Here's an interesting informal experiment I recently conducted: Select an entry point on a chart and a direction for the trade. Based on the chart (and the chart patterns perceived), select the target point at which you would exit and the stop point you would honor. In other words, estimate how far the market will move in your favor and how much it could move against you. My experience is that successful traders are more realistic in the setting of those targets and stops. In other words, they don't place targets unrealistically far away, and they don't place stops unrealistically close. When I've polled newer traders and then actually calculated the odds of hitting the price targets within a given holding period, the odds were much less than 50%. In other words, the less experienced traders overestimated the directional movement possible within their holding period. Conversely, those less experienced traders underestimated the odds of getting stopped out. Those odds, for a given holding period, well exceeded 50%. The net result was that traders were getting stopped out well before reaching their targets and then becoming frustrated at "choppy" markets. That's bullshit, however. It's not that the market is choppy; it's that the trader's estimations of price movement are unrealistic. I find this dynamic to be especially prevalent among those who trade over longer time horizons based upon fundamental criteria. They set price targets with those fundamentals in mind, but over the course of their anticipated holding period, volatility would have to spike for them to hit those targets. They are implicitly trading a volatility view, and that's been lethal in recent low volatility markets. Interestingly, I recently observed a trader who was experiencing consistent success, with profitability every month this year and most trading days. When we discussed what the trader was doing well, it turned out that he was patient in his entries and *very* realistic in his price targets. When others were seeing price make a local new high or low and getting excited about the "move", he was already taking profits. Because of his conservatism in taking profits, he implicitly was expecting reversals--a dampened volatility view. To cement these observations, I went back to my recent trades and calculated my typical holding period. I then went back to historical prices and examined the expectable directional price movement during that holding period. In many cases, my targets were not well aligned with the movement that could be expected. If I had taken profits halfway to my target instead of waiting for the target, I would have been much more profitable, with a higher hit rate. As a result, I created a measure of microvolatility: the amount of movement expectable over intraday time periods. When targets were adjusted for microvolatility, the hit rate and profitability soared. Traders--and I include myself here--lose money because we are stupid. We impose our needs/desires/expectations onto markets rather than adjust to the actual behavior of markets. If I operated in such a manner in my social life--or as a psychologist!--I would alienate quite a few people. The socially skilled person reads the verbal and nonverbal behavior of others and is sensitive to that when responding and conversing. The skilled trader similarly reads the behavior of markets and trades within the framework of what markets provide. Anything else is stupid--and unprofitable. Further Reading: The Actual Relationship Between Volume and Volatility
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I found an excellent way to assess experienced traders. Simply ask them to show you what, specifically, they are now working on in their trading. The best traders--including the ones experiencing current success--can show you concrete improvements that they are making to their research, their trading, their risk management, and/or their trading business. Not intentions to make changes, not journal entries about changing, but actual, concrete, documented change efforts. Here are a few things traders I've been working with have been doing to get to that next level of performance: 1) Teaming up with other traders to create unique opportunities - The successful traders seek out others different from themselves and skilled/knowledgeable/experienced in different areas to create mutual learning and synergies. A talented discretionary trader might team up with a talented quantitative researcher; someone expert in trading one region of the world will team up with someone with extensive background in a different region; etc. In romance as in business, when the right people pair up one plus one becomes three: everyone makes everyone else better. 2) Becoming granular and working to improve specific trading processes - One trader I know is looking to high frequency market information to improve his entry execution, measuring results by tracking the adverse and favorable excursions of each trade. Another trader is building specific time into his schedule to implement creativity exercises and generate more unique and promising trading ideas. Yet another trader is implementing a system for sizing trades up and taking greater advantage of the trades found, through his research, to have the best hit rate and profitability. The more detailed and sustained the improvement process, the more likely it is to result in meaningful change. 3) Learning new tricks - I recently spoke with a trader who has created a unique correlation measure to assess when money is flowing into multiple macro assets at the same time as a way of tracking the activity of large money managers. A creative trader is experimenting with generating sound patterns from the activity on charts, so that he can track more markets by simultaneously watching and hearing different markets. When one market demonstrates the right patterns, he moves to trading it, so that he is always trading where there is opportunity for what he does. Still another trader has added mean-reversion setups to his momentum ones so that he has different ways of trading slow versus busy markets. These traders make money in different market conditions and in different markets, while others remain one-trick ponies. Every successful company has an active research and development pipeline. They are creating tomorrow's products and services and testing them out, because they know that is where tomorrow's profits will come from. The auto manufacturer is working on driverless vehicles; the software company is building new virtual reality applications; the publishing company is electronically archiving chapters from all their books so that readers can, on the fly, select chapters from different books and create their own electronic texts. What is your R&D pipeline? How full is it? How much time do you spend in developing tomorrow's trading? How, specifically, are you going to be better by the end of this year? Those are some of the strategic questions that help guide the career success of traders. Further Reading: Three Varieties of Market Idiot
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Many thanks to the great site of Despair for this perspective on limitations. We see lots of motivational posters on how failure is a step toward success and we should always keep persevering, etc.
