Traders are generally sensitive to emotional factors that take them out of their zone and lead them to trade either too impulsively or too cautiously. Less well recognized are biases in our thinking processes that lead us to erroneous conclusions and poor trades. This is because not all cognitive biases are accompanied by emotional upheaval. Indeed, many exist precisely to maintain an emotional status quo--even at the cost of distorting perception.
There are many cognitive biases that can impact trading decisions; more than we can typically be aware of at any given point in time. One of the most common that I observe is in-group bias. We allow our personal affiliations to overvalue and overweight the observations and decisions of our peers. This leads to a kind of bandwagon effect, where we no longer make truly independent market observations and trading decisions. For trading firms this is particularly pernicious, as--combined with overconfidence bias--it can lead to concentrated bets and correlated returns just as thought is most biased. Another common bias is the anchoring effect. This occurs when we seize upon a particular piece of information--often the most recent, salient observation--and draw conclusions from that limited data point. This frequently happens when traders don't have strong views on markets, but feel a need to place trades. The desire for a trade rationale leads them to overvalue recent observations. Of course, these biases can operate in concert. For example, a group of traders can anchor off a piece of salient data and set off a bandwagon effect that impacts other traders, leading to biased group-think. Some traders seek to minimize cognitive bias by taking a quantitative approach to their trading. Alas, this can have the effect of substituting even more subtle distortions for the better known ones. Strategies that look too good to be true often are, as the search for patterns can find seemingly good results in random ways. This most notably occurs when backtests of strategies are overfit: we keep searching for "significant" results until we find them. Such strategies typically boast phenomenal Sharpe ratios--lots of gain for little pain--but, as Marcos Lopez de Prado has recently observed, such ratios are deceptive if they are not deflated for selection bias. Traders typically think of discipline in emotional terms: taming one's fear, greed, and frustration in order to stick to trading plans. These plans, however, are only valuable insofar as they reflect a different, cognitive discipline. Rules that guide our trading are only as good as the rules that guide our identification of trading opportunities. More on that topic to come. Further Reading: Changing Self-Talk by Talking to Yourself
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Here are a few interesting ideas gathered this weekend: * Here's a post that caught my eye on the Dunning-Kruger effect--a cognitive bias in which people who don't know tend to also not know that they don't know. This excellent article puts the DK effect into context and makes the observation that experts are more likely to accurately assess their level of knowledge and success--and even modestly understate their gifts--relative to those who are poor performers. I have consistently found that to be the case in the trading world: less sophisticated participants seek levels of percentage of return that are never consistently achieved by the expert performers, whereas elite money managers tend to be humble about their current and future performance. * Thanks to a savvy trader at SMB for pointing out this article on collecting cortisol levels via smartphone. This very much fits with the Quantified Self movement, which uses real time technology to collect ongoing data regarding our lives and functioning. Check out this fascinating post on rhythmanalysis, as well as this post on mapping and tracking your happiness. It's only a matter of time before such projects assemble into big data efforts that tell us much more about psychology than ordinary (biased, limited) self-report.
* My last post has me thinking about the information that should ideally appear on a market chart. What I realized is that there is almost no overlap between any chart review I perform and any quantitative analysis I undertake. That doesn't seem right. What if a chart visually captured backtested patterns from market research? I'm working on it...
* Along that same line, I wonder if you took 100 traders and gave them access to market charts and X pieces of data that they found most relevant to making trading decisions. They would follow the same market for the same time period. Would the number of trades taken be a measure of the Dunning-Kruger effect? By the way, here's the original paper on the effect. The abstract neatly states their thesis. * Thanks to Abnormal Returns for the link to the article on diversification and the observation that diversification smooths emotions as well as investment returns. This strikes me as a broader life principle: those who are diversified in their sources of well-being are more likely to sustain consistent well-being than those with their psychological eggs in a single basket. One of my observations is that traders who sustain long-term success enjoy studying markets and understanding what is driving them as much as they enjoy trading. That gives them positive outlets when there are no trades to be had. When trading is everything, it's not surprising that everything is approached as a trade.
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Above is a chart of the last week's action in the ES futures. It looks like a normal chart, but there's a difference. Almost all charts are denominated in time. We can have price on the Y-axis, we can show an oscillator or indicator on the Y-axis, but the X-axis invariably reflects time.
Time is a chronological event, whether we measure time in birthdays or in the behavior of cesium atoms.
