Tuesday, November 07, 2017

Trading Psychology Challenges - 3: Inconsistency

Most traders have dealt with runs of winning and losing trades.  We can expect those to occur simply as a function of chance.  A greater problem occurs when we have runs of sound and unsound trading processes.  In other words, we become inconsistent in our preparation for trading; inconsistent in our research; inconsistent in our sizing and risk management; etc.  This inconsistency threatens any possible edge that we can have in markets.

One of the reasons I encourage traders to keep regular report cards to grade their performance is so that they can catch inconsistency as early as possible, before it can sabotage their trading and their mindset.  A trader I recently met with scored himself unusually low on his ability to anticipate risk.  He simply failed to engage in scenario planning should his position fall out of bed on adverse news.  Because he had been trading well, he became comfortable and complacent.  We used that lapse to help him make the scenario planning part of his daily checklist.  The goal was to review the "what if" contingencies--and mentally/emotionally prepare for them--*before* putting the trade on.

So what causes us to become inconsistent?  There are three important possibilities:

1)  The market has changed.  Our trading can become inconsistent when markets themselves exit one regime and enter another.  As trends change, correlations among markets change, and volatility changes, what had been working may no longer bear fruit.  If you find that your trading processes have remained relatively constant but your results are noticeably worse, you want to take a deeper look into what you're trading and whether it has become a different market.  If so, you want to make sense of that new regime and develop fresh trading ideas based on new understandings.  Be especially attentive to alterations you have made in your trading processes in reaction to changed markets.  One trader I recently spoke with found himself trading more frequently as markets became less volatile, in essence pressuring himself to make money by taking more trades since each trade was yielding less.  That overtrading led to poor results. 

2)  Our state has changed.  In the example from the second paragraph above, the trader became overconfident and overeager after a period of winning.  In other situations, we lose consistency when we become frustrated or fearful.  The state change into fight or flight mode causes us to act in a reactive, unplanned fashion.  At such times, we place trades as much to manage our states as to optimize our profitability. If we find that critical portions of our planning have been overlooked in the heat of battle, then our goal is to work on staying calm, focused, and mindful in real time.  In my Trading Psychology 2.0 book I discuss self-hypnosis as a way of replacing negative states with positive ones.  The Daily Trading Coach covers a number of methods for state-shifting, including the use of trance and behavioral exposure techniques.  When we can recognize problem states in real time, we can then use meditation and guided imagery methods to switch into a calm, focused mode before the agitated state can hijack our trading.

3)  We have become fatigued.  Fatigue is a special kind of state change, as it relates to energy level more than emotionality.  Very often traders spend long hours in front of screens and overtax their willpower.  This is a short-term equivalent of the burnout described in the recent post.  In that situation, we need to renew ourselves, typically by getting away from screens and entering a different mode and state that is stimulating and renewing.  Taking an exercise break midday, getting off the desk and talking with colleagues--these are ways of shifting gears that can be renewing.  Getting the right amount and quality of sleep at night is also an important consideration, as the lack of restorative sleep can lead to diminished concentration and susceptibility to inconsistent trading.  The positive impact of healthy eating, healthy exercise, healthy sleep patterns cannot be when it comes to optimizing one's energy level.  Building positive, stimulating activities into non-trading time can also be highly renewing.

In short, there is no single answer for inconsistent trading, as there are many potential causes.  As a rule, if your process is inconsistent, then state changes could well be the trigger and culprit.  If your processes have remained rigorous but results have gone downhill, it could be a sign of changing market regimes--important information in itself.  Inconsistency in trading generally means that you have fruitful work to do, either on yourself or on markets.