No.
Sometimes perseverance is denial of limitations. And sometimes failure--like losing your entire trading stake--really is failure.
So much of the reason many traders fail is that they never pursue trading the right way, as a performance discipline. They don't have a structured process of learning. They don't have the tools to properly replay, review, and correct their trading. They don't have mentors to role model good trading practices. They don't learn strategies with true edges and instead trade random patterns on charts or headlines of the moment. They don't have enough capital to survive their learning curves. They don't find the trading markets and styles that best fit their particular strengths.
Could someone on their own train for and reach the Olympics in an athletic event? Could someone on their own practice acting and make it on Broadway?
Of course not.
Performance fields require ongoing programs of development. Without such programs, success is unlikely.
It's not what individual traders want to hear, but it's what I've learned in over a decade of working with everyone from beginners to portfolio managers managing billions of dollars.
There are two components to good decision making in markets: our ideas and our trades. Good things happen when these line up. When I refer to our ideas, I mean the bigger picture of the trade: the factors that lead us to believe that the market will make a particular directional move. For shorter time frame traders, those ideas may be based upon data releases or earnings events or other such events. For longer time frame traders, ideas may be grounded in fundamental factors, such as an acceleration of growth in the U.S. economy. Our ideas express what we believe will be moving the market. Sound ideas have some basis in reason--they make sense--and typically have some basis in backtesting.
The second component of our decision making is our trading of the idea. This is how we implement the idea to achieve a favorable reward relative to risk. Our criteria for trading an idea are separate from the idea itself. For example, I may want to buy stocks on a surprise economic number that is bullish, but I might wait for the first pullback after the release to enter the trade. I want to see how sellers behave after the first pop higher in price to tell me if the catalyst truly is altering capital flows. If I see selling drying up at a price higher than when the news was reported, I'll enter the trade for at least another leg to the upside. The news catalyst framed my idea, but the dynamics of the price and volume action framed my execution of the trade.
We see the same thing in sports. A coach will call a play on the basketball court. The focus then turns to executing that play well. A good play exploits the weaknesses of an opponent. But the good play doesn't lead to a score unless it is executed well, with good ball and player movement and players getting to the right spots on the court. You can't score if you don't run good plays, but good plays cannot lead to scores unless they are executed well.
Above we can see a snippet from Friday's trading session in the ES futures. The screen grab captures four things I look at in executing a trade idea. The basic idea for my trading comes from an assessment of market cycle: specifically the relationships of event time spent in rising/falling in past cycles as those relate to the dynamics of a current, evolving cycle. (See the post on Cyclically Adaptive Trading for more background.) My basic idea was that a short-term cycle had peaked on Thursday and that we should see lower lows and lower highs over time on Friday.
In executing the idea, the four elements I keep track of are time (and event time denominated in volume bars); price (red and green bars); volume (bottom of chart); and upticks/downticks among all NYSE stocks moment to moment (blue line). Note that we sold down around 12:15 PM with downticks greatly exceeding upticks and volume expanding on the decline. Sellers had taken control.
