Many people set goals in their minds, thinking that the setting of the goal will somehow make things happen. If goal setting itself got things done, a lot more New Year's resolutions would be fulfilled by December 31st. The reality is that the setting of a goal is only the start of a productivity process. How we set and act upon goals will determine whether they in fact become realities.
Think of goal setting as operating on three levels. On the largest, longest-term level, goals should represent our visions, aspiration, and ideals. No one was ever energized by an item on a daily to-do sheet. What motivates us is what inspires us. It's the vision, the ideal, the dream that makes us jump out of bed in the morning.
The recent Forbes article is one of the most important things I've written, hands down. It explains precisely how large goals draw upon our reserves and energize us. When we tap into our deepest sources of motivation--our most fundamental ideals and values--we no longer have to push ourselves to do things. We are now pulled toward our desired future.
It is the function of medium-term and short-term goals to divide and conquer, making the achievement of the grand goal challenging but doable. When we create short and medium-term goals that move us forward meaningfully, we create small wins that accumulate into a more general sense of winning. Those shorter-term goals organize us, but also ensure that we're not just doing things right, but also doing the right things.
When you read about the woman who is running 50 marathons in 50 days in support of a cherished cause, you realize that the right goal setting makes us far more than we are in our ordinary, daily lives. The right goals form the structure of our days and weeks, but also transform us. The art of goal setting is knowing what will bring the best out of you and making that a meaningful part of your daily reality.
Further Reading: How Goal Setting Helps Performance
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Great traders, like great poker players, know when to play and when to fold their cards and wait for something worth betting on. Too often, the love of trading expresses itself as a need to trade, and the need to trade leads players to play the wrong hands. Worse yet, the need to trade leads players to sit at the wrong tables. If you're at the wrong poker table, the hands you draw won't really matter.
Folding your cards means that you're properly focused on opportunity, but the opportunity isn't present, right here and right now. Yesterday, I wanted to be a buyer of stocks, but volume was waning through the day. That tells me that momentum and follow-through on moves will be limited. I want to buy weakness, not try to ride breakout strength. If the market is showing me strength and I don't want to chase it, I've got the wrong hand and I'll wait for the pullback to give me better cards. A great poker player is a patient one.
But let's say that I'm stumble onto a Vegas floor and plop myself down at the first table where I see an opening. Had I stood by and watched play for a while, I would have recognized that these are experienced sharks waiting for some bait. Instead, I start playing at the wrong table and become the bait. That happens in markets when we force our trading style onto markets that are moving a very different way. If I'm a trend following investor who places bets based on central bank policy and those policies have radically changed from their norm, I'm at the wrong table. I'm playing the wrong game.
If you're in drawdown mode, it's important to ask if the problem is with your betting versus folding or if the problem is sitting at the wrong table or playing the wrong game altogether. Are your tactics needing adjustment, or do you need a different strategy? The most important thing you can do when you're in an unusual drawdown is figure out why you're drawing down.
There are three big reasons why people have big drawdowns:
1) They're trading a strategy that doesn't fit the present market;
2) They're trading the right strategy, but their head isn't in the game and they're not following their strategy;
3) They're trading the right strategy with a good mindset, but they're employing the wrong tactics and thus not implementing their strategy the right way.
You can't cure a drawdown if you can't come up with the right diagnosis. Sometimes coming up with that diagnosis means you fold the cards for a while and focus on studying yourself and your trading rather than just studying markets. Risk management is key because it keeps drawdowns manageable, so that you're sure to have time to learn from them. The key is folding your cards before you lose your stack.
Further Reading: Finding Your Trading Strike Zone
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Imagine you come late to a party and a group of your friends has already arrived and is involved in an animated discussion. What do you do? Chances are good you might join your friends and see what the conversation is all about. Only after getting a sense for what they're talking about might you jump in and participate.
One theme I've discussed a number of times is that we can think of market activity as a conversation among various participants. The flow of prices captures the transactions occurring among market makers, active day traders, longer-term thematic participants, asset managers, etc. The skilled trader is the skilled listener, picking up on the nuances of the market conversation. As in the example of the party, that requires a willingness to stay silent and get a sense for the conversation before jumping in and participating.
Too often, traders formulate their views and impose those on the market without truly listening to the flow of conversation. That is like the boor at the party who talks at you, not with you, hogging the conversation with what they want to talk about. Rarely does that work socially, and even more rarely does it provide an edge in financial markets. When we're full of ourselves and our own views, we become less sensitive to the flow of conversation in the market, missing what is often obvious in retrospect.
That is why silence and a quiet, open mind are great tools for starting the trading day. It's also why the questions that are most important to ask about any market are those that pertain to the flow of conversation among participants.
One heuristic I've found helpful is to divide recent market volume into quartiles: low volume, low-average volume, high-average volume, and high volume. At each quartile, a different class of participants has become active in the market conversation. What are the prices at which the conversation is picking up or dying out? When a new group enters the conversation, how "sticky" is their participation? Do they continue and pick up their involvement or fade away? If we look to upticks and downticks, volume occurring closer to the market bid side or offer side, how balanced is the conversation? Do we see a growing tilt to the direction of the conversation?
