Sunday, April 09, 2017

Overcoming Overtrading: A Powerful Exercise

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