When the buyers take their turn, we can see upticks handily outnumber downticks at several peaks between 12:30 and 13:00. Note, however, that volume dries up during those bounces and price can only retrace a fraction of the prior decline. The buyers just can't get it done. When I look at time, I'm looking for a rough correspondence between the amount of time spent declining and the amount of time spent in the subsequent bounce. (If we draw volume bars, the time equivalence is about equal in this example). Waiting for that time relationship to play out and selling on the final bounce in the NYSE TICK nicely executes the trade idea for a move down to 2341 a little after 13:00--a fresh low for the day on expanded volume.
You may very well trade different ideas on different time frames and implement those trades in very different ways. The important point is that you trade well-researched, sound ideas and implement those in a way that aligns market flows with your bigger picture. It is not enough to have good ideas in markets; we have to be able to translate those ideas into good trades. Similarly, it is not enough to focus on chart patterns and short-term price relationships when larger market forces can run you over. The greatness of a painter is that he or she sees a big picture--an inspiring vision--and then executes that brushstroke by brushstroke. It takes a similar combination of vision and execution to make for great trading. Further Reading: Time and Trading Psychology
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Bella recently wrote a blog post in which he described five things that top traders at SMB were doing to facilitate their success. It was interesting for me to read his post because, as he notes, I've been working as a coach with many of these same top performers. I see the traders from a different angle so, with that in mind, I offer three additional "best practices" that I am seeing among traders experiencing consistent profitability: * Accountability - The most successful traders are the ones that most consistently bring their numbers to meetings with me. They show each day's performance and review with me what happened: good and bad. They let the numbers tell the story: whether or not they let losing trades get away from them; whether or not they were consistent in trading their edge; etc. In one case, P/L was down for the month, but the distribution of winning and losing trades showed real consistency and superior risk management. It was simply a time period where opportunity was more scarce in that trader's strategy. But the conversation focused on what the trader was doing right, not simply on the lower P/L. The best traders hold themselves accountable; they hold themselves to the goals they set and they set their goals in measurable ways. * Working on Psychology in Real Time - The most successful traders develop strategies for staying in their trading zone during the course of the trading session. Psychology is not merely an add-on, something to be reviewed at the end of the trading day. It is an integral part of their trading process. For example, one trader has found that he is much more successful when he is in a mind state of calm, patient, self-awareness. Accordingly, he takes breaks during the day to ensure he sustains his optimal state and practices meditation outside of trading hours to build his capacity to enter that zone. On the trading floor, the traders frequently refer to trading "setups": criteria that have to line up in order to provide an edge in a trade. We've recently begun talking about each person's psychological setups: the cognitive, emotional, and physical factors that need to align for best trading. Edge occurs when our psychological setups overlap the setups offered by the market. * Adopting a Process Focus Trade by Trade - A promising new trader who will be joining the trading floor recently emailed me and asked about "trading process". Because he had experienced success as an athlete, I responded by drawing an analogy to football. When you're in the game, you focus on blocking, tackling, and executing the next play well. You don't get caught up in the scoreboard or what others are doing. *That* is a process focus: being immersed in the doing rather than the results of the doing. Imagine that each month is a season for your basketball team and each trading day is a game that you're playing during the season. Your goal is to win the game, but to accomplish that you need to be focused on making the crisp passes, boxing out to get the rebounds, keeping yourself between the ball and the player you're defending, moving without the ball on offense, and screening to free up the good shooter. To win a season, you have to win many games; to win a game, you have to run many good plays; to run a good play, you have to execute on offense and defense. I've written in the past about my favorite bumper sticker, "Forget world peace. Visualize using your turn signal." That is process focus! The worst traders have a passion for trading. They need to trade. The best traders have a passion for trading well. They need to get better. Show me what traders are doing outside of market hours, and I'll show you the odds on those traders' success. Further Reading: Mental and Emotional Preparation for Trading
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The recent post highlighted the challenge of short-term trading returns over the past year and, indeed, since 2009. In this post, I will sketch how I am addressing those challenges in my own trading.
