Trading Psychology: How to Improve Your Trading Results

Many traders focus on their results--their P/L--and never make the process changes that could lead to sustained results.  A great deal of writings in the area of trading psychology emphasize the changes that traders should make--not actual techniques traders could employ to make those changes.  When I wrote The Daily Trading Coach, the idea was to create a "cookbook" that would help traders coach themselves, using established, proven techniques from applied psychology.

It's time, however, to update those "how-to's".  In the most recent Forbes article, I explain how evidence-based approaches to short-term therapy can be adapted to help us achieve peak performance in our trading--and in our personal lives.  This is a major development in psychology.  Until recently, change techniques have been used to help troubled people reduce their problems.  They have equal value, however, in achieving positives as "therapies for the mentally well."

In future posts and presentations to trading groups, I will be elaborating the how-to's of trading psychology, drawing upon techniques proven in their effectiveness based upon outcome research.  (This book, which I wrote/edited with two colleagues at the medical school where I teach, reviews the research going into each of the methods.)  Three of the specific approaches are covered in the Forbes article and will be a starting point for future posts:  behavioral techniques; cognitive exercises; and solution-focused methods.  As always, thanks for your interest and support!

Further Reading:

Psychological Techniques for Improving Your Performance 

.

Follow Your Joy...And Your Pain

The SMB Blog recently posted its 10 top trading tweets of the week.  There are excellent insights here, including reflections on "What I Wish I Knew Before I Started Trading".  One of the tweets pointed to the importance of feeling pain when we're trading poorly.

This past week, I've been teaching psychology and psychiatry trainees in techniques for helping people make changes.  A major theme I've touched upon is that, in our normal, routine states of mind, we tend to think routine things and engage in routine actions.  If we're looking to make changes, we need to get out of our habitual consciousness and access new ways of experiencing ourselves.  Interestingly, joy and pain are both helpful in that regard.

When we feel joy and gratitude, we focus on what we've done well; when we feel pain, we focus on how we've fallen short of our ideals.  Both states of mind cement our perceptions and help them stand out from routine.  We change via powerful emotional experiences, not simply by writing things in journal and talking them aloud.  

Many of our most powerful learning experiences occur in the context of meaningful relationships.  The experiences we provide our children as parents; that are part of our romantic relationships; and that occur in counseling and therapy are processed deeply because of their emotional power.  Because they are also part of ongoing relationships, we achieve the repetition that helps us internalize those new experiences of ourselves.  Many of our most powerful changes occur within the context of (new) social roles.

What is your relationship with markets?  How do you experience yourself in your trading?  What emotional experiences are you internalizing over time during your trading?  There is a role for joy in trading and a role for pain.  Both help us learn from our experience and, together, they help keep us confident and humble.

Further Reading:

Worthwhile Posts on Overcoming Trading Psychology Challenges

TraderFeed Home Page and Index

.

Becoming Your Best Self

In coaching, counseling, and therapy, people typically try to change the "texts" of their lives: their thought patterns, habit patterns, etc.  But what if our greatest changes come from shifting, not texts, but contexts?

In the most recent Forbes article, Aries, the black tabby cat, poses an interesting thought experiment:  

Suppose a movie is going to be made of your life.  Is it a film you would go out of your way to watch?

The sad truth is that most of us are living good lives, but not adventuresome ones; not ones that we would be proud to have made as books or movies.  

The article poses a unique perspective:  perhaps we are operating at states of energy and in environments that fail to bring out our greatest strengths.  If you're trading and living with less than movie-worthy adventure, perhaps this is not because you lack discipline or proper self-talk. 

Perhaps, like Aries, you need a change of context.

Further Reading:  

How To Use Energy and Environment to Access Your Greatest Strengths

.

A Formula for Trading and Investing Disaster

Many problems of trading and investing have a simple source:  People follow the markets on a different time scale from their intended holding period.  Typically this means becoming psychologically attached to shorter-term movements up and down and not holding positions as initially intended.  The general rule is that, as pattern-recognizing beings, we will find patterns in whatever time frame we follow.  When our egos become attached to the patterns we perceive, we act on what we see at the moment and fail to maximize our trades and investments.

Imagine the same problem in relationships.  We could become very invested in each new, interesting person we meet and thus never follow through on cultivating any single relationship deeply.  In making short-term dating "trades", we would never truly invest in relationships.

Hanging on every tick in markets, making P/L a daily focus of attention, is a recipe for trading and investing disaster.  If we follow markets closely, that will be reflected in our actions.  Inevitably, we act upon what we see.

The answer to this challenge is not "discipline" or ever-louder exhortations to control emotions, follow plans, etc.  The answer is to not allow ourselves to become slaves to the screens and, instead, only follow markets when we have specific trading decisions to make.  Away from screens, we need to find fulfillment in a wide range of personal, social, and creative activities so that we don't try to impose those needs upon markets.

Too often, we "overtrade", not because our markets are full of opportunity, but because our lives are otherwise empty.

Further Reading:

Taking Ego Out of Trading

TraderFeed Home Page and Index

.

Four Essential Ingredients of Trading Success

One of the great experiences I've had as a trading coach at a variety of trading firms is the opportunity to witness, first hand, what goes into sustained success.  Here are the four success ingredients I've noticed among top performers across different markets, time frames, and types of trading:

1)  A big picture perspective that indicates opportunity - I refer to this as "the idea".  It could be one asset mispriced relative to another one; an asset mispriced relative to changing fundamental information; a shift in momentum and market flows; etc.  Very often, this idea has been backtested or at least has objectively demonstrated its value in real time trading.

2)  A near-term perspective that provides a bet with superior risk/reward - I refer to this as "the trade".  The trader sees an opportunity to act upon the idea in a way that has limited downside (risk) and greater upside (opportunity).  Very often the trade reflects the lining up of short-term (market flow) information with the longer-term perspective.

3)  A methodology for sizing and managing positions, providing risk management and the management of opportunity - This amounts to bet sizing, so that the trader is taking proper advantage of an opportunity without courting undue losses and risk of ruin.  Very often, the successful trader will update bigger picture opportunity and near-term risk reward during the life of the trade to size up positions and/or scale out of them.  This allows them to lose less when ideas and trades are wrong and make more when they play out.  The successful trader very often displays average win sizes larger than average losses.  

4)  A framework for adapting trading to changing market conditions - The successful trader views the opportunity set as dynamic and will typically run periods of higher and lower risk taking as a result.  There is a regular process of taking in new information and feeding that into both ideas and potential trades.  This requires an openness to new data and the capacity to make changes in trading approaches in real time.  For example, a trader may emphasize directional, momentum opportunities in one type of market and relative value or "mean reverting" opportunities at other times.

Very often, trading problems result from overemphasizing one or two of these elements at the expense of others.  For instance, a trader may place great emphasis on big picture fundamentals and longer-term market opportunities, but lack an awareness of near-term flows to obtain good risk/reward trading opportunities.  Or a trader may focus on short-term "setups", but lack coherent ideas regarding why the asset should move as expected.  Or the trader will see good opportunities, but will fail to adequately capitalize on them through proper sizing and position management.  And, of course, many traders keep doing what has worked well after market conditions change, failing to adapt to shifts in the opportunity set.

When traders don't have an adequate grounding in all four areas, their performance is impaired and this can create psychological frustrations that further interfere with decision making.  In such cases, traders often look to psychology for answers to their trading woes, when in fact they need to make process improvements in one or more of the four areas above.  This is why mentoring is so powerful:  you can see, first hand, how the successful trader blends these success ingredients.

Further Reading:

Overcoming the Triggers to Poor Trading

TraderFeed Home Page and Index

.

Can This Market Go Higher Still?