If we do enter the market with a larger picture view, staying open minded with respect to here and now flows can provide us with valuable information for when our good idea becomes a good trade. The excellent trader is the sensitive listener; emotional intelligence helps us execute our intellectually intelligent ideas.
Further Reading: Bayesian and Static Reasoning in Trading
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A reader recently asked the question of whether market movements are random. At an informal level, I am struck by the number of skilled traders at each firm where I've worked who have accumulated multi-year track records of success, making money with a high Sharpe ratio trading actively in markets. To be sure, these are not the majority of traders, but they are a distinguished minority. As a trading coach working with them, I'm able to appreciate their talent first hand and recognize that their success represents far more than luck.
Of course, on a more formal level, there is an entire research literature in mathematical finance detailing the non-randomness of financial returns. These excess returns can be categorized by factors, such as value (the purchase of undervalued assets and sale of overpriced ones), momentum (the tendency of strength or weakness to persist), and carry (the returns that come from owning an asset, as in the case of dividends or interest rate differentials). A strength of asset management comes from harvesting expected returns from portfolios that cut across these factors. Balancing and rebalancing factor-based portfolios produces a level of diversification that smooths return streams and allows investors to count on returns superior, on average, to simply buying and holding a given asset or throwing darts at boards.
Factor portfolios have no opinions about markets; they do not trade expectations regarding the Fed, the election, data releases, or world events. When individual traders ground their decisions on their opinions, they often are not factor neutral. They implicitly take a position in a particular strategy, such as momentum or volatility. Many naive traders, for example, trade from technical patterns that have them buying weak readings and selling strong ones (value) or buying/selling upside/downside breakouts (momentum). Their weakness is that they apply the same strategies across markets and market conditions. They are not diversified. They are like Maslow's holder of the hammer, treating everything as nails.
So how can active individual traders achieve diversification and yet stay true to their trading strengths? This is a challenge generally ignored in trading psychology. Too many trading coaches assume that you'll make money if you just stay in the right emotional state. If you trade a flawed strategy while keeping yourself in a calm, positive state, you'll most likely lose money with minimal emotional disturbance.
Participation in financial markets can be categorized broadly as trading versus investment. Holding period is part of that difference, but only part. Trading is predicated on microanalysis, the real-time construction of patterns by moving markets. The trader thrives on rapid pattern recognition: the recognition of what markets are doing as they are doing it. This requires fast, broad thinking and quick response times. The investor thrives on the macroanalysis of broad conditions that impact markets and an understanding of their unfolding implications for future market movement. To a large degree, trading/pattern recognition is about intuition and a feel for markets; investment is about formal reasoning and the understanding of patterns.
Traders achieve diversification when they trade multiple, independent "setups". For example, they may trade momentum patterns in which price movement is accompanied by volatility breakout as well as reversal patterns in which price movement becomes exhausted, with a loss of volume and volatility. Because they trade many setups during the day, they achieve diversification--even though they may be trading a single instrument.
The investor achieves diversification by participating in multiple, independent hypotheses about the world. For instance, an investor might buy crude oil based upon geopolitical conflict and seasonal factors and might sell U.S. assets in favor of emerging market ones based upon differential monetary policies. The investor places fewer trades across multiple markets for multiple reasons. The trader places many trades in a limited number of markets with a defined set of independent setups.
Either way, whether you are an investor or trader, the smartest thing you can do to produce greater returns is to diversify. One trick ponies run out of tricks when market conditions don't favor their particular factors. A great strategy for your trading development is to identify the kinds of markets where you typically don't make money, figure out which factors are working during those occasions, and produce a strategy to allow you to participate in returns from that factor. There will always be a high level of randomness/noise in financial returns. We are most likely to find success if we can exploit multiple sources of signal amidst the noise.
Further Reading: A Systematic Approach to Discretionary Trading
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Here is a great way to get better as a trader--and as a person:
Identify the times in the past week in which you were most sorely tested. When did you face your greatest tests? When in markets did you experience your greatest challenge? When in your relationships? What were the most difficult situations you faced?
Those are the situations in which life is giving you a test in order to teach you a lesson. We learn from our challenges; we develop by tackling what is difficult and expanding our boundaries.
We gravitate to comfort. It's not fun or easy to be challenged and pushed to our limits. But that's where we'll grow.
Certain market conditions are challenging for us. Certain situations test our patience and tax our concentration and mood. When you deliberately face testing situations, you are given many lessons. That's not a bad format for a trading journal: tracking the occasions in which you were tested, the lessons you learned from those, and how you will apply the lessons going forward.
Development depends upon discomfort; what taxes us potentially enriches us.
Further Reading: Supercharging Your Trading Journal
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What makes trading challenging is that being average is not good enough. You can be an average teacher, store manager, or contractor and you'll be able to make a living. In trading, however, what is average is losing. If you stay consistently average, you'll consistently go broke. In performance activities, ordinary is not good enough. The ones who make a living from their performances are extraordinary.