When traders refer to the difficult trading environment, they often make reference to "choppy" or "noisy" markets. Usually their next sentences lament the "algos" and their impact upon markets. I find these to be expressions of frustration, not constructive formulations of trading challenges. Invariably, those lamenting choppy markets dominated by algos that "manipulate" markets engage in their venting--and then go back to trading as they've always traded...and continue to lose money. A key to understanding the recent poor returns of short term traders is to appreciate that these traders don't merely lack an edge; they have a negative edge. What they are doing, which largely falls into the category of trend/momentum trading, is systematically not working over time. Waiting for high Sharpe trends to return to markets has not been a sound business model. But perhaps we can trade in a way that benefits from anti-trending/mean reversion as well as momentum. In coming months, I will be rolling out an approach that I refer to as Cyclically Adaptive Trading (CAT). The core idea behind the strategy is that all markets contain linear, directional elements (trends) and cyclical elements. On a given time frame, a "noisy" or "choppy" environment is simply one in which the cyclical aspects of market behavior dominate the linear ones. Note that any market cycle itself has linear (rising and falling) components and range bound ones (topping and bottoming). Very often, what is a trend on one time scale is a portion of a longer-term cycle. The interaction of cycles over multiple time frames creates challenging irregularities, as markets switch between mean-reverting and trending phases. The idea of CAT is that you trade the market's personality, not your own. Instead of trading the time frame and style you happen to prefer, you trade the cycles setting up in markets. Because there are multiple cycles at work at any one time and because the dynamics of the current cycles are influenced by the activity of prior cycles, we can identify dominant cycles in real time and adjust trading parameters to those. This is the adaptive element in cyclically adaptive trading. The reason so many traders are failing is that they lock themselves into preferred time frames and trading styles. An adaptive approach is one that trades momentum/trend when we are in the rising and falling phases of cycles and one that trades in a value/mean-reverting manner when we are in the topping and bottoming phases. We trade longer-term when longer-term cycles dominate and shorter-term when we see those "choppier" conditions. Trading one time frame in one style systematically fails over time in markets possessing strong cyclical elements. (A corollary is that, to the degree you identify yourself, say, as a directional trader or a short-term trader, you are probably losing money. Someone who limits themselves to trading one facet of market cycles is like a baseball hitter who specializes in hitting fast balls. If you get enough of those guys on a team, it doesn't take the opposition long to put breaking ball and off-speed pitchers on the mound.) A second major idea behind CAT is that cycles are self organizing: recent cycles impact the creation of new cycles which interact to generate other, different cycles. There is no single periodicity to cycles that can be traded mechanically and, indeed, I have doubts that cycles even exist in chronological time. Markets move in event units of price movement and volume: as participants enter and exit markets, they impact cycles in ways that impact future price behavior. In other words, cycles are a function of the behavior of market participants, not a function of the passage of time on a clock. Our job as traders is to adapt to the market's clock and trade in market time, not our time.
The trading I am rolling out is based upon an advance I've made in tracking the self-organization of cycles over multiple event time horizons. Some sources of insight into market cycles can be found in the early technical works of George Lindsay and Terry Laundry. Important quantitative perspectives and tools have been offered by John Ehlers, who introduced the notion of adapting technical trading systems to dominant cycle periods. Relevant TraderFeed posts appear below, and I will be posting more as I formally roll this out in my trading.
Thanks to a savvy trader for this graphic of the Soc Gen Short Term Trading Index, which is the composite results of the largest diversified futures funds holding positions for less than 10 days. Even the longer track record is net negative. Interestingly, hedge fund performance was positive for the first quarter of 2017, but the performance of CTAs was negative over that same period. These results mirror my own experience working with trading firms: those trading short-term and those trading in a momentum/trend style have been performing worst. Those performing best in Q1 were ones focused on Asia, as well as activist funds and funds trading volatility strategies. In other words, those market participants with specialized strategies have been outperforming the generalists. Working at a number of funds as a performance coach, I can tell you that--on average--those placing directional bets on interest rates in Q1 greatly underperformed those trading relative value strategies. Even among day trading firms, uniqueness of strategy has been an important predictor of success thus far in 2017. Those traders day trading big liquid instruments have underperformed those finding unique opportunities in carefully selected individual stocks. I'm not so sure this is all that different from the dynamics in the broader business world. If new participants enter a crowded space, they are less likely to be successful than if they find unique niches. This is an important challenge for those aspiring to trading success. The risk tolerance of most trading firms does not permit long holding periods for directional positions. This tends to throw everyone in the short-term camp depicted above. You're not going to win by playing the same game as everyone else, just as you're not likely to find gold if you prospect the hills that have been well picked over by previous miners. It's not enough to learn how to trade; it's critical to trade uniquely. It's not enough to trade with rules and discipline; one must also find opportunity creatively. The firms achieving the results depicted above are trading trends in liquid markets in a disciplined fashion. A great approach to success would be to research strategies that made money during months when those other participants were performing worst. There is no guarantee that future returns will mirror backtested ones, but digging for gold in well-mined fields is a poor risk/reward proposition.
