Sunday, November 18, 2007

From Solution Patterns to Best Practice Rules: Learning From Success

A theme I hear from many traders is the tendency to get complacent after a winning period in the markets. After all, when we’re doing well, there really aren’t that many problems to work on!

The fallacy, of course, is that self-development is limited to “working on problems”. It is equally important to drill down, identify strengths, and build upon these. In that sense, we can work just as hard after winning periods as after losing ones.

One way I work on my trading after a winning streak is to crystallize what has contributed to that success. As I’ve described in past posts, this is the essence of the solution-focused approach. The idea is to turn those solution patterns—the things we're doing right—into trading rules that represent best practices.

Here are a few of those best practice rules that I’m focusing on this week:

1) Keeping on top of the market’s larger picture – The indicators that I’ve been updating daily on this site and in the Trading Psychology Weblog have been exceedingly useful in detecting underlying strength and weakness in the market. This has helped me enter the market short-term in the direction of the larger market picture. Even when my timing has been less than perfect, the market has been forgiving, because I’m catching that larger picture. In practice this means that, before starting my trading day, I’m creating a framework that identifies whether we’re trending up, down, or range bound and using that to guide shorter-term trading decisions.

2) Adjusting position sizes for market volatility – I’m estimating the day’s volatility and, as volatility rises, I take my position size down. What that means in practice is that each trade from day to day is risking a similar dollar amount and seeking a similar reward. The smaller size has enabled me to sit through market noise that would otherwise take me out of trades, and it has brought a consistency to my P/L that helps promote consistency in my trading.

3) Sticking to the knitting – I have core patterns that I trade and core times of day when those trades have been most successful. During the winning period, I have not moved away from that base. It is easy to get caught up in success and increase trading as profits roll in. In the past, that has led me to move outside my areas of greatest competence. Recently, my approach has been workmanlike: trade my patterns, make my money, and move on. By not getting too excited about the winning, I avoid overtrading and the inevitable disappointment caused by overtrading.

Too often we get back to basics and trade well only after suffering a drawdown. By requiring ourselves to generate rules for best practices, we can ensure that we are doing the right things before those drawdowns occur. That can make a dramatic difference in trading results—and in our frame of mind.


Best Practices in Trading

A Solution Focused Linkfest