Two factors define the ordinary trader:
1) Lack of innovation - The average trader looks at the same headlines, the same charts, and the same information as other traders. Years ago, a vendor of trading software shared with me that, when they helped customers via their support service, they found out that the vast majority of traders never moved the indicators off their default values. Even fewer utilized customized features of the software.
2) Lack of distinctive effort - Only in trading would keeping a journal be considered diligent effort. If an owner of a startup restaurant went from day to day and simply kept a journal to make improvements, the restaurant would be poorly equipped to exploit trends among the dining public. Many traders focus on central bank announcements and GDP reports. Of those traders, how many actually read the statements of Fed governors, study the papers from Fed symposia, or follow the inputs to the final GDP numbers?
When a lack of innovation is combined with a lack of distinctive effort, the result is a passivity of perception. The ordinary trader is not in an active mode of processing information, and that ensures that new and deep learning will not occur. When traders look at new information and put information together in new ways and actively investigate the utility of the novel data, they exercise their creativity and their capacity for effort. Over time, deep learning--an internalization of meaningful patterns--occurs.
Every day, your preparation for trading, your actual trading, and your review of your trading are trips to a gym. What makes you more than average is that each of those trips is an actual workout of your talents and skills. Innovation and effort are what turn routine activities into workouts that make you stronger.
The chart above is what I call the Power Measure, which is a running correlation of price movement and volatility. The above version is constructed with event data; the bars are not time-based. The power measure is a way of visualizing whether buyers or sellers are having an easier time moving the market. Calculating the power measure with event bars takes volume out of the equation. It tells you more purely whether a given unit of volume is more likely to move markets higher or lower.
There's a lot you can do with this information. A simple first derivative of the readings tells you if markets are getting easier or more difficult to the upside or downside. A moving average of the readings (depicted above) acts as a kind of overbought/oversold measure. A cumulative total of readings acts as a measure of whether demand or supply is dominating over time.
You may or may not employ a power measure in your trading. The point is that creating measures that make sense to you, tracking them every day and within the day, and observing their patterns creates a depth of learning that is impossible for someone looking at the usual charts and canned indicators. Innovative trading begins with innovation in perception and effortful information processing. All of us take trips to life's gym; the question is whether those trips provide us with the workouts that make us stronger.
Further Reading: Calculating the Power Measure
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In a post a while back, I wrote about two proven methods for increasing your happiness. A very important idea from that post is "You're most likely to work on your trading if your trading brings you positive experience." It's when we feel happy and fulfilled that we're most likely to tap into productive and creative energies.
It is understandable that competitive traders look to their winnings to bring them their positive experience. This is also where such traders most often lose their positive mindsets. When inevitable drawdowns in the P/L occur, they create drawdowns in energy and attitude. That's when traders often look for their happiness in the same place that they lost it. They hope to regain happiness by regaining profitability. Such an approach does not gain happiness; it loses control over one's happiness.
That is why one of the most important performance principles is to approach performance in such a way that the process of doing is what brings fulfillment, not just the outcome. If trading is truly expressing and developing cognitive and personality strengths, it will be *intrinsically* rewarding, not just extrinsically so. Your great challenge as a trader is to develop a process that is so internally rewarding that it will not break down when external rewards aren't forthcoming.
A skilled, successful trader wrote to me about knowing all the right things to do, but not cultivating the kind of routines that would routinely ground him in those right things. Traders in such a situation assume that "discipline" is their problem, and they push themselves harder to make themselves do the right things--only to have such a push take them further from the joy in what they do.
If you want to follow a disciplined process, you have to find a way to make the process rewarding and enjoyable. The best way of doing that is to yoke what we *need* to do with what we're *good* at doing. We most often lose discipline because we're more concerned about being disciplined than being fulfilled. The first step to turning that situation around is to stop looking for our happiness in the very place we lost it.
Further Reading: Two Proven Methods for Building Your Happiness
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Almost by definition, if you're pursuing your own, unique path--in life and in markets--you are going to face uncertainty. If we live life solely by following tradition and consensus, we'll find the security of the known, but will never have the adventure of finding our own path by tackling the unknown.
As the recent post outlined, successful trading is all about standing apart from consensus and finding unique perspectives and edges in financial markets. But if you pursue uniqueness, you'll pursue uncertainty--and that requires a tolerance of what is uncomfortable and unfamiliar.
Two ways of gaining perspective on markets are microanalysis and macroanalysis. In microanalysis, we break a market down into smaller pieces and look for clues to future activity based upon the patterning of those pieces. So, for instance, I might look at the alignment of sector behavior within the SPX to gain clues as to what is strong, what is weak, and what the patterns of strength and weakness might mean for the economy and stocks overall. A different form of microanalysis would be to break the price action of a stock or index into intraday pieces, as in the case of tracking volume flows or upticks/downticks over short intervals. Many times, beneath the surface, we can see evidence of accumulation or distribution that gives us a clue as to forward market behavior.
