The Most Important Reason Traders Can't Size Up Their Positions

It's really true:  confidence doesn't come from success alone, but rather from facing failure and moving beyond it.  When you've been tested and tested and tested again, you begin to recognize that the tests are what make you stronger.  They provide the opportunity of learning, not merely the threat of loss.

But many traders fail to look fear in the face.  They chronically undersize positions in an effort to prevent major losses.  When their ideas work out, however, their undersizing also prevents major gains.  Over time, those traders are nagged by the sense that they have skill, learning, and an edge in markets, but are not taking proper advantage of their strengths.

So they come to me and ask for help in risk-taking.  They want to size up positions, but can't bring themselves to do it.  It's too scary to look fear in the face, so they settle on quick glances.

Why is this?  Why are some very talented traders unable to take optimal advantage of their talents?

I recently met with a group of traders and reviewed their journals.  Most of the journal entries were very detailed, suggesting hard work and desire to improve.  The entries went through the trades they put on, how those trades went, and what they could have done better to manage the positions. Sometimes the journal entries also spoke of missed opportunities and positions sized too large or taken in the absence of a clear signal.

My first reaction was that these journals are a waste of time.  They outline problems, but don't contain any detailed plans for correcting those problems.

But I was wrong.  The journals were worse than a waste of time.  They were killing the traders.

Look at it this way:  Suppose I kept a detailed journal of your life and wrote down everything you did wrong, as well as the things you could have done better.  Better yet, imagine approaching a young son or daughter in this manner.  What would be the result?

Damaged self-confidence.

If you keep harping on what you do wrong, why would you internalize a sense of opportunity and achievement?  If all you focus on is what you could have done better, eventually you'll believe that all you can do is fall short.  A good sports coach or military leader knows when to praise and when to criticize: when to build up and when to tear down.  Without the building up, all we do is tear down.

So what happens?  We make money but internalize the sense of "could have done better".  What we don't internalize is confidence.  We're never on the front foot when taking risk because we've programmed ourselves to expect shortcoming.

Take a look at your trading reviews and journals.  Do they inspire?  Do they focus on specific learning and achievement, or are they simply ventings of frustration and things that didn't go as well as possible?  Many, many traders are not working on their trading at all.  They are working on tearing themselves down.

Further Reading:  How To Become A More Confident Trader

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Turning Our Goals Into Commitments

One of our great vulnerabilities is that our intentions tend to be mood dependent.  When we've just lost money and are in a remorseful state of mind, we vow to correct our errors and stick to our best practices.  Then, the remorse gives way to curiosity and excitement and we forget our resolution.  We allow our new moods to create different intentions--and different action patterns.  True discipline means acting in a consistent manner regardless of mind state.  That requires commitment.  If we are truly committed to losing weight and getting in shape, we get to the gym no matter what time of day it is or what the weather is like.  When we are committed to self-improvement, we don't rest on our laurels when things are going well.  As Mike Bellafiore recently pointed out, we use positive performance the same way we use negative performance:  as a source of learning and development.

Commitment is something we do, not something we have.  The religious person starts each day in prayer; the basketball team meets each day for practice and conditioning; the world-class trader searches for opportunities and re-searches sources of new opportunities.  These are routines sustained by a sense of urgency and importance.  They are not mood-dependent because the sense of urgency transcends the moods of the moment.  I might not feel like going to the gym and eating a healthy meal, but if I know the health of my heart depends on those actions after I've just had a heart attack, my feeling state of the moment becomes irrelevant.  

Traders focus on setting goals to further their development, but goals by themselves lack power unless they are backed by urgency and are fueled by commitment.  If I deeply love my wife and am filled with gratitude for the many things she has brought to my life, I can be in a funk and yet still want to do things for her and with her.  If I urgently desire to win the next game, I'll shrug off my tiredness and push myself and my teammates in practice to take us to the next level.  Show me your daily routine, and I'll show you your commitments.  If it's in your heart, it will be in your calendar; if it's in your calendar, it will become an intrinsic part of you.  Our activities express our character and shape it.

Further Reading:  Time Maps as a Psychological Performance Tool

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Four Important Trading Insights

Here are a few valuable insights I've gathered from my recent work with skilled, successful traders:

1)  What you trade is as important as how you trade:  The successful traders are trading instruments that move in meaningful ways and that capture their best ideas.  That means trading instruments that show the right kind of movement, and it means expressing your ideas through positions that offer the best risk/reward.  The successful traders have many ways to capture ideas:  many time frames, many instruments (stocks, futures, options), many markets.

2)  Balance matters:  When trading gets difficult, it's often the traders most passionate about trading--who devote most of their waking hours to trading--that are most vulnerable.  It's easiest to see markets clearly when trading fits into your life, not when you are frantically fitting your life into trading.  The goal is to have a happy, fulfilling life no matter what markets or P/L are doing.

3)  The best trading ideas come to you:  So much of trading boils down to real time pattern recognition.  You see many things, and you see them line up, and the idea comes to you that the market is making a top or bottom, that the momentum move will continue, etc.  Finding the good trade means shutting down the ego, emptying the mind, and becoming receptive to insight.  If you are actively *trying* to make money and thinking about how much you're making or losing, you fill your mind with outcome-thinking, which crowds out the process focus.

4)  Develop a higher cause:  I hear traders fretting over losing trades, getting frustrated and losing discipline and focus because of missed opportunities.  Chill.  There are people with real problems in the world: their homes flooding, their lives in jeopardy, their futures uncertain--in Houston, in Florida.  I've been impressed with traders who are strongly grounded in their religion.  Of course they don't like making trading mistakes, but they don't let the most recent trades dictate their moods or perspectives.  Perspective is the most powerful psychological tool of all.

When we develop relationships with other dedicated, successful traders, we build role models.  We learn from their experience, accelerate our development, and contribute meaningfully to the growth of others.  Trading goes best when it is yoked to rewards (intellectual fulfillment and challenge; committed teamwork) that are independent of the most recent trading results.

Further Reading:  The Power of Doing Nothing
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Overcoming Perfectionism in Trading

A reader recently asked the question of how to overcome perfectionism in trading.  Like many traders, the reader recognized that the quest for perfection was actually demoralizing him and leading him to trade worse and worse. Trying to buy the bottom tick and sell the top, he was missing trades. Losing money, he became his own worse critic.  Even when he made money, he found himself focusing on how he could have made even more by holding a little longer, sizing a little larger, etc. Slowly, perfectionism was stressing him out and interfering with his trading.

Sound familiar?  It's a fine line between being success-driven and achievement oriented and being perfectionistic.  We want to keep pushing forward, but at some point the push becomes part of a problem, not a solution.

There are two keys to understanding perfectionism:

1)  It is a way of talking to ourselves;
2)  It is a way of channeling anger and frustration.

The perfectionist is channeling anger inwardly, looking at the gap between the real (actual performance) and ideal (possible performance) and becoming frustrated at that gap.  That is why so much perfectionistic thinking is of the "should" variety:  you *should* have held the trade longer; you *should* have been sized larger; you *should have taken the trade; you *shouldn't* have taken the trade.  It's all frustrated self-talk.

As I discuss in my books, we generally possess enough social sensitivity that we would *never* consider talking to a friend or colleague in the tone we use with perfectionistic self-talk.  We would never get in some one else's face and tell them all the things they *should* and *could* have done better.  We would recognize right away that there is no constructive value in such talk.  It doesn't help anyone move forward.

That is the key point to recognize:  there is nothing constructive about perfectionism.  It's self-abusive; it doesn't move us forward.  It's a dumping of anger, not an effort to learn from mistakes.

Once the trader recognizes that the problem is not their trading, but their way of thinking about their trading, then they can begin the work of recognizing the frustration in real time, interrupting the perfectionistic thoughts, and introduce self-talk that is more similar to talk one would do with valued friends and colleagues.  

In practice, the sequence looks like:  "OK, I just lost money and I'm feeling frustrated.  I can feel myself getting caught up in *should* thinking.  That is the same perfectionism that has stressed me out and hurt my decisions.  I might have made a mistake, but I don't deserve having anger dumped on me.  Before I take my next trade, I'm going to review what might have gone wrong with the last trade and see if I can learn anything from it that will help the next trade.  I refuse to keep talking to myself in a harmful way!"

Many times, keeping a cognitive journal is a great way of structuring this process and developing new, constructive habit patterns.  The Daily Trading Coach book describes this journaling in detail; see also the reading below.  Once we become aware of the *consequences* of negative thought patterns, we can truly *regret* them, and build a determination to not repeat them.  It is very healthy to focus on self-improvement:  we move ourselves forward when we try to become better.  We shut ourselves down when we demand more.

Further Reading:  What Format of Trading Journal is Right for Me?

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Turning Trading Anxiety Into Growth

Here is a powerful psychological technique that I learned from a wise therapist I saw when I was in graduate school.

Identify clearly what makes you nervous, uneasy, fearful, or anxious.  Typically, those will be situations that you find yourself avoiding.  Anxiety is a form of psychological pain. No one likes pain, and so it's often easiest to avoid the situations that make us uncomfortable.

A good trading example would be bumping up your trading size and hence your risk-taking.  You've been doing well in different market conditions and would like to take greater advantage of your edge in markets.  Increasing the size of your trades, however, will increase the P/L swings for each trade, each day, and each week.  That is not necessarily comfortable.  So we may find ourselves making excuses, avoiding the situation that makes us nervous.

The therapist I met with in Kansas specialized in dream interpretation, so much of our discussion centered on my dreams from the past week.  One dream was that I was on a playground, climbing a tall slide.  At the top of the slide was a lever.  You could set the lever anywhere from 1-10.  I realized that the setting would determine how fast you went down this large slide.  I decided to be prudent in the dream and selected a "5" setting.  

Now I should mention that the issue that brought me to therapy was feeling "blah" in my life.  I didn't feel all that much excitement about what I was doing and felt that the resulting malaise was keeping me from doing my best in all situations, from school work to relationships.

The therapist quickly perceived that the dream image of the slide with the lever was a creative metaphor for my life at the time.  I was going down the slide, but keeping my descent safe and predictable.  Perhaps it was time to try a higher setting on the slide.

That's when the therapist offered a keen perspective.  She said that, if you're not a person with an actual pathological anxiety disorder, your fears point the way toward your growth.  We grow by embracing and pursuing what makes us anxious.  The reason for this is that we always grow by extending our boundaries, by going beyond our natural comfort zones.  Whenever we forge new territory and push our self-defined limits, that's scary, that's the unknown.  

The implication is profound:  we tend to avoid what makes us uncomfortable, and our discomfort tends to occur in those areas where we most need to grow.  If you find yourself procrastinating, avoiding, nervously setting your life's challenges at a comfortable "5", those are the areas to pursue. In mastering those fears, we find the person we're meant to be.

And the ride down life's slide becomes a helluva lot more fun.

Further Reading:  Embracing Stress, Minimizing Distress

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The Power of Regret in Trading

One of the more fascinating phenomena in trading psychology is that traders will trade poorly, miss opportunities, and lose money--and then they will proceed to do exactly the same things the next day and the next week. Finally, hurting from the losses, they seek psychological assistance.  But is the problem primarily one of psychology?

A close look finds that traders commonly respond to losses in two ways:  

1)  As frustrating events, inevitable but difficult to experience and important to move beyond;

2)  As mistakes, to be noted and learned from.

Not uncommonly, traders will respond in the first way and then transition to the second in order to put losses and missed opportunities behind them.

Then, having placed the experience behind them, the traders repeat the exact same behaviors!

Why?  Haven't they done the right things, psychologically?

Let's imagine a different situation.  Suppose you unwittingly hurt the feelings of someone you love and damage their reputation.  Or suppose you are entrusted with the care of young children and feed them improperly, causing great and painful illness.  How would you respond?  Would you simply deal with it as an annoying, frustrating event?  Of course not. Would you respond by merely keeping a journal and jotting down a lesson to be learned?  I don't think so.

If you truly hurt people you cared for, you would feel deeply guilty.  You would be overcome with regret and you would beg their forgiveness.  You would not deal with the situation as a mere psychological issue.  You would respond to it spiritually: as something profoundly wrong requiring repentance.  You would be unlikely to repeat the hurtful situations, because your sense of regret would sear into your heart and mind a commitment to be more aware and sensitive in the future.

We commonly view guilt as a negative emotion to be overcome.  We view "guilt trips" as things to be avoided.  It is not by coincidence, however, that all major religions incorporate the ideas of sin, guilt, and atonement.  It is also not by coincidence that programs such as AA emphasize moral inventories and making amends for the damage created by addiction.  We don't change because we're frustrated by a behavior, and we don't change because we treat that behavior as an error.  We change because we feel horror, regret, and disgust at what we've done and the damage we've created.  We move on, not by minimizing our behavior, but by fully connecting with the consequences of that behavior and then proceeding, in all sincerity, toward forgiveness.  

Alcoholics who hurt their health, hurt their friends, hurt their career opportunities, and hurt their spouses and children--and who don't view all that with absolute regret and an absolute desire to change--those are alcoholics at risk for relapse.  Traders who lose their money, miss opportunities in life and in markets, who fail to support families that count on them--and who don't look at that with a deep feeling of guilt and responsibility--those are the traders who will continue the error of their ways.

All the psychological techniques in the world can't help someone who doesn't perceive and deeply feel the need for transformation.  Pain alerts us to a situation in our body that needs to be evaluated and treated.  In that context, pain is an important part of health.  Guilt and regret are pain of the spirit. They are telling us we have been on the wrong path. That can be a very constructive element in our development.

Further Reading:

  Peak Performance Conditioning

Regret and Trading

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The Unappreciated Reason Hard Working Traders Underperform

I recall a trader who was struggling with his trading, getting out of winning trades too early and letting losing trades run. His coach worked with him tirelessly to keep daily journals and track his discipline.  Amazingly, the more he worked on his "process", the more erratic his trading became. Eventually he could not sustain his career and went into other work.  It was one of the first times I had seen coaching directly lead to a trader's demise.

The problem was that the trader was placed on a strict risk management regimen.  Essentially he had a mandate to make money, but lose very little.  This tight regime led him to trade increasingly short term to limit his losses.  That short term horizon did not allow him to meaningfully participate in the bigger picture ideas he generated.  On the few occasions in which he did try to faithfully follow his research, he drew down before the position ultimately worked out and had to stop out prematurely. That compounded his frustration. 

Quite simply, the trader's strength was as a big picture thinker and investor.  He was given a mandate to be a trader and that took him out of the zone of his strengths. Journaling and rigidly adhering to a process that did not capture his strengths only served to block and frustrate those strengths. His weakness was a function of strengths that could not find expression.

So it is with many traders.  They work and work and work on their "discipline" and "process", when in reality the problem is that their trading method does not capture their true cognitive and personality strengths.  If you are finding that the usual psychological approaches are not helping your trading, I encourage you to check out the recent article on how our strengths can create weaknesses.  My hope is that the article gets you thinking about your strengths in a new light, so that, instead of working on "problems", you can focus on leveraging the best of your information processing, emotional, and interpersonal assets.

If your trading results aren't what you hoped, even after considerable work, perhaps you are trying to participate in markets in ways that thwart the best of who you are. Working harder at the wrong things can only produce disappointing results.  We are best able to figure out markets if we first have figured out ourselves.

Further Reading:  How Our Strengths Can Weaken Our Performance

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Ideas For Jumpstarting the Market Week

*  If you want to know another person's psychology, just listen to their words and observe their actions.  Are they dwelling on the past or creating opportunity for the future?  Do they express anger and frustration or gratitude and fulfillment?  Do they actively create positive experiences for others, or are they largely focused on their own needs?  Do they seek adventure or the sameness of routine? If their words and actions were foods, how nourishing would you find their diet?  Does your trading reflect awareness and acceptance, or does it come from a place of ego?  All the psychology in the world won't help a trader living the wrong values.  Our psychology reflects our values in action.

*  Seriously, if you haven't delved into Weighing the Week Ahead and all its links, you're missing some solid market prep.  Check out winners of Jeff's Silver Bullet Awards:  perhaps a gold bullet should go to winner David Bailey and colleagues for consistently provocative, thoughtful research.

*  Nice to see Merritt Black teaching new traders with a framework of auction theory and Market Profile.  Recognizing value areas in markets and how volume behaves as we move away from value is key to understanding short-term price action.  Jim Dalton's work remains a tremendous resource in making sense of seemingly random market behavior.

Further Reading:  Evaluating Yourself as a Trader

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Awareness and Acceptance in Trading

Two of the most powerful psychological assets in trading are awareness and acceptance. Let's look into those.

Awareness means that we consciously direct attention to something.  We become a keen observer; we focus our attention.  Self-awareness means that we direct our attention inward and observe ourselves. Market awareness means that we step back from moment to moment price action and observe something about the market.  We most effectively act on something if we sustain awareness of it.

As Branden's quote suggests, however, awareness means little if it is not accompanied by acceptance. In a state of acceptance, we are open minded; we readily process what we observe.  When we lack acceptance, our awareness cannot become insight.  We shut off our awareness when we fight against it.  Acceptance means that, sometimes, we have to process information that is uncomfortable.

The trader who lacks awareness is clueless.  The trader who is aware but who lacks acceptance is defensive.  This is a very important principle.  When we find ourselves becoming tense or frustrated in trading, it is often because we are aware of something we have difficulty accepting.  Whatever that something is, is usually important.

Yesterday I was trading long in the market early in the day and doing well.  I then did my usual thing, waited for a qualified pullback and bought.  The market ticked higher, stalled, and then went to a lower low on increased selling pressure and volume.  My awareness said, "This shouldn't be happening."  My acceptance said, "This is the wrong trade."  I exited for a small loss.

Then, however, a second level of acceptance kicked in.  I said to myself, "A good trade that fails can be a signal in the opposite direction."  In other words, if flows truly had shifted in the market, we should not look back and surpass the highs that preceded my qualified pullback.  That acceptance of a change in market flows/direction allowed me to sell the next bounce and, indeed, continue to trade the short side in the afternoon.  That made for a good day of trading, but it was only because I could truly accept the information the market was providing.

Earlier in the week, I was locked into a view that we would move higher in the market and failed to accept the same exact information.  That not only led to losing trades, but the failure to capitalize on potential winning ones.  Interestingly, my lack of acceptance interfered with even my awareness.  A closed mind cannot accept, but it also is hampered in processing what is in front of us.

It is not enough to try to eliminate negative emotions in trading.  Many of those emotions, from uneasiness and nervousness to frustration and discouragement, reflect an awareness that we are having trouble accepting.  Losses and missed opportunities are less threatening when we view them as tools for expanding our awareness and gaining new perspectives.  As in my case, the losing trade was the catalyst for winning--but only because of awareness and acceptance.

Further Reading:  The Power of Self-Awareness in Trading
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Capturing Value and Momentum in the Stock Market

In mid-2014 I hit upon an idea for analyzing the strength and weakness of the overall stock market. Suppose we took every stock in the New York Stock Exchange and assessed whether it gave a buy signal, a neutral signal, or a sell signal for a standard technical indicator, such as Bollinger Bands. Such a measure would capture the breadth of strength and weakness for stocks as a whole, not just for the index itself.  Would this be a useful measure?  It turns out that the measure was indeed useful and I began collecting the data daily from the Stock Charts website.

Then I hit upon another idea.  The signals from cumulated stock performance on one indicator (such as Bollinger Bands) were different from the signals from other indicators (such as RSI and Parabolic SAR).  Might it be useful to create an indicator of indicators? This would show occasions when we have strength and weakness across all stocks *and* all indicators.  

The resulting cumulative indicator measure is charted above from 2016 forward (indicator in red; SPY in blue).  Even within the considerable uptrend we've had over that period in SPY, we've seen relative periods of overbought and oversold in the measure.  Note that we currently stand at a significantly oversold level.

Going back to June of 2014, when I first began accumulating these data, next ten day returns in SPY have averaged +.01% when we have been in the top half of the distribution for the cumulative measure.  When we have been in the bottom half of the measure, next ten day returns in SPY have averaged +.63%.  This is a significant value effect.  Returns have been significantly better over a swing period when we've been oversold than when we've been overbought.  If we break down returns by quartiles, the upside returns are even more striking in the weakest (most oversold) quartile, which is where we stand now. Interestingly, when the indicators have been simultaneously strong, we've seen superior upside returns over the same ten day horizon.  

In other words, the cumulative measure is capturing both a value effect (buy when things have gotten weak) and a momentum effect (buy when there is a broad thrust higher). Returns have been subnormal if we are not broadly weak or broadly strong.

This is a nice illustration of the value of "big data" and especially the value of well-conceived unique data sets.  As a discretionary trader, I find it crucial to be quantitatively informed.  I observe that integration of discretionary and quantitative among the great majority of the successful traders and portfolio managers I work with.  Even for longer time frame active investors, timing market entries and exits with shorter-term measures that capture value and momentum can meaningfully enhance returns.

Further Reading:  The Foundation of Trading Success

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What I've Learned From My Trading Setbacks

During the summer months, I have made a concerted effort to work on my trading.  My year to date results had been well below my average returns and indeed had turned negative for the first time in recent memory.  I took that as a worthy challenge and engaged in a detailed review of what was working and what wasn't working in my trading.  I'm pleased to say that the results of this work have been quite positive, not only turning the P/L around but also instilling both a consistency of process and a consistency of results.  Below I share a few of the things I have learned in my trading that might be of help to other traders who are adapting to challenging, low volatility markets:

1)  Think in Cycles - This has been one of the two greatest changes I've made in my trading.  I stopped thinking about trends and ranges entirely, I don't focus on chart patterns, and I don't pretend to know what the "big players" are doing apart from noting volume patterns.  Instead, I am identifying dominant cycles in the market at short, medium, and longer time frame and focusing on how those cycles interact with one another.  I am focusing on cycles of volatility in the market, as well as cyclical price action.  This has been a much more effective way to participate in directional market behavior, especially when implemented in event time. The cycle framework has naturally made me more flexible as a trader:  at certain junctures in a cycle, I am a "trend" trader, following the momentum that occurs when cycles line up.  At other cycle junctures, I am a "mean reversion" trader, adjusting to the "choppiness" that occurs when cycles are not aligned.  Most of all, I've become better at focusing on dominant cycles and the ways in which volatility regimes shift the cycles that dominate.

2)  Focus on Execution - A side benefit of the cycle framework is that it allows for simultaneous tracking of short term and longer term cycles.  The short term cycles become extremely useful in entry and exit execution, allowing the trader to extract more from each trade.  I find that the difference between good entries and exits and poor ones in low volatility markets is an important component of making and losing money.  I might be trading a longer term cycle, but I will use a short term cycle to get in near a trough and exit near a peak.  This is a bit counterintuitive, as you're buying when things look worst and selling when they've been recently strong.  By giving execution a short volatility bias, it's helped me participate in directional moves that do occur.

3)  Focus on Trading Spirituality, Not Just Trading Psychology - This is subtle and is a topic not everyone is comfortable with.  Trading just doesn't work when it is *me* focused.  Me making money, me losing, me becoming successful, me working on my state of mind, etc.  Once the ego is the focus, we lose flexibility and perspective.  I of all people should know that: as a psychologist, if therapy ever becomes about me, I lose my effectiveness.  The skill of a therapist is in listening, understanding, and responding to another person.  If I'm concerned about my income, my reputation, or my feelings about the other person, I lose my focus and my impact.  In the past months, I've regrounded myself in my religion and made spiritual readings a daily part of my morning routine. The change in perspective has been dramatic. A turning point occurred when my research yielded a very good trade opportunity.  I didn't feel excitement, conviction, greed, or any of those things.  I felt grateful.  It's a big change.

I'll be doing a free online workshop this week and will be happy to amplify these ideas.  Setbacks occur for a reason; they point the way to new directions we need to take.  I hope you always have setbacks in your trading and I hope they always make you a better trader--and a better person.
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Free Group Coaching on August 9th

I've recently found group coaching sessions to be highly productive.  When a group meets with me for coaching, we can discuss the common challenges members are facing and each person can learn from the experience of others.  In recent sessions, I've outlined specific psychological and trading approaches that address those challenges, so that group members can take away concrete goals and directions for improving their trading.

I'm pleased that Futures.io is hosting a free group coaching session with me at 4:30 PM on Wednesday, August 9th.  The extended "ask me anything" format means that this will *not* be a lecture-style presentation.  Rather, attendees will be part of a group that interacts for group coaching. Participants can ask questions about their personal lives, their trading approaches, psychological challenges they face in trading, how to join trading firms, and much more.

Here is the link for registration for the event.  Space in the room is limited, so please sign up early.  And start thinking about the best questions you have regarding trading psychology.  It's a great opportunity to learn from each other's experience!

Thanks as always for the interest--

Brett

Renewing Our Trading And Regaining Our Passion

One of the most striking differences among traders I have encountered is their grounding in a problem-based mindset versus an opportunity-based mindset. The problem-focused trader is chronically frustrated, battling one challenge after another.  The opportunity-focused trader is inspired, finding meaning and direction in setbacks.  It's easy to become problem-focused when losing money and it's easy to perceive opportunity when things are going well.  The successful traders I've known look for problems when things are going well, because they are always looking for opportunities to improve.  They are also looking for what is going well during periods of drawdown, because that is where opportunities may be showing up.