Where is it written in stone that markets move in chronological time? Lopez de Prado explains that our reliance on chronological time is "rather arbitrary", as it reflects the role of the sun in agricultural societies. He describes the "new paradigm" in market analysis as one in which we move from chronological time to event time. Indeed, there have been efforts to liberate market charts from the strictures of chronology. Point-and-figure charts draw a new bar when a threshold market move is made, making market movement the X-axis. Richard Arms adjusted the width of chronological bars for their volume, thereby changing the scale of the X-axis. Lopez de Prado's high-frequency trading directly denominates time in volume, as each X number of contracts or shares represents a time unit. As he points out, this brings a number of statistical advantages, including eliminating intra-session seasonal effects (e.g., changes in volume and volatility as a function of time of day). Once we liberate the X-axis from chronological time, we open ourselves to the graphical display of many relationships. Just as the X-axis can bucket movement or volume, it could reflect units of sentiment change, volatility, correlation change, relative strength change, etc. My experience is that such event time charting displays relationships that are not immediately apparent when looking at standard charts based on chronology.
So back to the above chart of the last week in ES. A fresh bar is drawn every time the price of ES moves 500 times. During busy periods, we see more bars; during slow periods, we see fewer. If you had a trading system that went long or short with an X-bar signal, the system would give you more trades in busy markets--and busy market times--and fewer trades during slow markets. In other words, the chart would not only normalize market action statistically, but it would normalize the trader's behavior, creating fewer trades when markets offer less movement. That makes the event-time chart a psychological tool, as well as an analytical one. I will be posting more on event-time analysis in the near future.
So you draw a poor hand at poker. What do you do? You "muck" that hand: you fold and wait to bet a better hand. Good poker players know that there are times to bet and times not to bet. They bet when odds are in their favor and when they perceive weakness among the other players. Suppose a poker player was into the thrill of betting and played every hand. Over time, the odds would catch up to him and he would lose his stake. You can't win at poker until you master the art and science of not playing.
It's a lesson worth heeding for traders.
If you only traded on days when you had objective, tested odds in your favor, how many trading days would you play? How many would you muck? Perhaps one reason so few traders succeed is precisely because they have a "passion for trading". If they had a passion for markets and the calculation of odds, they would be far more likely to win by knowing when to not play. Further Reading: Poker and Trading
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Animals adapt to their environments in part through their displays. Some blend in with their surroundings so as to avoid predators. Some have bright, showy displays to attract mates. Some have threatening displays to ward off predators. Some have deceptive displays to attract prey. Displays attract or repel. Displays maintain offensive or defensive positions in the ecosystem. People maintain their own displays, through how they dress, how they speak, and how they present themselves in person and online. A great deal of unhappiness is created when people need one thing, but achieve the opposite because their displays achieve the wrong purpose. Consider lonely people who long for companionship, but who maintain defensive displays to avoid hurt; vulnerable people who wish for safety, but send signals of neediness; traders who desire collaboration, but keep themselves--and their work--hidden. All experience a mismatch between what they need and what they display. What are your displays? What do they say about you?
Do you display confidence or lack of confidence? Energy or lack of energy? Interest or lack of interest? Sincerity or lack of sincerity? What others see is what you get. Further Reading: Corrective Emotional Experience
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An important line of research and thinking in cognitive neuroscience suggests that, not only does the body hear the mind, but our consciousness is also influenced by our physical states. Embodied cognition means that much of our thought is grounded in physical experience and metaphors that link body and mind. Consider the psych experiment on priming where people were asked to rate a stranger. In one condition the raters held a warm cup of coffee; in the other, they held a cold cup. The first group rated the stranger as significantly more trustworthy than the second group. Literally, the first group had warmed up to the other person.
Damasio's somatic marker hypothesis suggests that cognition is embodied as experienced states. When traders say they have developed a "feel" for markets, they may be literally correct. What we typically call intuition may be felt knowledge: our body's preconscious apprehension of a situation. We have all had situations in which something just didn't feel right, though we couldn't put our finger on the source of our concern. Similarly, we may have a gut hunch about the right answer on a test, even though we cannot pull up the specific material we had studied. The somatic marker idea suggests that what we feel is inextricably linked with what we know, shaping our preferences and choices. In recent posts, I have suggested that a key to peak performance is our ability to control our internal environments, as well as our external ones. Tuned minds and bodies are most likely to be sensitive to the felt signals that deliver our embodied knowledge. A noisy environment--whether the noise is internal self-talk or external chatter--is likely to drown out the subtle cues that give us our market feel. Because somatic markers are so crucial to fast pattern recognition, trading performance is likely to be a function of our capacity to access those signals. It is common for traders and portfolio managers to ground their ideas in explicit research and reasoning. Once the idea is generated, however, what determines when and how we act on it and how we manage its forward path? We like to think that all of those decisions are codified and made mechanical via trading plans. My experience, however, is that the implementation of such plans is greatly influenced by market feel at the time of trade execution and position management. This is not to suggest that trading decisions are "irrational"--rather, decision making may be a much more complex interplay of body and mind than we typically acknowledge. If this is the case, the next leaps in trading psychology may come, not from helping traders tame their emotions, but from enabling them to become better generators and receivers of their embodied wisdom. Further Reading: Biofeedback and Self-Control