Macroanalysis, on the other hand, places market activity in a broader context and looks for patterns among larger variables. We could aggregate global economic data, for example, and infer patterns of growing global growth and weakness that could impact the behavior of stocks. Similarly, we could look across the policies of world central banks and assess whether monetary conditions are skewed toward liquidity or tightness. In macroanalysis, we might view SPX as a sector itself within the broader universe of global equities. For example, since 2015, the correlation between daily moves in shares in Europe, the Far East, Australia, and Asia (EFA) has been about +.84 with the daily moves in the U.S. (SPY). The correlation between daily moves in emerging markets (EEM) and the U.S. (SPY) has been about +.80. Quite simply, markets are global and what happens in one part of the world is tremendously relevant for other parts.
If you find markets are unclear and/or you find yourself trapped on a consensus path, very often the answer is to take a fresh look through a microscope or a telescope. Looking beneath the surface of market activity by zooming in on short-term patterns can bring clarity. Stepping back from day to day activity and focusing on the big picture can also bring fresh understanding. To gain perspective, we have to shift perspective. Microanalysis and macroanalysis are two ways of accomplishing that. It is difficult to stay stuck in a perceptual rut if we have many microscopes and telescopes available to us.
Further Reading: Market Profile as a Fresh Perspective on Trading
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At every trading firm where I've worked in recent years, I've observed winning traders and ones that struggle to win. What makes the difference? What are stand-out qualities of stand-out traders? Five characteristics are especially notable:
* Successful traders trade uniquely - They look at markets differently from consensus. They process different information and they process the same information differently. They have found a way of making sense of markets that makes deep sense to them and that grounds their decision making.
* Successful traders are multidimensional - They have ways of making money in different markets and in different market conditions. They are flexible; they find ways to win in difficult market conditions.
* Successful traders work at their trading - They work on themselves and they work at markets. When markets are closed, they're still engaged in their work. Their focus is on self-improvement. They don't just set goals; they live them.
* Successful traders know when to not trade - They wait for opportunities, they pull back their risk taking when they're not perceiving opportunity. It's not that successful traders are always successful. It's that their success springs from knowing how to not lose when they're not seeing the ball well.
* Successful traders are self-aware - They know their limitations, and they know what they do well. They are quick to recognize when they're not "in the zone" and they also recognize when they are seeing unusually good opportunities. They are not afraid to say, "I don't know".
A very significant proportion of successful traders have been mentored by successful traders. Success breeds success.
A very significant proportion work in teams, relying on others who they can mentor and make successful. Success becomes a team sport, with everyone making each other better.
There is nothing static about the successful traders I've known. They are continually learning and adapting, and they are continually searching for fresh opportunity. Performance is not simply something they are good at; it's a way of life.
Further Reading: Two Great Predictors of Trading Success
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The first post in this series examined how successful performance is a joint function of talent and skill. The second post focused on how traders can identify their core talents. This third and final post will address the problems that undermine our trading success and what we can do about them.
The central psychological challenge for trading is that frustration and doubts over losses and missed opportunities can lead to self-doubt, and self-doubt can lead us to tinker with trading to the point of veering from our greatest talents.
A classic example is the intuitive trader who has a keen sense for pattern recognition. After a period of frustration and loss, he begins to overthink his entries and exits, losing a feel for markets. This compounds the losses and turns the normal setback into an outright slump.
Yet another example is the trader whose key strength is risk management and prudence of decision-making. She decides she should be taking more risk and sizes up positions, creating greater volatility of P/L, and destabilizing her emotionally.
In each of these cases, it looks as though the trader is self-sabotaging. What is actually occurring is that, under conditions of stress and emotional arousal, the trader has a more difficult time accessing and acting on his or her strengths.
How can we know when we're getting away from doing what we do best?
Two tell-tale signs let us know when we're no longer aligned with our talents:
1) Trading becomes not fun - When we veer from personality strengths, we no longer experience gratification and fulfillment in our work. That's when we find ourselves stressed and procrastinating. Recall the key idea from the previous post: the exercise of talent brings our well-being. When trading becomes work and drudgery, we know we need to pull back and get back to what we do best.
2) Trading becomes confusing - When we lose touch with our cognitive strengths, we no longer experience a sense of understanding and mastery. We trade best when markets make sense to us, when the factors we look at align in ways we've experienced before. When we are confused, it could be the case that markets themselves are confusing: those factors aren't lining up. Often, however, our confusion reflects a shift in our processing of information. We're in the dark because we've gotten away from how we best make sense of things. That's when we know we need to step back and return to our best modes of information processing.
Viewed in this way, our experience becomes a barometer of whether we're aligned with our talents or not. The single most important thing we can do when in drawdown is reacquaint ourselves with what we were doing when we consistently made money. Find when you've been most successful and have traded best and you're most likely to find--and return to--your signature talents.
Further Reading: The Surprising Reason for Trading Failures
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The recent post looked at trading success as a function of native talent and acquired experience and skill. Because the exercise of talent is intrinsically fulfilling, we gravitate to activities that express our talents. This exercise is what propels us through hours, days, weeks, months, and years of deliberate practice and skill acquisition. Whenever we see unusual passionate motivation, we are likely to see the consistent expression of talent.
