Friday, July 06, 2007

The Trader Coach Project: Beginning the Change Process

If you recall, my last post regarding Trader C viewed his presenting problems from a unique angle. Instead of simply framing his concerns as ones of "discipline", I took a step back and suggested that he was experiencing a kind of mismatch. His emerging strengths as a trader are his ability to develop, trade, and manage multiple ideas and his confidence in pursuing those aggressively when the time is right. These strengths have enabled him to develop a style of trading that is part scalping (short-term trading) and part portfolio management (longer-term combinations of long/short ideas).

The mismatch occurs when we view Trader C's style in conjunction with the risk management of his firm. Specifically, his firm manages risk on an intraday basis, requiring traders to exit positions when certain (relatively modest) loss levels are hit. This almost ensures that Trader C will be stopped out of even very good positions. As a result, he has become frustrated and caught in a cycle of pursuing good ideas, sizing those too large or letting them run too far with respect to his firm's loss limits, pulling those positions back, achieving diminished returns, and becoming even more frustrated.

To break this cycle, I suggested two steps to Trader C, both of which made sense to him:

1) Reorient His Longer-Term Trading - I suggested to Trader C that he view the portfolio management part of his trading as an audition for either expanded/altered risk management parameters at his firm or for joining another firm that encourages such trading. My deal with Trader C is that if he can size his longer-term ideas quite small, he will still have a valid track record to show firms--which I will help him with. Moreover, the resizing will enable him to fly under the radar of his firm's risk management, so that he can actually profit from those ideas. My specific suggestion to him was that he assess the correlation of his positions with the general market and size those positions so that a two-standard deviation intraday market move would not force him into untimely liquidations. Note that this means he needs to manage risk on a portfolio-wide basis (i.e., viewing all of his positions vis a vis the probability of hitting his daily loss limit, not just risk managing each position in isolation and then finding that the combination of positions entails far more risk than he realized). This creates a new goal for Trader C: to position himself for the next phase in his career by managing his positions conservatively; not by trying to maximize his P/L by sizing aggressively and trying to hit home runs.

2) Grade Himself Daily - Out of a lengthy phone conversation, Trader C and I decided that he would issue himself a daily report card that covers three aspects of trading: a) how he sized each trade (to stay within his firm's risk parameters); b) how he established and honored his loss limits (stop losses) for his positions; and c) how he established and honored his initial profit targets for his positions. Each day, as a result, Trader C would give himself a grade between A and F on these dimensions. So far, early in the exercise, he has achieved A and B grades. The report card enables us to focus on the process of trading rather than P/L (which can't always be controlled), and it further cements our goal of creating a consistent trading track record that he can use to position himself for a future trading larger capital either at his firm or elsewhere. The grades, over time, will also enable us to establish a connection between *how* Trader C trades and his overall risk-adjusted performance.

What we're trying to do is channel Trader C's strengths, particularly his aggressiveness, into an effort to become aggressively consistent. His frustration has resulted from focusing on P/L in situations where he's been stopped out of good positions. The grading system enables us to focus on the process of trading, which he can control.

My work with Trader C illustrates a couple of important principles for coaching and change. First, successful change efforts have to be mutually framed. These goals and initial efforts at breaking a cycle came about as a result of extended discussion with Trader C. Effective coaching cannot be "one size fits all", in which pre-fab techniques are applied mechanically without understanding of the trader's unique circumstances. How I'm working with Trader C and viewing his problems is radically different from how I might work with a different trader who presents similar initial concerns (diminished profitability, frustration, discipline issues).

Second, the coaching with Trader C highlights the importance of consistency and accountability. The work that Trader C is doing on himself requires a daily effort. We're not simply talking about problems once a week and vaguely hoping that this will change established behavior patterns. Rather, we're creating hands-on exercises that he can perform each day to reframe his goals and alter what he does. The grading system and our tracking of his performance ensures that each of us is accountable to the other.

With respect to hands-on exercises, I recently suggested two more for Trader C to support the efforts mentioned above. Those exercises--and how you can apply them to your own trading--will be the focus of the next post in this series.


Becoming Your Own Trading Coach

Self-Coaching to Let Profits Run

When Coaching Works and Doesn't Work