What distinguishes successful individual participants from the others? Having worked at multiple trading firms and interacted at a close level with many traders for over a decade, I've identified two factors that seem to be responsible for success. The first distinguishing factor is uniqueness of perception, which is related to creativity. If a developing trader isn't seeing something unique in markets, it's unlikely they will generate unique results. The successful trader looks at different market data, different market strategies, different markets and relationships among markets. There is not much "plain vanilla" in what they do. In an important sense, they are playing a different game from consensus traders. It is because of this uniqueness of perception that successful traders find unique edges in markets. They cultivate the uniqueness by talking with successful market participants in different strategies and markets; reading out of the box market-related research; and trying out lots of new ideas in modest size. They love innovation; they love tinkering; they are intellectually curious--and they have the practical bent to put new perspectives into practice. Many times, the quantitative study of markets--searching for reliable patterns in markets--provides fuel for these fresh ideas. The second distinguishing factor is self-awareness and self-understanding. The traders successful in today's markets know their strengths, recognize their vulnerabilities, and craft strategies that play to their cognitive, as well as personality, strengths. Per Kahneman's distinction of thinking fast vs. slow, the truly excellent traders are either deep thinkers or fast thinkers. They either analyze markets in greater depth than others and see detail and nuance that others miss or they view markets broadly, seeing patterns emerge in real time. The successful trader is distinctive in one of those forms of information processing--and they make the most out of that.
It is this self-awareness and self-understanding that helps the successful trader take a good amount of risk when opportunities are present and stand aside when they are not. It is also this self-awareness that helps the great traders hire assistants and build out teams that expand their skill sets and trading scope. Very, very often, the successful traders have benefited from formal mentoring from a more senior, skilled trader. Very often, the successful traders eventually become mentors themselves. Success starts with raw materials (drive, persistence, curiosity) and develops through real-time mentoring and experience, just as it does for physicians and plumbers. The bottom line is that at every firm where I work, I do see successful traders who achieve success consistently. The opportunity sets may have changed over the years (more on that in an upcoming post), but the talent and skills to capitalize on those new opportunities are alive and well. A new generation of traders is emerging, doing new things to exploit those new opportunities. Further Reading: The Single Most Important Trait of Individual Traders
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We've all known traders who are permabears and permabulls. Their dispositions lead them to favor one market direction over another. Being a permabear or permabull is like reading all people as threatening or trustworthy. Neither is conducive to social success. We thrive in relationships when we learn to read others, not impose our dispositions onto them. Traders are always in relationships with markets. Traders thrive by reading markets, and that takes open-mindedness. One of the most important things to read in any market is volume. Per the recent important post, volume can tell us who is in the market; the combination of volume and price can tell us what they are doing and where they're doing it. Markets are auction processes and to understand markets we need to see how much inventory is clearing and where the clearing is occurring. It's not about shapes on charts or indicator readings or the next economic report or world event. It's about who is participating in the auction and what they're doing. This is why volume is so important. A low volume market, such as we're currently seeing in U.S. stocks, is one in which market makers are dominant and longer time-frame participants are largely absent. Why are they absent? It's not just because it's August; take a look at how busy August, 2011 was. It's because those longer timeframe participants do not perceive distinctive value right here, right now. Sellers don't think prices are so high that they want to part with their inventory, and buyers don't think prices are so attractive that they want to scoop up inventory. As a result, little volume occurs, and that means that we experience little price movement.
Since 2014, the correlation between the day's true price range in SPY and SPY volume for that day is +.87. The great majority of volatility can be known simply by knowing volume. That makes sense. It's the larger, longer-timeframe, institutional participants who trade and invest directionally. When they are in the market, we see more movement at every time frame. Slow volume markets are quiet movement markets. No one is there to push price meaningfully higher or lower. That creates a very changed opportunity set for directional traders. It also changes the nature of the opportunities. Let's say I create a trading system that draws bands around current prices (as in Bollinger Bands) and enters long when we move above the upper band and enters short when we move below the lower band. The target/exit is a defined distance above or below those bands. In my research (and trading), that system makes money when volatility is above a threshold level and loses money when we fall below that level. Same system, same signals, different results. Why is this the case? In higher volume and volatility markets, moves are more likely to extend. In lower volume and volatility markets, moves are more likely to reverse. What makes you money in one regime, loses it for you in another. If you're not following the market auction process and identifying the regime we're in, you are less likely to adapt. You're more likely to be dancing your same dance when the music has changed. In low volume, low volatility markets, you have one of three good choices: You can choose to not play; you can choose to play by a set of rules that works in slow auctions, or you can move to other instruments and markets that give you the volatility your trading needs to succeed. The poor choice is doing the same f*cking thing that worked for you a few weeks ago in the name of "discipline" and "sticking to your process."