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An interesting news article once again points out the benefits of moderate exercise for both physical and emotional health. One of the particularly valuable points is that exercise can be as effective in health outcomes as a prescribed medication. This is not to disparage the use of medications, but rather emphasizes the value of physical activity. A particularly fascinating study finds that exercise changes the microbes in our digestive system, aiding digestion, regulating weight, and guarding against health problems. The implication is that it is important to both decrease sit time and increase fit time. Surprisingly, this simple formula brings cognitive benefit as well as emotional gains, aiding learning and concentration. What these studies don't reveal are the potential virtuous circles created by positive lifestyle changes. For example, more exercise and better eating may aid sleep quality and mood, which in turn could improve our willpower reserves and aid real-time pattern recognition and disciplined trading. Those gains in trading could further boost self-confidence, provide energy for deeper market preparation, and thereby yield further trading gains. Could it be the case that, just as lifestyle changes can be as effective as a drug, that they could be as effective as coaching or counseling? Might we accelerate learning curves in trading by maximizing our physical, emotional, and cognitive resources? My recent post suggested that our work environments are often poorly suited to maintaining an optimal state of focus. It may well be the case that our inattention to the needs of mind and body place us in inefficient states for sustaining peak performance. Can we really expect to fire on all cylinders when we fail to maintain our cognitive and emotional engines? It takes a world-class pit crew to win an auto race; perhaps no less to win the race for trading performance. Further Reading: The Value of Preparation
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A major topic in my recent webinar was the importance of maintaining an attentional focus that can keep us from frustration and undercontrolled trading, as well as anxiety and overcontrolled trading. This post from the Lifehacker site makes some excellent points about the importance of focus and how we can sustain unbroken attention. One very important point is that distractions can be both internal and external. Only by paying attention to our attention can we identify the distractions that trigger a loss of concentration. This is important, because brain studies show that distractions cause lapses in performance as well as focus. Focus is a kind of braking system for the brain: it stops us from traveling down the wrong path. As the research literature on willpower suggests, our braking resources are finite: every time we are distracted and have to regain attention, we use up some portion of our brain's glucose. By minimizing distractions, we maintain our brakes and maximize the degree to which our resources are deployed in the service of our goals.
Consider all the noise and conversation on a trading floor, not to mention the constant barrage of inputs from chats, news sources, and social media. Many trading environments are poorly set up for sustaining focused attention. Indeed, it is not coincidental that when I have discussed with traders meditation and biofeedback as optimal disciplines for building focus, the action steps have inevitably required getting off the desk. Our work environments are set up to maximize information flow, not attention and concentration. In that sense, our trading screens are more like slaloms than racetracks: they require frequent braking and prematurely deplete our cognitive resources.
It's all well and good to write in a journal and exhort oneself to greater levels of discipline. The fact of the matter, however, is that such discipline will always remain beyond our reach if our trading environments act as cognitive vampires, draining us of our willpower.
Trading colleagues kid me because my trade station consists of a laptop with a single screen. No multiple monitors, no chats, no newsfeeds. If I'm watching the ES futures, I need to click and bring up a fresh screen to see how bonds are trading or how sector correlations are behaving. What I've found is that the frequent clicking and bringing up of screens facilitates fast cognition: by making me active in recruiting information, the process engages me in pattern recognition. Interestingly, if someone converses with me during this process or if I take a phone call or try to answer a message or email, the flow state is broken and with it goes my pattern recognition.
Working on my trading, I recently found that my entries were not as good as my exits. The reason for this is that I was entering the market shortly after following it intensively but before I was in any kind of flow state or "trading zone". By the time I had processed market action during the life of the trade, I was highly focused and exited quite well.
As a result, the change I made to my process was to follow the market intensively before the open and place one or more paper trades that I had to follow intensively. That seems to be enough to nudge me into the flow by the open, without depleting my brakes. Notice in this example how it is a change in process that yields the psychological/cognitive shift. By maximizing focus, I minimize distraction, avoid poor trades and subsequent frustration, and maximize those willpower resources so that I can stay true to trading plans. In optimizing trading process, we can optimize trading psychology.
As promised, here is the link to the recent webinar hosted by the Big Mike Trading forum. I want to thank Mike and the forum for hosting me. Hope the talk sparks some good thinking about the psychological factors that impact trading performance. I particularly believe that an unappreciated facet of trading psychology is the notion of states of consciousness and how those impact our information processing. I'll be posting further on this topic later in the week, with an emphasis on specific techniques that can help us stay "in the zone". .
The Brian Tracy quote is a relevant one for traders, because we cannot control markets and yet we can control how we respond to markets. We have no control over the outcome of any single trade, but we can control when we trade, how we trade, and how much we risk in trading. Many of the emotional disruptions of trading described by market participants can be conceptualized as problems of undercontrol and overcontrol. Undercontrol reflects impulsive, unplanned trading: placing captial at risk when opportunity is not there. Overcontrol can be seen in overanalysis and a failure to pull the trigger when genuine opportunity is present. Somewhere between undercontrol and overcontrol is an optimal degree of control that reflects what traders describe as being "in the zone". What are methods for dealing with undercontrol and overcontrol--and how can we escape the spiral that occurs when we oscillate from one to the other? That will be a main topic of my webinar today at 4:30 PM ET, hosted by the Big Mike Trading Forum. Participation is free, but advance registration is required. I will follow up the webinar with posts on the topic. Hope to see you at the session, and hope you get one of the ten autographed books Mike and I will be giving away to participants who answer quiz questions based on the presentation!
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In my recent post, I suggested that a dynamic technical analysis would not rely upon a fixed set of indicators and chart patterns to be interpreted in a uniform manner. Rather, fresh predictors would arise from a study of drivers impacting the most recent market regimes. Traders would follow the indicators that have demonstrated predictive accuracy; not untested ones presumed to possess universal validity.
Let's take an example from the current market. Using tests of stationarity, I have identified a stable period of market behavior embracing the recent past. That stability means that market price changes during that period can be assumed to proceed from a single process. If the time period under consideration possessed wildly different statistical properties, such as 2008 and 2014 for stocks, then there would be no assurance that price changes were resulting from a stable process. That would give us no reason to extrapolate patterns from one period to the other. A major problem with traditional use of technical indicators is that they are employed uniformly across non-stationary periods--especially intraday. It turns out that during the most recent stationary period (i.e., "regime") a major driver of short-term price has been correlation. How SPX is correlated with other equity instruments has been significantly predictive of short-term forward price change. The catch is that single measures of correlation were not particularly informative in my research. Rather, aggregated correlations across a large number of stocks and sectors and over intraday horizons ended up being an excellent measure for short-term trading signals. In other words, the most valuable indicator of correlation was not a standard technical indicator, but rather a measure that required research. Moreover, I had to research it in such a way as to not overfit the data relationship. But there it is: when the correlation measure exceeds .40, the next day's price change has averaged +.35%. When the correlation has been below .40, the next day's price change has averaged -.37%. As long as we stay in the current regime--a key assumption--I expect market strength when correlations are high and rising and weakness when they are low and falling. That becomes a potential trading "setup" for the current regime. In a future regime, correlation may be much more modestly associated with forward price change--or it may be predictive over longer time frames. Setups become dynamic, because they adapt to changing markets.
But correlation is but one factor that sets up in the current regime. There are others, from options ratios to intraday volatility. This is how many hours of preparation go into a single hour of trading. It takes time to create and test large correlation matrices. It also takes time to test the many other variables that are associated with the factors of sentiment and positioning that are key drivers in the current regime. Once the research is done, however, the trader knows the indicator levels that are significant and is able to automate alerts. That way, the trader can seamlessly incorporate multiple tested technical signals with his or her discretionary judgment about the market. The challenge is not that technical analysis doesn't work. The problem is that technical analysis works the way that parenting works: powerful when dynamically adapted to situations; diluted when applied uncritically.
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* This post from SMB builds on a TED talk that makes the case for doing something for 30 days as a way of building new patterns of behavior. Viewed in that light, what we call "discipline" is not the goal of a change process, but an intermediate step. It takes discipline to do something consistently and routinely for 30 days, but once we internalize the repetitions, what formerly took effort now becomes second nature. Driving a car is a good example of this: initially it takes effort and considerable conscious thought; eventually it becomes a natural part of us. The goal of trading psychology should *not* be instilling discipline, but rather using discipline to instill positive habits. * Per the above, choosing a single goal, identifying a specific change connected to that goal, making that change for 30 days, and keeping a 30-day journal to track results would be a much more effective program for change than tackling many goals at one time and never consistently implementing changes connected to those goals. From this perspective, setting goals is not what creates change--it's turning those goals into consistent habits. * Abnormal Returns links a WSJ article about simple truths that investors typically get wrong. One of those is assuming that making money will bring happiness. Despite talk of a hedonic treadmill--that we maintain a relatively constant level of happiness through life--there is evidence that specific life changes are associated with improvements in happiness. Interestingly, some of those changes are ones specific to lifestyle and not to monetary success per se: spiritual development, healthier lifestyle, etc. * Interestingly, one of the best predictors of happiness in the study was the gap between how many hours you work per week and how many you would like to work. Those who feel overworked (they'd like to work fewer hours) and those who feel underworked (they'd like to work more hours) are less happy than those who are working as much as they like. * The positive psychology work of Ed Diener and colleagues also tends to challenge the notion of hedonic treadmill. One important observation is that we have different happiness set points for different facets of life: work, marriage, etc. Also, our level of positive emotion can change more or less than our level of negative emotion. An important component of positive experience, the authors note, is life satisfaction. In many ways, focusing on life satisfaction is more important than focusing on the rises and falls in positive and negative mood. * To bring the above topics together, it's interesting to speculate on what a 30-day program to increase happiness and life satisfaction might look like--and how such a program might impact one's work performance. Suppose you dedicated X minutes per day to doing something that was deeply personally rewarding. Might the resulting satisfaction broaden into other experiences during the day and build a much more general sense of well-being? Not a bad personal project!