Consider four dimensions of emotional well-being:
* Happiness - Finding joy in life's activities
* Satisfaction - Doing things that are meaningful and gratifying
* Energy - Doing things that stimulate us mentally, physically, and emotionally
* Affection - Building fulfilling relationships with others
When our life's activities provide us with these four elements of well-being, we are most likely to be productive and creative. We're also most likely to be doing what we're good at. Talent is one of the great sources of emotional well-being.
So if you're a developing trader, how do you know where your talents lie and what you're truly good at?
The simple answer is to examine what makes you happy, what provides you with meaning, what energizes you, and what brings you fulfillment with others. Your talents are hiding in plain sight, bringing you your most positive life experiences.
Look to your passions and you will find your talents.
When I worked in Chicago, a number of successful daytraders were video game junkies. They would spend hours in front of screens, trading actively, and then go home and go in front of screens and play actively! Their talent was for hand-eye coordination and quick decision making, particularly in a competitive context. Suppose I tried to turn them into long-term investors, researching the fundamental strengths of assets and creating balanced portfolios. The activity would no longer express their strengths. They would lose their intrinsic motivation. They would likely become mediocre performers at best.
Conversely, a talented long/short equity manager I work with is a phenomenal detective, identifying value in places where others fail to look. His great talents are intellectual curiosity and attention to detail. If I were to try to turn him into a daytrader, he would find the activity utterly meaningless. He could never sustain a learning curve. It's no surprise that, before he started trading, he ran a successful eBay business as a young kid. He was finding value and buying and selling it before he knew what the stock market was.
So often, talents can be found in the activities we choose to perform when we're not required to engage in activity. No one has to tell me to rescue cats or write blog posts. I don't have to get up at 4 AM daily to greet and feed my cats, follow overseas markets, and write my 4500th post to TraderFeed. As Ed Seykota pointed out, it's not even that I have those talents. Those talents have me.
You will find your success, in life and perhaps in trading, by leveraging the talents that have you. In leveraging our talents, we have the best chance of living a life filled with happiness, satisfaction, energy, and affection.
Further Reading: Finding Opportunity Amidst Adversity
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Talent is what we're born with; skill is what we acquire with practice and experience. Exemplary performance, such as that at the Olympics, lies at the intersection of talent and skill. Without the hard work of skill development, talent becomes unfulfilled potential. Many hours of hard work without distinctive talent, on the other hand, can produce competence, but rarely more.
We have one great advantage in our quest for exemplary performance: talent loves to be exercised. When something comes naturally to us, when we gravitate toward activities in our free time, when we lose ourselves in the flow of an activity--the odds are good that talent is involved. Skill building is not always a labor of love; sometimes it is much more labor than love. When we yoke skill building to talent, we can find the motivation to get through difficult drills and detailed performance reviews. When skill building is attempted in the absence of talent, it is sheer drudgery, and it is rarely sustained.
Can anyone succeed as a trader? Of course not. Not everyone succeeds as an athlete, and not everyone can succeed as an opera singer, surgeon, or graphic artist. Performance follows from talent and intentional efforts to cultivate talent to its fullest. Without the right kinds of bodies, we won't be Olympic sprinters, wrestlers, or swimmers. Without the right kinds of minds, we won't be chess grandmasters. Raw material matters. It may not be sufficient for greatness, but it is necessary.
Show me a great trader, and I will show you at least one great talent. Great traders play to their great talent; they maximize their strengths.
Show me a great trader, and I will show you a passion for his or her work. Why? Because talent loves to be exercised. A great talent is like a great horse. You can't keep it in the stall indefinitely. You have to let it run. Great talent loves to run and run free. The result is unusual productivity. But only if the talent is awakened and refined by skill development.
Trading success comes with greater difficulty in recent years, because the machines have at least two sources of talent: processing speed and processing breadth. Machines can "think" faster and can integrate more information than those relying on the unaided mind alone. What person can trade dozens or hundreds of strategies across multiple time frames and multiple assets to create smooth profit/loss curves? Little wonder that asset management firms relying on such processing power have amassed hundreds of billions of dollars of assets. Markets work by the golden rule: those who have the gold, rule. Market movement is a function of capital flows, and those who have the greatest capital are in a position to most influence those flows.
Great size comes at the expense of great maneuverability. When you have hundreds of billions of dollars, you cannot easily sell out of your holdings without greatly disrupting markets and getting very poor prices as a result. Large money managers have to build and trim positions over time, and that building and trimming leaves footprints. Among the traders who are succeeding in the current environment are those who possess the talents and skills to read those footprints. Opportunity does exist in the trading world, but it is a different opportunity set from the one I encountered when I first began trading in the late 1970s.
But you cannot exploit those opportunities if you don't understand your strengths, how to exercise them, and how to refine them with skill development. How can we know what we're truly good at? That will be the focus of the second post in this series.
Further Reading: Creativity and Greatness in Trading
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Here is a little-appreciated principle: Accompanying every dream is a fear. Very often, the greater the dream, the greater the fear.
The fear manifests itself in many ways, not always as outright anxiety. Sometimes the fear shows up as excuses that keep us from moving forward. Sometimes the fear takes the form of procrastination; sometimes it shows up as a fatigue and a suppression of our drive. Yet other times, the fear is a direct fear of failure, hesitancy to take risks on the way to reward.