Every time you begin trading, you're sitting down at a poker table. How many people are around the table and who they are will matter greatly, helping to shape your betting strategy. If you're at a car auction and want to sell your vehicle, how many people are bidding and how many of them are there to buy and sell will help shape whether and how you participate.
And, oh yes, the correlation between volume today and volatility tomorrow is about +.57. In the absence of a catalyst, when buyers and sellers accept value within a narrow range, that narrowness tends to persist. Your disposition may lead you to look for breakouts, but a statistically significant number of times in slow markets, those breakouts are likely to be fake outs.
What if you knew that, at times, you were a great trader? What if you knew that, at other times, you were a really poor trader? If you truly knew those things, there would be one overriding priority: to figure out what you were doing when you were great and what you were doing when you were poor. In other words, you would study the hell out of yourself. You would collect as much information about your trades and your trading as possible to figure out what made you tick. You wouldn't try to be a different trader. You wouldn't try to be like anyone else. You would try to become more consistent with your great trading and more aware of your poor trading.
You would break your good trading down into components and see what you're doing when you're trading successfully and unsuccessfully.
You would break your personal life down into components and see what you're doing when you're most and least successful. In short, you would try to become more of the trader you already are when you trade greatly. Here's a self-coaching exercise to get you started with your study of yourself:
A commonly encountered view in writings on trading psychology is that good decisions require that we tame our emotions through discipline and self-control. Many of those same writings talk about trusting your gut and not overthinking decisions. How we are to be open to our feel for markets and yet trade in an emotionless, zen-like state is left unanswered. In this post, I will propose something different. Our task as effective traders is to tame the ego, not dampen our emotions. Indeed, it is when we trade without the ego that we're most likely to be open to our feel for what markets are telling us. The recent post made an important distinction between understanding and prediction. Discretionary traders seek to understand market behavior from the ground up, by listening to markets the way we listen to people when we seek to understand them. When traders become uncomfortable with market uncertainty, they often seek false security in predictions. They impose views from the top-down, and they stop listening to what markets are trying to tell us.
Why do traders become so enamored with prediction? Perhaps it is because prediction is all about us. We are the ones calling the moves and leading the markets. In the dance with markets, the trader seeking understanding lets the market lead and takes their cues from the market's steps. When we seek prediction, we seek to lead the dance with the market. It becomes about us.
It occurred to me after writing the post that, when I've developed quant models of market behavior than anticipated a move, I've often heard kudos from others about my "good call." When I'm a psychologist and listening to my clients, helping them make changes in their lives by accessing strengths they didn't realize they had, no one compliments me on good calls. As a psychologist, it's not about me; my ego is placed as far to the side as possible. It's about listening to others and discovering those hidden strengths.
Emotions become problems in trading when they follow from our ego involvement in decisions. If we're making a market call and looking for self-validation by anticipating a market move, then it will be particularly frustrating if and when that move doesn't materialize. We no longer feel validated. If a trading decision is the result of listening and isn't about us, being wrong doesn't feel like being stupid. Being wrong becomes information. It tells us we have to listen harder, listen differently. Imagine if I were to come into a session with a client with a clear conviction about what we needed to talk about that day. Chances are good I'd miss what that other person had to say and might even create a frustration for them. It's no different with markets. Once it becomes about me, I can justify ignoring the messages of markets simply by calling myself a contrarian or a "mean-reversion" trader. Very often, ego-involvement is the source of trading without emotional intelligence.
How ironic it is, then, that would-be trading coaches tell us to trade with confidence and double down on bets when we have our greatest conviction. Listening to markets and following their lead requires the utmost of humility and open-mindedness. The trader with supreme conviction is the one most likely to be blind as markets turn. Once we put ego aside, we can pick up on market cues the way we pick up on the subtle nuances of tone and facial expression when we speak with those closest to us. If I'm in a rush, focused on my needs to get to work, will I really be attentive to what my wife or children are trying to tell me? We are wonderful pattern recognition machines if only we can learn to not superimpose our needs and views on what we're meant to process from the world. It's when set the ego aside that we become most attuned to our feel for the world. Perhaps the best trading strategy of all is to live a fulfilling life outside of trading. If you don't need markets for your self-validation, you're less likely to seek those "good call" compliments, and you're less likely to make your profit/loss statement a barometer of your personal worth. It's when we insist on leading the dance with markets that we're most likely to stumble as the music changes. Further Reading: Cultivating Emotional Creativity
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This post was written from Glacier National Park in Montana. Sometimes it takes a complete change of scenery to create a fresh mindset and renewed focus on what is essential--in life, as well as in trading. It's when we introduce novelty into our lives that we are most likely to achieve new insights. Recently I wrote a post that has found unusually strong interest from readers, focusing on what is most important in markets. The post was distinctive because it emphasized market understanding, not the prediction of markets. This is a very important distinction for discretionary traders. Let's say I'm a parent and I notice my son being unusually quiet, talking softlyand keeping to herself. I've seen those facial expressions, tones, and behaviors before and know that they have typically occurred whenever he has felt hurt or rejected. As a psychologist, I also know that those same behavior patterns occur in other people for other reasons, such as when they are deeply reflective about a challenge at work or when they are deeply frustrated about a situation. For those other people, the period of quiet might be followed by a burst of work effort--or a burst of anger. The quiet comes from a different place for my son, however, and has in the past led to periods of sad mood and poor work performance.
With that understanding, I simply give him a hug and let him know that he is special to me. That reaching out is enough to bring him out of his shell and get him talking about what went wrong with his best friend. With the emotional release, he begins to feel better, short-circuiting the depressed feelings and helping him reengage with other life activities. Being a therapist is all about tracking the thoughts, feelings, and actions of a unique human being; understanding what is driving those; and then using that awareness to help create a set of conditions that can lead to growth rather than setback. In a different context, that is also what a great parent does. What therapists and parents don't do is conduct backtests of all similar occurrences across all people and then generate a prediction of future behavior to figure out how to respond. Understanding is built from the ground up, taking particulars and making sense of them, creating possible explanations. Prediction is a top-down process, starting with universal patterns and applying them to particular contexts. A meteorologist seeks prediction, making use of complex models that track temperature, humidity, wind, air pressure, etc. A historian seeks understanding, looking at the motives and cultural influences that lead to political, economic, and military decisions and outcomes. Each is an approach to knowledge: we might accurately predict the outcome of a ball game and also understand the decisions and strategies that led to the outcome. Successful discretionary traders I've known and worked with have been distinguished by their level of market understanding. Successful quantitative traders I've encountered have excelled at analysis and prediction. Sometimes the successful discretionary trader makes use of predictive models as inputs to decisions; the successful quantitative trader will ground models in sound market understanding. At the end of the day, however, quants trade their predictions and discretionary participants trade their understanding. One trades universal patterns; another trades insights specific to what is observed here and now in a particular market. What I realized in the Montana mountains is that the psychological challenges faced by traders often leads them to seek quick (and artificial) security in market predictions. Instead to staying grounded in what is happening here and now, as in the example of my response to my son, a frustrated or uncertain trader might look for answers in top-down predictions. If a psychologist were to do this, he or she would become emotionally tone-deaf, no longer tracking the meaning of the unique individual in the conversation. When discretionary traders leap to a mode of prediction, they often lose their feel for markets by imposing ideas that clash with the actual messages of "the tape". I propose that successful discretionary traders are successful for the same reason that people are successful in relationships: they are able to stand apart from their own emotional responses and habit patterns so that they can appreciate and understand the thoughts, feelings, and actions of others. When we track who is in the market, what they are doing, and the price levels at which they are acting, we assemble the raw materials for understanding market activity. It is difficult to truly understand what someone is saying if we're busy fitting them into a model and trying to predict what they'll do. The same is true for the trading of markets: we fail when we become so eager to anticipate outcomes that we stop listening to the actual messages of markets. Quantitative information can assist the understanding of a discretionary trader; it can never substitute for it. Further Reading: Trading Emotionally, With Intelligence
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Author of The Psychology of Trading (Wiley, 2003), Enhancing Trader Performance (Wiley, 2006), The Daily Trading Coach (Wiley, 2009), Trading Psychology 2.0 (Wiley, 2015), The Art and Science of Brief Psychotherapies (APPI, 2018) and Radical Renewal (2019) with an interest in using historical patterns in markets to find a trading edge. Currently writing a book on performance psychology and spirituality. As a performance coach for portfolio managers and traders at financial organizations, I am also interested in performance enhancement among traders, drawing upon research from expert performers in various fields. I took a leave from blogging starting May, 2010 due to my role at a global macro hedge fund. Blogging resumed in February, 2014.
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