A while ago, I posted on the topic of divergences appearing in the U.S. stock market. Specifically, we were near all-time highs in the large cap averages, but a significant number of stocks were making new lows and small caps in particular were dramatically underperforming. When I examined past instances of such underperformance, I found very different results depending upon the VIX regime that we were in. When divergences occurred in high volatility environments, the forward results for SPX were bearish and volatile. When the same divergences occurred in a low VIX environment, the forward results for SPX were actually nicely bullish. The same results could have been found if I had been looking at chart patterns, oscillator readings, or other trading "setups". It's not that they lack value; it's that their value is contingent upon the context in which they occur. Should you buy after a couple of days of strength? In a low volatility, range bound market, the answer might be quite different than in a rising volatility market displaying momentum characteristics. This is a limitation of how traders tend to implement technical analysis. Too often we assume a static reality, so that a given chart pattern, oscillator reading, or Fib level has a fixed meaning and significance. Psychologists tend to be skeptical of static depictions of reality. Most human interaction is context-dependent: someone reaching out to hold my hand crossing a street means something different than the same gesture in a hospital room. Or, as the old joke has it, "bear right" means one thing in a car, another thing on a hunting trip. Challenges in anticipating market movement may be a function of our need to find fixed setups. Looking for the same patterns in very different markets might be a formula for temporary trading success. I strongly suspect this is an important topic.
Connie Brown was on the right track when she proposed that oscillators behave differently in bull and bear markets, requiring different interpretation. As many technicians have noted, oscillators themselves are more useful in certain market conditions (range bound) than others (strongly trending). John Ehlers and Ric Way compute dynamic cycles for stocks and indexes, with frequencies and amplitudes that wax and wane with shifting market conditions. Their use of quantification to turn static indicators into dynamic ones also strikes me as quite promising. But what if, as market regimes change, fresh technical indicators gain predictive value and others become less relevant to forward price movement? In such a dynamic world, "setups" would always be evolving; you'd always be learning markets. Your edge wouldn't be a core set of trading patterns, but your ability to identify and trade the patterns that possess an edge here and now. The implications for coaching are significant: Advising traders to "stick to your plans" and "follow your process" works as long as market regimes are stable. Then it doesn't work. In a world of changing markets, adaptability is the new discipline. The implications for mentorship are also significant. Teaching the same chart patterns and technical rules at all times to all traders is like using the same training for soldiers who will be performing in the desert, at sea, and in rainforests against established military forces at some times and insurgent guerrillas at others. If there's one thing elite fighting forces and well trained athletic teams know, it's that you study the opponent and adapt your strategy and tactics to the situation. How many traders truly study markets and adapt their strategies and tactics to the threats and opportunities they identify? In the next post, let's take a look at what a dynamic technical analysis might look like. Further Reading: What Are You Doing Between Trades?
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Over a most enjoyable lunch with Francisca Serrano and Sergio Malagon, one topic that came up was "giving back". Both made the point that the students who attend their classes make particular efforts to share ideas and experiences with one another. As a result, the number of teachers expands exponentially, as everyone is both teacher and learner. When they first asked me to speak at their Madrid workshop, they made it clear that proceeds would go to a cancer research charity--particularly meaningful, given Francisca's experience as a cancer patient. This topic came up in my interview with Ima Sanchis of La Vanguardia. How can one maintain emotional balance when periods of uncertainty and loss are assured in trading? One answer is that successful trading must become more than a profit/loss figure at the end of a day, month, or year. Successful trading is an opportunity to learn and develop, to participate in the learning and development of others, and to use the proceeds of success to make the world a better place. Francisca and Sergio provided an excellent example of tapping into deep personal motivations to energize their development as traders and trading educators. One way to give back is to leverage the online medium to share ideas broadly. That is the great strength of StockTwits, as well as trading blogs. Through webinars, the world becomes a classroom, with the potential to apply lessons to markets in real time. In that vein, I look forward to participating with the Big Mike Trading Forum in a free seminar on trading psychology on Tuesday, June 17th at 4:30 PM ET. The focus will be on specific psychological techniques for dealing with the most common--and challenging--emotional disruptions of trading. Registration for the GoToMeeting session is available for all TraderFeed readers and Forum participants.