The most recent post took a look at the real reason traders lose money. Though we often justify our style of trading by asserting that the style fits our personalities, the reality is that traders lose money precisely because their personality traits interfere with the identification and trading of opportunities that legitimately exist in markets. Nowhere is this dynamic more prevalent than in the frequency of people's trading. For the most part, traders trade with a frequency that suits their needs for involvement, not their objective assessments of opportunity. The result is overtrading--taking many more trades than opportunity rewards. There are all sorts of excuses for overtrading, including the common assertion that frequent trading contributes to one's "feel" for the market. In reality, however, the chop, chop losses that often accrue with overtrading contribute to the very psychological problems--frustration, loss of discipline--that traders recognize lead to a loss of market feel. The real question is whether frequency of trading is positively correlated with P/L. Very often that correlation is zero or negative. Periods of more active trading correlate with worse trading performance--not better market feel. It's no coincidence that one of the most read TraderFeed posts deals with why we trade emotionally. We typically encounter psychological issues in trading because we're overinvolved in markets, not because we lack commitment or passion. Indeed, too often passion is used as the excuse for addictive trading.
So here's an experiment that I've been working on.
The inspiration for the experiment comes from the idea that artificial constraints can act as prods that stimulate creativity. For instance, suppose I tell myself that I have to prepare a tasty dessert that only utilizes three foods. Moreover the first two components of the dish have to be cake and cherries. So now I have to think out of the box. How do I put cherries and cake together into a unique and tasty dessert? I decide that the dessert needs liquid to bring the cake and cherries together, so I squeeze juice from some of the cherries. I then recall that I had a delicious fruit beer during a recent brewery tour. I blend the beer with the cherry juice to create a tasty sauce and pour that over the cherries and on top of the cake. Voila! A unique dessert that I never would have thought of had my options been unlimited. With that in mind, how would I trade if I could only trade once per week? Hmmmm...that changes everything. If I can only fire one bullet, I have to make sure it counts. That means I won't take little scalp trade ideas; I'll want to benefit from more significant market moves. So now I have to go back to my market research and identify the characteristics of the few great trades that set up during a week. I look back at many weeks, across many market conditions. Lo and behold, there *are* criteria that clearly indicate good weekly opportunity, but they are different from the criteria I've been looking at. They are longer term, and they rely on setups that simultaneously occur on multiple time frames. They're like the fruit beer: criteria I wouldn't have thought of had I been free to trade any and every time frame.
