Monday, May 28, 2018

When Trading Psychology Problems Just Won't Go Away

As we saw in the last post, the starting point for addressing psychological problems in trading is making sure that the methods you are utilizing really do provide you with positive expected value.  I recently spoke with a frustrated trader who was making money, losing it, making it, and then losing.  He couldn't understand why he couldn't sustain his gains.  It turned out that he was making use of trendlines that were promoted by an online trading service.  The guru running the service pronounced that there was a "strong edge" in placing trades based upon these lines, but when I questioned, the trader acknowledged that he had not independently verified this edge.  When I conducted a quick backtest, the signals based upon the lines displayed random forward returns.

The trader's problems had nothing whatsoever to do with psychology.  The psychological discomfort was the result of the problem, not the cause.  All the attempts in the world to stick to his plan, improve his mindset, listen to his feelings, control his feelings, etc, etc, etc would not have helped him.

This should always be the null hypothesis--the base case--for a trader experiencing distress and behavioral problems, especially if those do not show up in his or her non-trading life and if an edge had not been soundly established previously.  The first hypothesis is that there is no edge--and you need affirmative evidence to reject that hypothesis.  It is your methods, not your psyche, that need working and reworking.

Only after establishing the soundness of what you're doing should work on psychology and performance take front stage.  An analogy would be a golfer who runs into a string of poor scores.  If the mechanics of the swing and the mechanics of putting have not been mastered, there's little sense in using visualization exercises to foster a winning mindset.

A related hypothesis is that the edge that once was present is now no longer operative or has changed.  If the golfer is playing in rainy conditions, that may dictate a change in swing and a change in each approach to the hole.  If traders find themselves in low volatility conditions, that may dictate a change in the trading of momentum-based patterns.  Edges are dynamic, requiring frequent adjustments by traders.

Once you have identified and verified patterns in markets that capture your understanding of what makes markets move, any problems you might have in implementing the trading of those patterns might be psychologically driven.  Here, the key is determining whether problem patterns in your implementation are caused by emotional or behavioral factors that show up as problems in other parts of your life, or whether the problems affecting your trading are indeed unique to the trading context.

Many problems that impact trading are not specifically trading-related.  For example, a person with fragile self-esteem or a person with poor emotional self-control will find these problems impacting their family lives and personal relationships, not just their trading.  In such cases, work on those problems needs to occur outside of trading and well as during trading hours.  There are research-backed psychological techniques for the great majority of these issues, as I lay out in the Daily Trading Coach book and in many blog posts.

Trading problems that won't seem to go away are usually trading problems not being properly addressed.  By looking deeply into the root causes of poor returns, we can figure out what is going wrong--and that's the first step in setting things right.

Further Reading: