Saturday, September 02, 2006

The Most Important Psychological Skill for Traders - Part One

A holiday weekend is a good time to review trading journals, pick apart your results, and engage in self-assessment.

If your results are not what you hoped for, an important question to ask yourself is, "Why?".

There are three basic reasons why traders don't succeed:

1) They are trading a market and time frame that lacks opportunity;
2) They are trading a method that does not possess an objective edge in the marketplace;
3) They have a promising market, time frame, and method, but are not executing it properly.

Of these reasons, #3 is the most frustrating for traders. They feel as though they have the tools to succeed, but they themselves get in the way of their own success. Many times this is because emotional factors interfere with sound decision-making.

My recent post on techniques for dealing with emotional disruptions of trading offered a number of links to articles on cognitive, behavioral, and solution-focused methods for gaining self-control. Many more articles on trading psychology are available on my personal site, and a much more detailed explanation of the relationship between psychology and trading can be found in my book. It was because interest was so high in learning self-help methods for dealing with emotional disruptions of trading that I included step-by-step self-help manuals as the last two chapters of my latest book.

My hope is that these resources will help traders become their own mentors.

After my recent post, I received several emails asking a similar question: "What is the best technique I can use for getting myself in control?"

Most psychological disruptions of trading involve either under-control or over-control: traders either become impulsive and lose discipline when frustrated (resulting in overtrading), or they become anxious and negative (and miss out on opportunity).

The key to understanding these problems, as I stress in my book, is to recognize that they are generally state-dependent. They do not occur at all times, under all conditions. Rather, they are triggered by particular events and associated emotional states. The trader who is frustrated or depressed trades differently from the trader who is in a normal, non-aroused emotional state. This is because of brain physiology: we activate different brain regions and functions under conditions of arousal vs. conditions of calm concentration.

For this reason, the most important psychological skill for traders is simply the ability to control your body's level of arousal. It is near-impossible to maintain a collected frame of mind when your body is racing in flight-or-fight response patterns or withdrawing in the face of defeat. If you can control the body, you are much better positioned to achieve cognitive and emotional control.

Three steps can help you gain rapid control if you practice them frequently:

1) Stop whatever you are doing and take a break;

2) Sit comfortably and focus your attention on something neutral. As I mention in my book, a sound and light machine is ideal for this: you simply focus on the patterns of light and eliminate (as much as possible) stray thoughts. Biofeedback games can also be effective in focusing your attention;

3) Once you have your attention fixed, regulate your breathing by taking longer, deeper, and slower breaths. The slowing and deepening of the rate of your breathing will help slow your heart rate, lower your muscle tension, and reduce other biofeedback indicators of stress.

In the beginning, you may need to do this exercise for 10-15 minutes at a time a couple of times per day. As you become more skilled, you'll find that it takes less and less time to get yourself focused and calm. Eventually, just focusing your mind and taking a few deep breaths will get the job done. But it takes steady, consistent practice.

The exercise interrupts negative patterns of thought by controlling your concentration. It also slows your body down, which in turn helps you slow down racing thoughts. Because so many negative behavior patterns are triggered by states of frustration, heading off these states by proactively engaging in this exercise is especially effective.

Take a look at your P/L. How much money have you lost by not following your rules due to emotional disruption? If that figure is significant, the investment of time you spend learning these techniques will produce meaningful returns.

In my next post, we'll take a look at how you can integrate cognitive methods into the basic relaxation exercise.