Friday, August 21, 2009

Why Can't I Follow My Trading System?

Perhaps the most common concern I hear from traders is that of "discipline": following one's trading plans, rules, signals, and/or system. Sometimes the lapses from discipline involve failing to take trades that are indicated. Other times, the problem is one of overtrading: taking trades that lie outside one's rules.

If we think of lapses of discipline in other areas--cheating on a diet, for example, or procrastinating on work that needs to be completed--we can see that, many times, we act against our longer-term self-interest by becoming caught up in shorter-term needs. If, for example, we cannot tolerate boredom, we might eat to fill the void and break our diet.

Ignoring those short-term needs, as a whole, doesn't work. Unmet, they eventually sabotage those longer-term intentions. We can tell ourselves that we'll do nothing but work all day, but other needs will inevitably creep in. Even if we don't act on them directly, we'll play them out in daydreams and escape work that way.

When discipline works, it's often because people have found constructive ways to meet those short-term needs. The smoker who craves a cigarette may chew gum as a substitute oral activity. I enjoy sipping on a hot drink while I'm working, but too much coffee can get me wired and that gets in the way of the work. Now, as I'm writing this, I'm sipping my herbal tea.

The key to sustaining discipline is to identify the specific short-term needs that are occasionally overshadowing trading rules. Once you've made that identification, it is easier to then brainstorm constructive ways of addressing those needs. Traders who overtrade, for example, often have problems during quiet market times. Their needs are for stimulation. By creating stimulating activities during the trading day that don't take them away from their screens, they can avoid using unwanted market activity as their stimulation.

This is one reason that teamwork and training at trading firms can be so valuable: they provide a constructive focus for traders apart from trading, especially during slow times. At one prop shop, Trading RM in Chicago, traders actively call out their "special trades" and make teamwork and interaction a routine part of the trading day. It's a little more difficult to avoid good trades and put on bad ones if you're sharing your actions with your colleagues!

Other times, traders fail to follow their rules because they don't truly have confidence in their ideas. They front-run their own signals out of anxiety and wait for perfection in setups before they act. Their short-term needs often are for safety and security: they need to believe in what they're doing. Very often this problem occurs when traders have short-circuited their learning curves. They are putting meaningful capital at risk before they've done the paper trading and small real-time trading needed to build a successful track record. You believe in your system when you see, in your own experience, that it works over time, across market conditions.

In general, I've found the cognitive and behavioral methods outlined in the Daily Trading Coach to be particularly helpful for discipline issues. For more on the topic, check out these readings:

* Rules and Discipline

* Turning Plans Into Commitments

* Trading Discipline Linkfest