If past experience holds, giving away ideas and techniques will lead to worthwhile contacts with others eager to share their work and we will all profit. It's yet another way in which trading is like life: best lived as a team sport. Further Reading: Teamwork and Trading Success
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Starting this week, TraderFeed will be taking a pause and posting on a weekly rather than daily basis. This is because I am pursuing a number of new directions in markets and coaching and need to focus attention on those. My goal is to integrate elements from those projects in my weekly posts and push the envelope in terms of integrating market analysis, trading practice, and psychology. As you may have gathered from my recent posts, I have developed a deep interest in melding mentorship and coaching by driving both to real time and creating ever more powerful performance-based learning. Bringing together high-level trader training and trading psychology--in real time--is the closest I can imagine to an Olympic training program for traders. That is the vision: an Olympic-style training program for traders. There are elite institutions for training musicians, artists, athletes, physicians, and scholars. Where is there elite training for traders? Not in the seminars that promote the usual hash of technical analysis. Not in coaching that imposes a psychotherapy model of intervention on a performance development process. Not in classrooms, not in consulting offices--because none of those are real time, and none integrate the learning and hands-on skill development that is central to expertise development. I look forward to chronicling this pursuit in coming posts. As always, I deeply appreciate the interest and support of readers. Brett
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A particularly valuable function of coaching is the ability to provide fresh perspectives on problems. As the Einstein quote suggests, attempting to solve problems with the same ways of thinking that created those problems can only lead to self-reinforcing and damaging cycles. If you think about how coaching occurs in performance fields--from performing arts to chess to athletics--you will see that coaching is always hands-on and coaching is always real time. The hands-on, real time aspects of coaching enable the fresh inputs of a coach to become integrated into a process of learning and deliberate practice. Can you imagine a basketball or football team where players were expected to keep journals about their performance and meet with a coach once a week to work on improvement? Of course, it would never work. Coaches work with performers daily, observing practice sessions and actual competition to offer concrete feedback and work on specific skills. This is why so many excellent coaches have performed in the areas where they now help others: it is difficult to give performance feedback if you don't understand the nuances of performance in that specific domain. One of the great challenges in trading is bringing coaching to a hands-on, real time basis. A skating coach would never meet with a promising skater in an office and discuss, second-hand, what happened the week before on the ice. Real coaching takes place on the ice. I predict the next breakthroughs in trading psychology will occur when coaches and traders are on the desk and not in the consulting office. Further Reading: Mentorship, Coaching, and Why Traders Fail
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Spending time in medieval villages in Spain provides a unique experience of being immersed in history. It's one thing to read about what happened in the world; another thing to see the places, touch the buildings, and walk the steps of those who lived that history. One very enjoyable part of the trip was the opportunity to interview with Ima Sanchis from La Vanguardia, with capable translation assistance from Mr. Sergio Malagon. That interview should appear in Monday's paper, and I will see about providing a link when it's available. Ms. Sanchis asked many good questions, but one that stood out concerned the value of trading. After all, most people in their work provide specific products or services. What does a trader provide? I addressed this issue in this post and in this one. My reply to Ms. Sanchis is that what I need to do to become a better trader--the capacity to think fast and deeply; the emotional self-control and self-awareness; the ability to adapt to challenging, uncertain situations--are exactly the things I need to do to be a better psychologist, a better husband, and a better parent. That is the beauty of the performance pursuit: in honing ourselves, we enhance our life--and the lives of those we touch. I may not make money every day, but a trading session is only a total loss if it hasn't taught me something that will make me better in all respects.
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I've been playing around with the StockCharts website and so far have been favorably impressed. The site does a particularly good job of enabling users to create custom stock screenings. There is also very regular and useful market commentary.
One indicator I'm tracking is the number of NYSE stocks closing each day above their upper Bollinger Bands (red line) and below their lower Bands (green line). Those data from the past month are charted above, as of yesterday's close vs. SPY.
I generally like to have a few new things to track at all times, with the frank recognition that the majority of technical tools will provide little or no value above and beyond a consideration of past price action. The Bollinger measure strikes me as a tool with potential in identifying thrusts from breakouts that might be likely to continue and also to identify turning points when fresh price highs or lows are accompanied by divergences in the Bollinger numbers.
You can see, for instance, that--despite recent price strength in SPY--fewer shares have been closing above their upper Bands and the number closing below their lower Bands has percolated higher. I'll be watching over time to see if there is predictive value in such patterns.
I'd like to thank @NASTrading for including this blog in his list of Top 10 Websites for traders. Nat makes a very good point in his post: the importance of leveraging one's time and effort. By focusing on reading the sites, research pieces, and information most relevant to you and your trading, you minimize distraction and increase the odds of synthesizing the useful material into promising views. Nat's list is a great place to start for leveraging web surfing time. There are other spheres of trading where leveraging efforts is important. I recently met with a group of traders to discuss best and worst trading practices. One topic that came up a few times relates to what I call "selectivity": taking the best trades and avoiding marginal bets. Many times traders ask about how they can avoid overtrading when they haven't clearly defined proper trading. What impressed me about the traders I spoke with is that they had made ongoing efforts to review their trading and identify the "setups"--the patterns of price, volume, order flow, etc.--that constituted their best trades. Once you define the parameters of good trades, you're in a much stronger position to leverage your resources and focus your attention on only the most promising situations. For example, because volume correlates so highly with market movement, I will not place daytrades unless volume hits a threshold level. If the market is slow, it's apt to be noisy and limited in opportunity, so I stand aside. Other traders might leverage their efforts with different criteria: this is where stock screening can be useful. Many of the best portfolio managers I speak with will only take a trade if they can clearly define a particular ratio of reward to risk. That enables them to be patient in their entry execution until the risk/reward threshold is reached. But the value of leverage goes even further in life:
* Doubling down on your time with the people who enrich your experience emotionally and intellectually and minimizing time with people who sap your energy or resent your success; * Maximizing quality time outside of markets to build your relationships, strengthen yourself physically, extend your learning, and rejuvenate yourself spiritually and minimizing low quality time that is not productive in any of these regards; * Focusing activity toward the most important personal and life goals and minimizing activity that keeps you busy but doesn't move you forward. In life, as in markets, we can "overtrade". We pursue marginal courses of action and thereby dilute our most promising efforts. By knowing what moves us forward as people, we can leverage our best personal "setups" for success. Further Reading: Overtrading and Unrealistic Expectations
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One of the things I'm noticing in the recent stock market is the importance of sentiment. When put/call ratios are high, the market is much more likely to rise/bounce than when those ratios are low.
For example, since 2012, suppose you combine the equity put/call ratio with the put/call ratio for stock indexes. When that measure has been below .80 on a one-day basis, the next five days in SPY have averaged a gain of .05%. When the measure has been above .80, the next five days in SPY have averaged a gain of .51%. Indeed, when the equity put/call ratio by itself has been above 1.0, the next five days in SPY have averaged a solid gain of .90%.
If you can figure out which way the herd is leaning, you can often find a good trade by identifying occasions in which committed traders will need to run for exits when their positions retrace. I find Market Delta especially helpful in that regard, as the persistent lifting of offers or hitting of bids provides clues to the bullish or bearish execution behavior of traders. What makes such trades unique is that you are not so much trading a particular stock or market as trading the behaviors of traders themselves.
A number of other indicators I follow are summarized in this archive post. When I return from my overseas work with traders, I will post some of the indicators I've found most useful recently.
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Postings this week and next will be a bit more spotty, owing to a much anticipated trip to work with traders in Madrid. Many thanks to Francisca Serrano and Sergio Malagon for their help in organizing the event. One of the topics of my presentation will be an interactive exercise designed to help traders identify their distinctive strengths. Recent posts have dealt with the importance of a process orientation to trading, but how can traders structure their processes to maximize the odds of success? My experience--and the findings of Schwager in the Market Wizards books--is that successful traders differ significantly in their approaches to markets. Some are shorter-term; others are longer-term. Some are more fundamentally grounded; others trade off price and volume data.
It is not the presence of any *specific* process that distinguishes successful market participants. Rather, each has found a way to engage markets that makes specific use of his or her emotional, cognitive, and interpersonal strengths. Nowhere is this more evident than in the information processing approaches of traders. The processes of traders with distinctive intuitive strengths are different from those of traders who are highly analytical. Extroverted traders often work well in teams and process information interactively. Introverted traders are more self-reflective and analysis-driven. Many short-term traders focus on pattern recognition; many long-term investors seek causal relationships. A crucial question for peak performance is: What are you really good at? If you're going to succeed as a trader, it will because you've found a way to take signature strengths and apply them to financial markets. It's hard to imagine anyone could be distinctively strong in their market performance if they are not drawing upon their own distinctive talents and skills.
So here's a useful exercise: Draw a series of sine waves with regular peaks and valleys. For each of the peaks, identify one of your distinctive life successes outside of trading and write down the strengths that made those successes possible. Make sure you identify at least 10 peak experiences and at least 10 core strengths.
Then, for each of the valleys, identify one of your distinctive life failures or setbacks outside of trading and write down the vulnerability that made those setbacks possible. Again, make sure you identify at least 10 setbacks and vulnerabilities.