Why do we fear at the same time we dream?
It's not that we're sabotaging ourselves, though continually giving into fear can end up derailing our quests. No, the fear shows up whenever there is uncertainty and change--whenever we prod ourselves out of our comfort zones. Any worthwhile goal entails a shift from the status quo, and those shifts take effort. They are not comfortable. Fear is our conserving force, tethering us to what we know and where we're safe. Fear preserves the status quo.
In many respects, this is adaptive. If we were wired for easy and continual change, we would find it difficult to navigate life's many routines. Instead, we're wired for habit patterns, and those make us more efficient. They allow us to get things done, while saving finite willpower resources for challenging situations. Once we exit our habit patterns, we extend ourselves and we expend resources. We introduce uncertainty and the unknown. And that's when fear kicks in.
So how do we overcome fear and clear the path to our goals?
Here is where the Naomi Principle kicks in: we can best overcome negative emotional experiences by tapping into stronger, positive ones. Imagine if we encountered a person whose sole mission in life was to keep us from achieving our dreams and thwarting our fulfillment. We would actively avoid that person; we would actively confront that person; we would take every action to minimize their impact upon us. They would become our enemy. We would find ample motivation to not allow our enemy to win. In short, our positive desire to fight for ourselves and win our freedom would overcome any fear or uncertainty we might experience.
When we visualize fear as that person standing in our way--as our enemy--we can summon that will to fight for ourselves. It's easy to give into procrastination, but if we clearly identify that procrastination is just another face of the enemy--just another form of fear--then we can ask ourselves, "Who do I want to win today: me or my enemy?" It's much harder to avoid that workout or prematurely bail out of that trade if we replace flight mode with fight mode. Anger, channeled as the will to defeat an enemy, is a more powerful--and more positive emotion than fear. That's what moves athletes and soldiers forward on the field: the desire to not let the opponent get the best of you.
When our dreams are bigger than our fears, we will fight for those dreams. No amount of reasoning, journal writing, or analysis ever got someone past a fear. Only fight beats fright: we achieve our dreams when we truly fight for them.
Further Reading: What It Means to be Free
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A worthwhile lens for viewing your trading processes is that of emotional intelligence. The above graphic depicts four aspects of emotional intelligence that are central to trading:
1) Self-awareness - Are you able to stand apart from yourself and observe your strengths and vulnerabilities in real time? Emotional self-awareness means that you observe and understand your emotional responses to market situations, and don't automatically get caught up in those. Self-awareness also means being fully grounded in one's "edges" as traders and not straying from those.
2) Self-management - Are you able to channel your thoughts, emotional responses, and behaviors in a constructive manner? Self-managing traders set goals that guide their activity through the day. They also behave in a rule-governed manner, whether it is with respect to entry/exit execution or risk management. Self-managing traders are ones who continuously review performance, learn from it, and place the lessons into subsequent practice.
3) Social awareness - Are you able to read participation in the marketplace? Can you pick up cues from volume, volatility, the co-movement of instruments and assets, and responses to news items that tell you whether buyers or sellers are dominant. The socially aware trader is keenly attuned to market flows, digging beneath the surface to figure out who is in the market, what they're doing, and the price levels at which they're acting.
4) Relationship management - Are you networking with others to make yourself better? Successful trading is a team sport, even when the trading is solo. There is simply too much information relevant to markets to process and stay on top of at all times. Successful traders filter out noise--the conversations, emails, and messages that contain little value--but actively filter in colleagues who have valuable perspectives. Very often, fresh inputs from those colleagues lead to fresh insights and trade ideas. Beneath every great individual performance is a well-functioning team, either real or virtual.
How well are you managing yourself and your trading relationships? How well are you sustaining a high level of awareness of yourself and of market participants? It's not a far stretch to imagine giving yourself a daily report card simply on these four dimensions to ensure that you're trading in a truly emotionally intelligent fashion. Very often, failing to monetize smart trading ideas is the result of a lack of emotional smarts. The good news is that, with practice, we can learn to be emotionally smarter: better at sustaining awareness and managing our resources.
Further Reading: Social Intelligence and Trading
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I recently wrote about the greatest weakness displayed by losing traders. Under conditions of drawdown, the winning trader becomes more grounded in his or her strengths. The losing trader veers from those strengths.
To successfully deal with a drawdown, you want to reacquaint yourself with your best trading: focus on the best trades, double down on your best practices for preparing for the day and keeping yourself in the right mindset. The great risk of drawdown is that the losses in trading create lost confidence and lead you to abandon what has worked.
Smart traders know that the same process needs to happen after winning periods in markets. A string of winning days can lead to overconfidence and sloppiness. It's when you're winning and feeling on top of the world that you once again want to double down on those best practices and best trades.
Losing money is not the only risk. The greatest psychological risk traders face is losing perspective. It's when you lose perspective that you want to rediscover the trader that you are.
Further Reading: Self-Regulation and Trading Performance
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What does it mean to be daring and different in trading financial markets?
It means being willing to look at new information and appraise markets in new ways.
Fresh insight comes from examining new data.