In a recent article, I outline why I believe we could be on the cusp of important market opportunities. Yes, it's been a challenging period for traders in terms of low-volatility market behavior and erratic trends.  But, as I outline in the article, there *are* strategies and approaches that are working; I *do* see people succeeding.  There is opportunity in current difficulty.

What has kept me alive in markets since the late 1970s, besides risk management, has been research.  Every week I update my database, explore ideas, and test out strategies.  Easily 80% of what I look at is either worthless or duplicates what I already have.  Another 10% is promising but ultimately has limited value.  It's that final 10% that opens new doors and yields fresh opportunity.  I could become discouraged about the 90% of research that never finds its way into my trading, or I could be energized by the 10% that moves me forward.  

If I were not innovating, what would keep me interested, driven, optimistic, and energized during periods of drawdown?  Too often, we are mired in problem-based mindsets because our focus is solely on P/L.  So our focus and passion rises and falls with our equity curves.  When we approach markets with intellectual curiosity and a love of sharing ideas with like-minded colleagues, we create whole new sources of motivation.

Trading was fun when it was new.  The challenge is keeping ourselves re-newed.

Further Reading:  Why Trading Has A Future

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Why We Overtrade and Why We Miss Opportunities

So many psychological problems of trading boil down to underaction, failing to act when it is appropriate to do so, and overaction, taking actions that are not warranted.  Undertrading means that we fail to "pull the trigger" on our ideas.  Overtrading means that we trade outside the range of our ideas.

As Gandhi's quote suggests, our actions express our priorities.  The trader who fails to act is very often prioritizing preservation of capital and avoidance of risk and loss.  The trader who acts excessively is prioritizing gain and avoidance of "missing out".

What I find in working with traders is that underaction and overaction occur in a specific context. Very often the trader has figured out the idea that would have them long or short a market or stock. What they have not explicitly outlined is the specific set of conditions that would have them act upon this idea.  In other words, traders have an idea, but not a clear "setup" criterion that would have them execute that idea.

In the absence of a clear entry or exit signal, traders are left with ambiguity.  That ambiguity is the fertile ground in which those psychological priorities--avoidance or risk, fear of missing out--grow and become dominant.  It is necessary to have sound ideas with edge to succeed in trading, but having great ideas is not sufficient to bring success.  One also must know how to implement those ideas.  Without a sound basis for implementation, ideas cannot come to consistent and optimal fruition.

To be sure, we see the opposite problem as well.  Traders will grasp as "setups"--patterns of price movement--as ideas and trade these without any objective verification of having a probabilistic edge in outcomes.  "Selling is holding at the X price level" may be a useful observation, but it is not a plan and in itself confers no edge.  A common problem among daytraders is such eagerness to trade and make money that relatively little time is spent researching ideas that are actually worth trading and that have the potential to make money.

Once we distinguish between the idea we're trading and our plan for executing that plan, we're in a better place to figure out when we need to work on our ideas and research (i.e., trading the wrong ideas) and when we need to work on the trading of those ideas (i.e., faulty execution of our ideas). Very often, we overtrade and fail to act on valid opportunities simply because we have not been explicit about the idea we're expressing and how we are expressing it.

Further Reading:  Why Disciplined Traders Make Bad Decisions

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Evaluating Yourself as a Trader

Very quickly, evaluate yourself on the following criteria:

1)  Innovation - Researching new sources of edge in your trading, drawing upon different inputs; learning new strategies and markets; finding new opportunities; learning from your experience and the experience of others.

2)  Flexibility - Ability to find opportunity in different market conditions, different markets, and different time frames; ability to move from being aggressive to being patient and back again; ability to trade different strategies and different sides of markets.

3)  Self-Improvement - Always assessing what you could do better and making steady improvements; following through on goals with concrete plans and actions; keeping yourself in peak performance condition.

If I had to identify one flaw affecting struggling traders, it would be stasis.  The static trader does not innovate; is too fixed in doing one thing; and has no consistent process for improvement.  Most important, struggling traders aren't following Elon Musk's advice and questioning themselves.  

Show me what traders are working on outside of market hours, and I will show you the odds of their future success.  A passion for trading in the absence of a passion for innovation and improvement is a sure path to losing money.

Further Reading:  Finding Your Trading Strike Zone

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Reaching the Next Level of Trading Performance

Einstein observed that we cannot solve our problems with the same level of thinking that created them.  In other words, problems exist in our deficiencies of perspective.  Once we reach a next level of perception, thought, and analysis, problems can give way to solutions.  An important contribution of mentors and coaches is to introduce us to next levels of thinking.  If we are locked into our old modes of perception and thought, we will be locked into our level of performance.

On Wednesday, July 19th, I'll be speaking at Stock Twits' second ever Futures Forum in New York City.  We'll be meeting at Slattery's Midtown Pub and enjoying food and drink--and I'll be presenting key ideas regarding getting to the next levels of trading performance. (Registration information for that free event can be found here).

One very important idea is that almost always we are already performing at that next level of performance on some occasions.  It is when we are at our best that we can clearly perceive our next level of development.  That is what we are ready for.  That is what we are already capable of.  At times, we are closer to our goals; at times we are more distant.  When we clearly identify what we're doing when we are nearer to our ideas, we start to piece together a roadmap for getting to our next level.

What are you doing well now and how are you doing those things?

Those are some of the most important questions in trading psychology.  Our next level of thinking is the thinking we're doing when we're performing at our best.

Further Reading:  Building Self-Efficacy

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Beyond Coping: The Inspiration Mindset

Let's consider a key distinction:  Being in a coping mindset versus being in an inspiration mindset.

The coping mindset is problem focused.  It means tackling a difficult, stressful, and/or unpleasant situation and getting through to completion.  The focus of a coping mindset is getting past a negative; getting through a disagreeable challenge.  Coping mindset is what we experience during a subway delay or during an interminable contentious business meeting.  Coping mindset is also what we experience when we have chores to tackle at home, responsibilities with family, and a backlog of demands from work.  

The inspiration mindset is different.  Whereas coping takes energy, inspiration gives energy.  Inspiration is value focused.  It follows from engaging in a meaningful activity, immersing ourselves in a greater vision or purpose.  The focus of an inspiration mindset is appreciating a positive, finding affirmation through our actions and/or experiences.  Inspiration is what we experience when we encounter a breathtaking vista or when we achieve a meaningful goal.  The inspiration mindset is also what we experience when we find closeness in our relationships and a sense of purpose in our work.

Very often the same activities can be undertaken in a coping mindset or in an inspiration mindset.  Performing physical exercise could be experienced as coping with an unpleasant, demanding routine or as a valued development of your capabilities.  Going to work or tackling your trading could be an exercise in coping with threats and frustrations or it could be an opportunity to make a meaningful difference and achieve new and better things.  A marriage can be something we cope with to avoid conflicts, or it could reflect a deep emotional, spiritual, and physical fulfillment.

During periods of flat performance or drawdown in markets, trading can feel like an exercise in coping.  I recognize this when I speak with traders and hear nothing of the excitement, challenge, discovery, and growth that initially attracted them to markets.  It is like speaking to a person who was once in love and now copes with a relationship that has lost its romantic spark.  The trader may choose to work on problem A, B, or C, but it's all just different deck chairs on the Titanic.  The problem is not A,B,or C, but the devolution to the coping level.  The problem is the absence of inspiration:  the way in which trading has become divorced from value, meaning, and purpose.

Traders who sustain an inspiration mindset find value and meaning in markets above and beyond recent performance.  They discover new opportunities through research; they learn new things in their professional networks; they benefit from developing teams and mentoring up and coming talent; they use their trading as a way to develop themselves as people.  To sustain an inspiration mindset means figuring out how to make negative P/L days winning days in process terms.  

Coping and inspiration mindsets are self-reinforcing.  Others respond to the energy we project.  If we come across as inspired, others are attracted to the meaning and fulfillment we radiate.  If we are absorbed in coping, our negative vibe will attract a very different tribe.

What will inspire your day today?  Your week?  Coping is far better than not coping, but there is much more to life than getting through tasks and burdens.  You know you're on the right path when you find meaningful, energizing ways of tackling unpleasant responsibilities and challenges.

Further Reading:  A Powerful Technique for Changing Your Trading Psychology

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Self Awareness and State Awareness in Trading

One of the topics I'll be addressing in depth at the upcoming Chicago workshop (July 24-26) is understanding your physical, emotional, and cognitive states and how those contribute to good and bad decision making.  

Much of our behavior--in and out of markets--is state dependent.  How we interact with others, how we take risk, how we tackle challenges:  all of these are impacted by the degree to which we are energized or fatigued; calm or keyed up; fulfilled or frustrated; distracted or focused; etc.  

In the right states, we can access our greatest strengths.

In the wrong states, we fall victim to our greatest weaknesses.

Awareness and management of our states--and the ability to cultivate new states and extend existing ones--is central to peak performance.

One of the great challenges of trading is balancing market awareness and self-awareness.  

You have a trading process: a way of identifying opportunity, defining trades, and managing the risk and reward around positions.

Do you have a self-awareness process?  

We track price action closely; how aware are we of ourselves and whether we are in the right states for peak performance?

This is one of those areas where work on our trading requires work on ourselves: in becoming better traders, we become more self-aware and self-determining human beings.

I look forward to working on that self-development at the workshop.

Further Reading:  A Cognitive View of Trading Psychology

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What Is Making Money Now In Financial Markets

I recently wrote on the topic of how trading has sharply moved in an evidence-based direction.  That has enormous implications for trading process.  Specifically, it means that traders are spending the bulk of their time researching opportunities in markets, not staring at screens and putting on trades.  The successful trader is looking less and less like an intuitive market wizard and more and more like an insightful, disciplined researcher.

Read carefully the recent blog post from The Mathematical Investor describing which hedge funds are outperforming the others--and outperforming the markets.  It's a relative handful of funds that are performing very well and gaining assets.  These funds have several significant advantages:

*  They utilize high frequency algorithms to place trades and manage positions, making trade management a profit center, but also freeing up traders' time from the tasks of execution.  In many situations, it is far more time and cost-effective to systematize execution than to hire a small army of discretionary execution traders.

*  They have the capability of ferreting signals from large, complex data sets, allowing them to generate edges in trading not available to casual inspection and intuitive processing. 