What you'll generally find is that it is difficult to identify 10 truly distinct strengths or vulnerabilities: the same ones tend to recur throughout life experience. One way you can see that clearly is to do the exercise a second time, but this time let the peaks represent your best trading experiences (and the strengths that contributed to them) and let the valleys consist of your worst trading experiences (and the contributing vulnerabilities). The odds are good that the lists will be similar for the two sets of sine waves.
What that means is that success is highly dependent upon playing to our strengths and avoiding our vulnerabilities. Indeed, the best processes are those that leverage what we do well and minimize what we don't. Many, many times traders do not reach their potential because they never come to a deep appreciation for their most basic strengths and weaknesses. It is at the intersection of market knowledge and self-knowledge that traders can find their greatest success. Further Reading: Lessons From a Successful Trader
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The first post in this series highlighted the role of reflection in learning. But how can we achieve such reflection and sustain it over time? I have spoken with many traders who start journals and drop them, only to pick them back up when trading becomes difficult. Clearly that is a suboptimal learning process. Worthwhile research from Staats and Upton suggests that manufacturing firms are not the only ones that can benefit from lean processes. Even in knowledge fields, simple and direct processes that are grounded in objective observation can yield meaningful improvements. Key to their findings is the recognition that effective process changes must be implemented at the lowest possible level of the organization. If you want to manage inventory better, you need robust processes that can be set into motion by those doing the receiving and stocking of merchandise. Similarly, for the individual trader, effective processes must be conducted from the front lines: as part of routine daily preparation for trading, not as part of an abstract, high-level quarterly review.
The problem with much trade journaling is that it is long on observations, short on process. It is one thing to observe that you are not being sufficiently patient in your trade selection; quite another thing to define and implement a repeatable process of trade selectivity. When Spear and Bowen studied the Toyota Production System, they found that a key to its success was the combination of open experimentation and rigorous implementation and measurement. In other words, workers were encouraged to generate creative solutions, but then each proposed solution was tightly controlled as a variable to objectively determine its value. This rigorous creativity turns lessons into processes. From this vantage point, reflection is necessary but not sufficient for the acquisition of expertise. Backing creative reflections must be rigorous applications of one's conclusions. If we think of traders as engaged in a Profit Production System, then mapping each step of the trading process, identifying where problems occur, brainstorming improvements, and rigorously testing those makes considerable sense. What I have found among successful traders is that each *has* such a production system, though in many cases those systems are as much implicit as explicit. Not infrequently, good coaching consists of helping traders follow their own (implicit) production systems. As suggested earlier, many efforts to learn trading fall short because the absence of integrated mentorship and coaching means that learning itself is not part of a production system. To maximize learning in any performance domain, there must be routine observation and reflection, structured efforts at improvement, and scorekeeping to determine whether those efforts truly resulted in improvement. Once learning becomes a process rather than an occasional event, adapting to changing markets occurs far more naturally, in real time.
Consider two traders: One trades daily, makes notes in a journal, and occasionally sets goals based on those notes. The other also trades daily, but actively makes use of a trading platform that allows for market replay to review the trading day bar by bar and examine what went right and wrong. That platform also summarizes performance statistics, so that there are objective measures of improvement--and need for improvement: number of winning vs. losing trades; average profit per winning trade and loss per losing trade; average drawdowns; time spent in winning vs. losing trades; etc. Which trader, over time, is more likely to experience a supercharged learning curve? Which is more likely to take the hard lessons of trading and use those to define and refine robust learning and trading processes? There are trading platforms out there that can serve as useful learning platforms. Ones that come to mind include Ninja Trader, TradeStation, MultiCharts, and TradingTechnologies. I reviewed Ninja Trader back in 2009 and will take a fresh look later this month. And, of course, if you know of other trading resources that facilitate learning, by all means feel free to mention those in comments to this post.
So let's conclude with a few questions: If an airline maintained its aircraft with processes as rigorous as your trading processes, would you feel comfortable flying? If a surgeon practiced surgery with processes as robust as your trading processes, would you want him/her in the ER operating on you? If an automobile ran as reliably as your trading, would you purchase it? The sober truth is that most traders do not lack profitability because of lack of emotional control or an absence of discipline. They lack profitability because they have not yet developed a production system that reliably generates profits. Further Reading: The Value of Trading Metrics
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Author of The Psychology of Trading (Wiley, 2003), Enhancing Trader Performance (Wiley, 2006), The Daily Trading Coach (Wiley, 2009), Trading Psychology 2.0 (Wiley, 2015), The Art and Science of Brief Psychotherapies (APPI, 2018) and Radical Renewal (2019) with an interest in using historical patterns in markets to find a trading edge. Currently writing a book on performance psychology and spirituality. As a performance coach for portfolio managers and traders at financial organizations, I am also interested in performance enhancement among traders, drawing upon research from expert performers in various fields. I took a leave from blogging starting May, 2010 due to my role at a global macro hedge fund. Blogging resumed in February, 2014.
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