I recently wrote about three questions to ask about any market. That post became far and away the most popular post ever on TraderFeed: number one out of over 4500 posts.
Why?
Perhaps because looking at markets as auction processes and focusing on who is actually participating in the market and what, specifically, they're doing takes a daring step back from the normal routines of looking at charts and following the news.
One of the most powerful ideas I've worked with is relative volume, tracking when market participation is waxing and waning.
Most of the time, high or low prices will shut off an auction. Buyers will refrain from buying if prices get too high; sellers will hold off on selling if prices are unattractively low. When price extremes shut off an auction, relative volume starts to fade. Those price extremes represent important information: they tell us where supply and demand are imbalanced. Should we later move through those prices with ease, we know that there is fresh participation in the auction. That is important information.
At other times, however, high or low prices may actually stimulate further auction activity. Buyers are eager to acquire inventory; sellers are desperate to unload theirs. That's when we see relative volume stay high, even as markets are moving directionally. That's how trends are made.
Within the volume that does transact, we can see whether those transactions result in net upticks for stocks or downticks. I track this across all listed stocks. That tells us a great deal about the relative activity of buyers and sellers at the auction.
Think of markets in a sixfold grid: high, medium, and low volume and high net upticking, balanced upticks/downticks, and high net downticking. A low volume market with high net upticking will grind higher; but not necessarily move all that far. A high volume market with high net upticking often trends significantly. Low volume markets with relatively balanced upticks and downticks tend to be rangy, slow markets.
As the auction proceeds, we update our views on volume and net activity. We assess who is in control and to what degree. We watch critical price levels that have represented past value and past auction extremes and see how markets behave at those points right here, right now.
All of that is information readily available to all of us...but only if we dare take our eyes away from the pictures on our screens and stories in our heads.
Further Reading: Creativity and Innovation in Trading
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People often have an interest in psychology because they wish to make changes in their lives. They see that their trading could be better; they want to make improvements in their relationships, or perhaps improve themselves in some way. The challenge is getting from here to there. How do we make meaningful changes in our lives?
Research into counseling and psychotherapy is a little-appreciated treasure trove of information on how people make life changes. What does this research tell us about ways of making significant changes in reasonable amounts of time? Here are five important principles:
1) Focus your change efforts - Sometimes we are frustrated with how things are going at work or at home and we want to address and change everything. That's a mistake. Setting smaller, targeted goals and creating a series of small wins is much more effective in catalyzing an ongoing change process than tackling everything in diluted fashion. When goals are concrete and measurable, it's easier to appreciate when you're making progress and when you're not and taking appropriate corrective steps as needed.
2) Make your change efforts active - Too many people approach psychological work the way they approach religious worship: once a week they devote their efforts and pretty much forget things the rest of the time. That doesn't work psychologically or spiritually. Any goal worth pursuing is worth pursuing daily, and it helps (as part of the aforementioned focus) to have daily activities that move you toward your goal. If you want to get into shape, you work out daily and maintain a daily diet. If you want to improve your trading, you work on improvements that can be implemented each day. When the change process is active, changes are more likely to become part of you.
3) Make your change efforts sustainable - It's tough to sustain an active change process if that process is onerous. The most effective changes we can make are ones that become habit patterns. Yes, we often have to motivate ourselves to get over the hump of old habits and engage in new behaviors, but eventually we want to move past motivation. We want those new behaviors to become routine. This is most likely to happen if our change efforts are sustainable: enjoyable to pursue and doable. If our efforts at change are frustrating, we'll likely abandon them. The psychology research is clear: it is easier to initiate changes than to sustain them. Goals must be engaging and achievable. Small wins, over time, sustain the sense of being a winner--and that energizes future goals.
4) Begin with changes you're already making - This is the essence of the solution-focused approach, where we change by building on existing strengths and positive patterns. If you want to improve your trading, study your best trading and identify what you do when you trade well. If you want to improve your marriage, focus on what you and your partner do when you're happiest and closest. We tend to forget that we make subtle changes in how we approach situations from day to day, week to week. Some of those changes lead to positive outcomes--or at least avoid the negative ones. By identifying what we're already doing that is working, we create goals that not only are doable but that are truly part of us.
5) Emphasize changes that are meaningful - Yes, small, achievable goals work best and consistency in implementing work toward those goals is essential. Typically, however, what drives us to work on change is an inspiring vision and a sense of meaning and purpose. If my overarching goal is to achieve a trading track record that will attract the capital of investors, that adds a measure of significance to my daily work toward goals. Keeping such overarching goals visible is important, even as we work diligently on the details of performance. That is why athletic coaches inspire as well as teach. They focus their teams on practice and drills--but they also remind them that a championship lies ahead.
No great things were ever accomplished within people's comfort zones. By definition, change means breaking from routine. Perhaps the most important change we can make is make the challenging of our comfort zones a daily habit. There is never stasis in life or in trading. We use it or we lose it; we extend our capacities or we allow them to atrophy. At its best, change itself becomes a lifestyle.
Further Reading: Two Proven Methods for Building Your Happiness
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How can you make yourself a better trader, right here, right now?
