Friday, April 11, 2014

Three Best Practices for Turning Trading Stress Into Performance

In the recent post on trading stress and distress, I suggested the former was necessary for our development as traders; the latter was a potential impediment to our evolution.  Stress is the result of challenge; distress is the breakdown that occurs when we are overwhelmed by challenges.

So how can we keep the normal, inevitable, and ultimately constructive stresses of trading from becoming sources of distress?  Three best practices that I'll be touching upon in my upcoming webinar presentation are key:

1)  RISK MANAGEMENT - Trading losses should be planned and anticipated.  By limiting risk per trade and limiting drawdowns across trades, you ensure that any single period of poor performance will not impair your emotional or financial capital.  This means that proper trade construction, portfolio construction, and reduction of risk-taking during periods of poor performance are as important to success as generating the next great trade ideas.  One of the most common trading problems I see among less experienced traders is that they size positions and predicate their risk taking based upon how much money they want (need) to earn, not on how much they can afford to lose.  They take so much risk that they ensure an eventual emotional upheaval.  

2)  PERFORMANCE FOCUS - The ever-changing nature of markets ensures that they will test you.  They will test your research and understanding; they will also test you emotionally.  Turning the stress of challenge into fuel for growth is a great way of staying positive, constructive, and free of distress.  Look at it this way:  the market is your gym and it's going to give you a workout.  What trading muscles are you going to build this week?  This month?  Turning setbacks into learning lessons and goals for future trading ensures that you will use losses and drawdowns to make yourself better.  A positive performance focus starts with constructive self-talk:  how you process market challenges will very much impact your emotional responses to those challenges.

3)  LIFE BALANCE - There will be times when markets will not sustain you emotionally--and quite possibly not financially.  What will get you through the lean periods?  Having activities and relationships that nourish you emotionally, physically, and spiritually can make all the difference in sustaining the mindset needed for optimal performance during difficult times.  Having diversified income streams takes a great deal of pressure off P/L and makes it much easier to have the patience to wait for good trades.  We know that emotional well-being contributes to creativity, productivity, and positive performance.  The best way to avoid distress is to build a life buffer of well-being.

So, as I'm writing this, I'm not a happy camper.  My models gave useful buy signals in stocks late in March and sell signals in the first few days of April.  They also were premature in giving buy signals the last few days and were completely leaning the wrong way yesterday.  Intellectually I know that the best of predictive models in markets only reduce uncertainty, but when I get false signals, I go back to work and see what I can learn from them.  It is not fun to get something wrong when you've put days and weeks of long effort into crafting something.  But I know that's the only way the craft will get better.

(Note to self: you get different results when you model realized vs. implied market volatilities). 

"If it ain't broke, don't fix it," is the wrong approach.  In fixing breaks, we build our selves.  And that ensures we benefit from the stress of operating in uncertain, risky environments.   

Further Reading:  The Well-Being Hypothesis