As a consequence, if the trade doesn't set up across defined time frames, I don't take it. Looking for a good idea isn't good enough when you can only trade once in a week; you need those great ideas that come to you. If it doesn't strike me as a slam dunk, I don't trade it. I don't want to waste that bullet. What I can report from this experiment is that the trading thus far has been profitable and consistent. If that continues, I'll size up the selective trades; I won't trade more often. I am fully engaged in markets and update my research daily, but I only trade when everything comes together. I'm perfectly content to miss moves, as long as I profit from the movement I do identify. But just as the fruit beer cherry cake is a new creation, my new trading style provides an entirely fresh experience. I check the market in the morning, midday, and evening, but I don't spend time staring at screens. That frees me up to do many other things with my time: I now have the bandwidth to take on new and interesting projects. Trading has fit into my life; my life does not revolve around markets. It's easy to tell when we're on a good path: the travel gives us energy; it doesn't deplete us. Trading less has meant making more, but also being more productive. It has also led me to identify patterns to trade in the market that I would have never otherwise perceived. Take it to the bank: Trading success comes from trading the market's personality, not our own. Further Reading: When Trading Gets Out of Control
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So I've figured out the real reason traders lose money. It's only taken me how many years as a psychologist to figure this out, but, hey, no one ever said psychologists have a monopoly on the insight market. Before launching into the actual reason traders lose money, let's step back and review an important principle: Most accepted wisdom in the trading world consists of kernels of wisdom that have been blown up into Grand Ideas that are utterly invalid. The poster child for this phenomenon is the idea of discipline. Successful trading requires having rules that guide decisions and actions. Success requires the consist following of those rules. Given a set of valid rules, the better performer will be the disciplined person who trades with fidelity to those rules. Makes sense. But once we blow discipline into a Grand Idea and insist that Discipline is the source of all trading success, we then have mentors and coaches who harangue traders with journals and checklists to monitor every minute activity. This ultimately serves two purposes: it makes traders so self conscious that they are no longer attuned to market patterns, and it so routinizes trading that traders become unable to adapt to changing market conditions. As a general principle, discipline makes sense. As a supposed formula for trading success, Discipline ensures consistency in losing. The same is true for ideas of emotional awareness and mindfulness in trading. Great ideas in context that, once blown into Great Principles, divert traders from the real work for identifying objective patterns playing out in the marketplace. If a trader trades randomness with self awareness, they will be a keen observer of their own demise.
Which brings us to the topic at hand: the real reason traders lose money.
One of those nuggets of wisdom that gets blown out of proportion is the idea that success comes from trading in a way that fits your personality. There is certainly truth to that. If you're an extroverted person, your idea generation is likely to benefit from talking with knowledgeable market participants. If you're introverted, you are more likely to benefit from reflection and analysis. Taken to the level of Grand Principle, however, the idea that success will follow from expressing your personality in markets becomes a kind of anything goes, do whatever you feel like justification for poor decision making. Because *that* is the real reason traders lose money: They ARE trading their personalities. Show me a losing trader and I'll show you someone acting out their personality in risk-taking. Consider examples drawn from the "big five" personality traits: * The trader who lacks conscientiousness in his/her personal life fails to achieve consistency in trading. The trader who is overly conscientious fails to innovate when market conditions change. * The trader who lacks emotional stability in his/her life trades impulsively and emotionally. The trader who is highly emotionally stable has difficulty taking proper risk out of fear of upsetting the emotional apple cart. * The trader who is highly introverted or extroverted allows internal or external stimuli to interfere with decision making. * The trader who is highly open to experience becomes so enamored of new ideas that his/her trading becomes skewed by the latest shiny toy. The trader lacking openness to experience finds one way to make money and can't do anything else even after that one way loses its edge. * The trader who is very likeable has difficulty tuning out people and becomes easily distracted by noise. The trader who lacks likeability alienates the very colleagues that could help inform his or her trading. In other words, traders lose money BECAUSE they are trading their personalities. Every personality trait brings potential assets and liabilities to trading. Sometimes, our personalities pose severe challenges to trading success. Every personality asset, when overutilized, brings its own set of problems. There is only one source of making money in markets, and that is identifying recurring patterns in market behavior and exploiting those in a manner that provides solid reward relative to risk. We marshal and attenuate various personality traits to identify and exploit those patterns. Success comes, not from indulging our personalities, but from knowing which traits to draw upon and which to work around. That is called wisdom.
In my next post, I'll provide a personal example of trading success that came, not from following my personality, but from properly channeling it.
Resilience is the ability to encounter a setback and quickly resume forward movement. The resilient trader doesn't allow losses in the morning to prevent good trading in the afternoon; losses in one day to turn into poor trading the next day. Resilience requires belief in oneself and one's processes, and it requires the ability to look at the setback and ask, "What is this trying to teach me?" Much of resilience is having other, positive things to fall back upon when one part of our life is not going well. It's much easier to absorb trading losses when we are fulfilled by family life and enjoy physical health, friendships, and meaningful personal pursuits. A great test of a trader is to see how they perform after a poor trading day or week. Do they become impulsive and lose discipline, trying to make the money back? Do they become fearful and miss good opportunities? Do they double down on preparation and learn from what they could do better?
Here are several articles pertinent to resilience and maximizing positive experience when trading. These will be helpful in that part of trading preparation in which you prepare yourself for the trading day:
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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