*  They have the bandwidth to develop many models in many markets, creating highly diversified sources of returns and more reliable revenue streams.

These advantages are conferred by superior processing power (supercomputers); superior programming capabilities (capacity to store and access data and automate processes); superior data sets (more information and more unique information); and superior mathematical expertise (better ways to transform and analyze large data sets without overfitting).

The point that The Mathematical Investor is making is not that quant trading is superior to discretionary trading.  It's that mathematically sophisticated trading/investing has been superior to everything else, including lower-level quant that attempts to systematize discretionary insights by applying basic statistics and modeling methods.

In that sense, trading is looking a lot like weather forecasting.  Forecasting was once a wholly discretionary activity based upon the reading of cloud patterns and the feel of the air.  Later, it became possible to quantify such variables as wind speed, air pressure, and humidity and use this information to understand weather patterns and make forecasts.  At present, computer models capture the complexities of interacting weather systems to make forecasts that would be impossible to an individual forecaster looking at a thermometer and barometer.  

Where I am seeing the greatest success of individual traders is in niche strategies and markets, where inefficiencies are most likely to be present.  Many of these exist in strategies and markets where there is limited liquidity and hence limited participation of sophisticated funds.  An example would be certain commodities and companies, where detailed knowledge of the market and industry can still confer an edge in trading.  This is akin to a small business person finding a niche in a community he or she knows well, thus performing well in spite of the presence of large retail firms.  Specialization, uniqueness, and detailed product knowledge are likely to outperform generalist trading strategies as sophisticated market participants continue to claim the most liquid sources of alpha.

Further Reading:  Becoming an Evidence-Based Trader
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Behavioral Techniques for Mastering Your Trading Psychology: Relaxation

A recent blog post outlined the process of diagnosing the problems that may be leading to drawdowns and poor performance.  This post will be part of a series for the forthcoming trading psychology online encyclopedia on the specific approaches and techniques for addressing those problems when psychology is at their root.  

Behavioral approaches to the change process involve skills building and especially the formation of new, constructive habit patterns.  When we engage in behavioral methods, we are literally teaching ourselves new action patterns: replacing problem patterns with new, effective ones.

The first behavioral method that I have found to be helpful for trading problems is relaxation training. In relaxation training, you teach yourself skills to calm both mind and body.  My favorite relaxation exercise is to listen to absorbing music--I find instrumental music preferable to music with lyrics--while controlling the rate and depth of your breathing.  You perform this exercise seated in a comfortable position and in a quiet environment, free of distraction.  While focusing on the music, you breathe deeply and slowly from the diaphragm, but not in a strained or exaggerated way.  If you notice your mind wander, you simply refocus on the music, perhaps following a melody line or beat from a specific instrument.  During this time, you stay very still and make your breathing increasingly deep and slow.

It usually takes 15+ minutes for beginners to get themselves "in the zone" with the deep breathing and focus.  As you practice (mornings and evenings are great times for practice), you will find yourself quicker and quicker at entering the calm, focused mode.  It's not unusual for a trader experienced in relaxation methods to completely center themselves with just a few deep breaths.  My experience is that the longer the relaxation session, the deeper the state you can enter.  Sticking with the exercise for 30+ minutes can induce a very focused and clear state of awareness.

A variant of this relaxation method is known as "progressive muscle relaxation."  In this method, you start at one end of your body (your toes, for example) and--while listening to music and slowing and deepening your breathing--you slowly tense and relax those muscles.  So you might curl your toes gradually and tightly and slowly release them.  Once you've done that, you work your way up the body, lifting and releasing your feet, then tightening and releasing your calf muscles, etc.  Eventually you work your way to your head and tensing and relaxing your brow and forehead.  All of this typically takes 15+ minutes.

The progressive muscle relaxation works for two reasons.  It calms and focuses you, but it also turns your conscious awareness to your body and away from day-to-day and trading stresses.  This "gearshift"--the alteration of your state of consciousness--is common to all the major approaches to counseling and psychotherapy.  It's a very important principle: to change a behavior, you first have to shift your state.  Learning a new skill in a new state accelerates the process of internalizing that skill.

The key to success with relaxation methods is practice, practice, practice.  It's like any skill: mastery comes from repetition.

Relaxation methods are valuable as preventive tools.  You can practice getting "in the zone" before you start trading and during breaks in the trading day to ensure that you avoid overconfidence, frustration, and discouragement.  It is difficult to get worked up if mind and body are greatly slowed down.  Doing the muscle relaxation midday is a great way to get into your body and return to markets in a fresh state.

Relaxation methods are also valuable tools when you catch yourself overtrading or anxious and avoiding opportunities.  By temporarily pulling back from the screens, you can center yourself relatively quickly and return to markets far more calm and focused.  I often find myself regulating my breathing during trading, thereby sustaining the state practiced in the relaxation exercises.

Relaxation techniques are a first building block for other, more detailed behavioral skills and so they're a great place to start your skills building.  For more detail on relaxation and other behavioral methods, you can check out the behavioral chapter in The Daily Trading Coach.  In the next post in this series, I will illustrate how relaxation methods can be combined with self-hypnotic suggestion for targeted behavioral change.

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