Per Coach Knight's observation, take a hard look at your trading results and identify the one kind of market you most hate, the one that is hardest for you to make money. Perhaps its a quiet market with little movement; perhaps it's a market that has already moved quite a bit. Perhaps it's a particular asset class or time frame. Identify where you really are a poor trader with no edge.
That is what you're meant to work on.
You work on your weak trading not because that's where you should put your eggs in the future, but because the weak areas of trading reveal the vulnerabilities that eventually will dog you in your bread-and-butter trading. The chain of your trading success is ultimately only as strong as its weakest link.
But, wait, you say: Aren't we supposed to be focusing on our strengths and making the most of those?
Of course you want to build on your strengths, and that is your path to growth. The creative challenge of making yourself better is to figure out how to leverage your strongest trading to improve your greatest areas of weakness. Somehow, in some way, your best trading holds the key to what you need to be doing in the markets that give you the most trouble.
I don't mind sharing that I took a bit of a butt-kicking this past week in my trading. Nothing dire--each loss was small--but most my trades lost! My win rate on trades so far this year has been close to 70%, so a week like the one past stands out as a fail. So what went wrong?
My strength lies in synthesizing data: looking at many measures of market strength/weakness and buying/selling and organizing my observations into a cycle-based conceptual framework. It's when multiple measures of flows come together and fit into a pattern that I'm most likely to place winning trades. The key to such trading is waiting for everything to line up. I don't find good trades; they come to me when I'm patient and maintain an open mind.
So what happens in a slow market such as we've had in US stocks? Everything moves s-l-o-w-e-r and it takes l-o-n-g-e-r for things to line up. But did my trading slow down? Hell, no! I simply moved to faster time frames and looked for things to line up on a near term basis. In other words, I adjusted my trading so that I could trade; I didn't adjust for opportunity!
Look, I've been trading since the late 1970s. I have a doctoral degree in psychology, and I've worked with more traders than I can count. I literally study markets every day. And still, at times, I can trade like an imbecile. Weaknesses break through, whether they are shortcomings in my psychology or my trading methods. Good trading is not about always trading well; it's about identifying and addressing weaknesses quickly and drawing upon strengths to remedy those.
Guaranteed, this weekend I'll be studying my best trades and then seeing how often those patterns set up in slow markets. That will guide my trading this week. Every setback has a purpose: to make you stronger. But that can only occur if you're willing to look setbacks in the face, accept them, and learn from them.
Further Reading: Trading With Your Brain--And Your Gut
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The most common reason traders encounter problems with discipline pertains to willpower as a limited resource. Reading, following prices, conducting analyses, and managing risk all day taxes our capacities for focused concentration. Like any muscle, our willpower can become fatigued. That's when we lose focus, and that's when we are most likely to take action in ways that we did not plan or intend.
An up-and-coming trader recently pointed out to me that he understands physical exercise and what he can get out of it, but has trouble understanding the benefits of cognitive exercise, such as meditation. As it turns out, brain training is critical for success for anyone who is in the business of decision-making throughout the day.
There are two enemies of trading success: distraction and arousal. Distraction occurs when our focus wavers--either because of fatigue or overuse--and we have trouble filtering out extraneous information and concentrating on essentials. Arousal occurs when our bodies go into fight-or-flight mode, generally in response to a perceived threat. At such times, our bodies are primed to act when, very often, what we need to do is think, plan, and respond in measured fashion.
The purpose of cognitive exercise, such as meditation and biofeedback training, is to provide us with greater control, so that we're less likely to fall victim to distraction and hyperarousal.
There are three primary purposes for brain training: helping us relax in performance situations; helping us build our capacity for concentration, and helping us build our resilience to stressful situations. The most common goal of brain training is the achievement of a state of calm focus. In the calm, focused state, we sustain a physical level of relaxation while we are in a heightened state of concentration. When we remain in such a state for a period of time, we experience that as being "in the zone." That state of flow is associated with creativity as well as superior decision-making and emotional well-being.
Biofeedback devices and programs, such as Wild Divine, provide users with constant feedback about their achievement of the flow state, so that they can figure out what they need to do to stay in the zone. Video game interfaces, where winning is based upon staying in the zone, make it easy and fun to practice mindfulness and self-control. When we sustain the calm, focused state for longer and longer periods of time, we achieve deeper and deeper levels of stillness in our minds. Very often, when meditation doesn't seem to work for people, it's because they haven't spent enough time with it to achieve their second wind of consciousness. Once in that state, we achieve a clarity of perception and awareness that is exceedingly helpful for real-time pattern recognition and decision-making.
Sustaining calm focus for increasing periods of time and during periods of increasing distraction and challenge is the cognitive equivalent of going into the weight room and building our physical strength. What we're building is our willpower: our ability to act with intentionality rather than randomness. Brain training is so much more than simply going into a quiet room to take deep breaths and relax. When approached in true training mode, it is our way of building our capacity to enter and operate in the zone.
Training to sustain calm focus and build our capacity to stay in the zone is the most basic exercise in the cognitive gym. In the next post, I will outline more advanced exercises that can move our trading forward.
Further Reading: The Power of Implicit Learning
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