Tuesday, June 12, 2007

The Trading Coach Project: Coaching Gets Started With an Assessment

I recently announced that I would be coaching a single trader free of charge for a month and posting the process to the blog to illustrate how to improve trading performance. The trader selected for this round of the Project is Trader C, a professional trader who has worked for a trading firm for several years. He has a track record of success over those years, even as many other traders have had to leave the firm. Expenses at his firm (commissions, fees) are not cheap, so that his ability to make a living from trading after all costs is itself a noteworthy accomplishment.

Trader C. has a number of strengths beyond his profitability. Unlike many of the traders I've worked with in Chicago and more like traders I've worked with at hedge funds, he trades many different individual stocks. He also trades different time frames, holding many positions intraday, but also carrying longer-term swing positions. I was immediately impressed by his ability to detect and trade themes in the market. For example, he noticed early on the rise in rates and was quick to short interest-rate sensitive issues. He will hold such short positions at the same time that he is long other stocks and sectors, creating a diversified portfolio.

Trader C. tracks his profitability by spreadsheet daily and has numerous printouts of his trading metrics, including his largest wins and losses, average wins/losses, profitability by day of week, and profitability by the particular stock traded. He keeps a journal in his spreadsheet, commenting on the day, and he has utilized cognitive techniques to improve some of his trading shortcomings. These shortcomings are what brought him to volunteer for the Project.

The histogram above shows the distribution of Trader C's trades thus far during 2007. (X-axis is profitability of the trade in ranges or bins; Y-axis is the number of trades with that particular level of profit). This is taken directly from his trading log/spreadsheet. When I work with a trader, I don't start with their psychology and try to use it to improve their trading. Rather, I start with their trading and use that to understand what is happening for them in their thinking, feeling, and acting. Keeping accurate data on your trading is one of the most important things you can do to identify both strengths and weaknesses.

What we can see from the above distribution is that:

A) Trader C is making modest money for the year; he hasn't been as profitable as he has been in the past;

B) He has many small winning trades;

C) The left side of his distribution shows a good number of large losers that negate many of his small winning trades.

When I examined the distribution of his profitable and unprofitable trades as a function of time, what I found was that he was losing money for much of the early part of 2007 and only recently had turned profitable for the year. His last 18 trades were 12 winners and 6 losers with only one relatively large loser, but four large winners.

In Trader C's initial email to me, he stated:

"I tend to break my rules in position sizing, get careless about keeping my stops and keeping my losses small, and finally taking profits off the board when I have a windfall because i think I can "get more". With the elimination or reduction of these bad habits, I would probably triple my income."

Later he elaborated:

"What I have been doing right is my feel for the turning point, or breakout, or direction of a group, but my drawback is the initial sizing in them. I find that I tend to go full size and more after I see the confirmation, but I chase a bit and have quite a bit of heat before going my way."

What is happening, it seems, is that Trader C is getting too aggressive on his entries, sizing positions too large initially, and then taking larger-than-necessary losses when his ideas don't work out. This creates the distribution pattern from his above histogram and is observable in a single statistic: the average size of his losing trades has been greater than the average size of his winners.

So why would an experienced and sophisticated trader like Trader C fall into this pattern? It's not enough to simply say he's "losing discipline". Successful coaching demands that we understand *why* these lapses are occurring. Diagnosing the problem--and understanding his strengths--will be the topic of the next post in this series.


Coaching the Professional Trader

Performance Coaching: When It Works, When It Doesn't

Why Coaching Fails: Stages of Change