Friday, December 19, 2008

Breaking Trading Slumps by Becoming Your Own Trading Coach

Here is an email from a developing trader that I believe all of us can relate to. It offers an outstanding opportunity for self-coaching:

"Is this month's ES market so different from September? November? As you may recall, I am new at this game. I have been working my tail off training to trade the ES by trading for real, but tiny in SPY. May is when I began to develop my current approach. As I am a newbie, the approach/strategy has morphed as I learn. In my practice trading, I achieved really quite good results in the fall. I make many discretionary decisions, but my most firm rules are for risk management. So, I think there is some consistency in my approach. But I would not describe my trading as very consistent. I have disciplinary lapses, but I am learning about them all of the time and the progress is good. December's results are horrible, however. No big losses, which is my strength. I keep them pretty small. But this month, so many losers! I am just so confused about it. I am looking at the same things, thinking the same way; I am not under any more pressure than I was in the fall...What the heck is going on? Is this par for the course for a guy who has been trading the ES for 6-7 months?"

There are two major reasons for traders entering slumps: 1) changes in their life situation and/or mindset leading to their getting away from strengths and sound trading practices; 2) changes in markets, especially with respect to trend and volatility. In the first scenario, the trader changes how he/she trades and loses money. In the second scenario, the trader trades the same under different market conditions and loses money due to a failure to adapt.

Our trader asks the question whether this month's stock index market is so different from recent months. As the monthly chart above suggests, the answer is yes. December is shaping up as an inside month, with a far narrower range than prior months. If we drill down to a daily level in SPY, we find that the average high-low range has been 4.34%, down from 5.83% in November and 6.74% in October. In the last two weeks, the average daily range has been 3.89%. In short, we have lost both trending and volatility in December.

Note that our trader prides himself on having "no big losses". In the current month, however, he has had many losing trades. The first thing I would investigate as his trading coach is how often he has been getting stopped out on trades that begin as winners and how often he has been stopped out of trades that not long after would have been winners. If he has not adjusted his stop-loss levels for the changes in the market's volatility, he will wait for larger moves than ultimately materialize. The trade starts as a winner, but eventually reverses against him. If he has overadjusted to the market's reduced volatility, he would set stops too tight and lose money on normal whipsaws before the market eventually goes his way. Both are very frustrating scenarios.

The other thing I'd look for in his trading is whether he is buying strength and selling weakness in the execution of his ideas. You can get away with that in trending markets, not in range markets. Once you buy into strength or sell into weakness, you are subject to normal reversal and can be stopped out of trades with losses frequently. The more range bound the market, the more important execution becomes. You have to wait for your prices, not chase moves.

On the psychological side, it's clear from the tone of the letter that our trader is frustrated. While frustration may not have been the initial cause of the slump, it can be instrumental in sustaining the slump. I'd look for changes in the sizing and frequency of trading, as well as changes in execution, as signs that frustration might be affecting decision-making. When I am frustrated with my trading, I have learned to take time away from markets and return with a clear head. Very often, that leads to a fresh view and much better trading.

Finally, our trader asks if this is par for the course for developing traders? The answer is yes. Slumps are common, even to seasoned professionals. The key is diagnosing the slump early, reducing risk exposure before losses become serious, and instituting corrective measures. It is very common for intraday traders to lose sight of shifts in trending and volatility and fail to adapt to market conditions. This often starts a slump; frustration often keeps it going. If you drill down and look at your trades in detail--what happened before and after--patterns may very well jump out at you that point the way out of the slump. That drill down is best accomplished, however, after you've stepped back and gotten out of the frustrated mindset.

For more background on breaking trading slumps, check out this post and its links.