Monday, February 16, 2009

Turning Trading Rules and Plans Into Commitments

Saturday's post on following trading plans emphasized that our actions are intimately related to our states of mind. When we undergo state shifts, our perspectives change, and those can alter our priorities. What seemed urgent in one frame of mind becomes lost in another. This most often occurs during trading when profit/loss (P/L) concerns take front and center stage, obscuring our best laid plans for our positions.

The links from the earlier post cover a variety of reasons why traders lose their discipline. There is, however, another reason why traders find it difficult to follow the plans they set: their plans aren't truly plans.

To understand this, consider the difference between plans and intentions. If I tell myself that I need to go to the gym and get into shape, that's an intention. It is not a plan. If I actually join a gym, sign up for classes, set up a schedule for exercise, and create weekly goals for how often I'll exercise and how much weight I'll lose, that is a plan.

Similarly, I might intend to take my wife on a trip that will help her get away from work stress. That is very different from actually planning the trip by discussing it, creating an itinerary, shopping for best airfares, etc.

Intentions are thoughts of future actions, often accompanied by "should". Plans require action--taking steps in the present to achieve the desired end--and they often have a social and motivational component. A business plan, for instance, is much more than intended success; it can be vital in attracting investors and key employees. Because intentions lack committed action, they are generally weaker than plans. We're likely to break a New Year's intention, but less likely to break those vacation plans once they've been formulated with a spouse.

Many traders formulate intentions for their trades and then wonder why they have veered from their "plan". When I ask to see their plan, however, there is nothing written down; nor is there anything specific that has been planned. To be sure, high frequency traders are not going to formulate detailed plans for each trade. In their case, trading rules about such matters as execution, sizing, and risk control would take the place of unique plans for each position. Often, however, I'll hear from "scalpers" that they've violated their discipline. When I ask which rules they've violated, they cannot give a ready answer.

My response is that you can't violate a discipline that isn't there to begin with. The problem is not that an excess of emotion interfered with their plans and rules. Rather, they were never sufficiently planful and rule-governed to begin with.

The single greatest way to build discipline is to turn rules and plans into commitments. That means that you have to give those rules and plans distinct life of their own. The more you think of them, look forward to them, talk them to others, write them down, grade yourself on them, reward yourself for them--the more real they become. You are most likely to abandon rules and plans that haven't been internalized as commitments.

Please check out the comment of reader Adam following the post on learning to think like the herd, but not follow the herd. You'll gain a valuable lesson in turning rules and plans into routines and commitments. Adam's observation regarding the value of checklists in high risk professions is excellent. He explains, "Trading is a matter of repeating over and over again behaviors that trap errors before they are released into the market".

Intentions aren't strong enough to trap errors. To catch the mistakes before they're released, you need the emotional force of commitments and the reliability of routines. Turning intentions into checklists and checklists into commitments is a great way to ground yourself in best trading practices.