Well, I have to say that the current rising market has not felt orgasmically great for many participants.  It was a very challenging V bottom in late December and those hoping for a substantial pullback to enter an uptrend have watched the market move higher in January, then February, then March, and now early in April.  I speak with a number of traders, and I have to say I observe little euphoria.  If anything, the sense is frustration at not having participated in the rally.

So can this really continue?  Can the market go higher still?

My aim is to examine the evidence in as open-minded a manner as possible.  I want to be open to weakness and strength, bear and bull possibilities.  And, perhaps most of all, I want to openly acknowledge when my research shows little directional edge.

Back in September, we were seeing growing weakness across a number of sectors and a cumulative uptick/downtick line that could not make new highs despite fresh highs in the large cap indexes.  That led me to question the upside.  Conversely, in early March, I took a look at what happens after a year starts with consecutive strong months and found a surprisingly bullish outlook.  A couple of weeks later, my look at that uptick/downtick line reinforced the upside view.

Well, that line has continued to make new highs.  There are no signs of divergence as occurred at the 2018 peak.  Moreover, we're not seeing any expansion of short-term new lows, as happened late last year.  Indeed, fresh one-month new lows across all exchanges (as reported by Barchart.com) have been quite low, which historically has led to bullish returns on a next 20+ day basis.  Usually, if there is going to be significant weakness, we see some sectors lead the way down, as housing did in 2007.  That weakness just isn't present at this time.

I noticed an interesting event at the Friday close.  Over 80% of all SPX stocks closed above their 3, 5, 10, 20, 50, and 100-day moving averages.  (Data from the excellent IndexIndicators.com site).  That is very broad strength.  Going back to 2006, we've only seen 23 similar occurrences--and none since 2013!  Many of those occurrences were seen in 2009 and 2010 and then again in 2012 and 2013 during protracted rises following market weakness.  Indeed, if we examine those 23 occurrences over the next 20 and 50 days, we find 17 occasions up and 6 down for both time frames.  The average 20-day gain was about 1.5%.

What this says to me is that we're seeing significant upside momentum in stocks.  Historically, such momentum has led the market higher, though not necessarily at the same rate previously seen.  The main takeaway is that we can't conclude that we're heading lower simply because we're "overbought".  Whether we think the valuations are justified or not, whether we like macroeconomic forecasts or not, equities have found meaningful demand.  Perhaps that's not so surprising in a world of low interest rates and tepid growth:  U.S. stocks may offer some of the few havens for yield and growth.  It may also be the case that the stock market, which has been kindly disposed to the current U.S. administration ever since the 2016 election, could display similar behavior should odds of re-election increase.

In any case, we're seeing broad strength and few signs of weakness.  A normal correction, given low levels of volatility and volume and the fact that stocks making new 52-week highs are not expanding, is clearly a possibility.  If the mood of participants that I speak with is indicative of a more general mood, any such pullback may find interest from frustrated traders late to the party.

Further Reading:

Reading the Market's Relative Volume

TraderFeed Home Page and Index

.

Reading the Relative Volume of the Market

Above we see a chart of SPY (five minute increments; blue line) over the past two trading days (4/3 and 4/4).  In red, we see the relative volume of SPY.  This is the ratio of the current trading volume to the average trading volume for that particular five minute period.  So, for example, the spike in relative volume at 13:50 PM for 4/3 tells us that the volume traded was five times the average volume that we've seen during that 13:50 - 13:55 PM period.  Conversely, during the prior topping period, note that volume was only half or so the expected volume for those time periods.

With relative volume, we can readily identify:

a)  Whether rising or falling prices are attracting trader interest;
b)  Whether larger institutional participants are active through the day;
c)  Price levels associated with unusually low and high volume;
d)  How the market behaves subsequently at those price levels.

It is not unusual to see cycles of varying duration in which falling prices attract volume (puking) and rising prices see volume dry up.  This pattern occurred on a large time scale during 2018 and during shorter time periods such as above.  Skilled traders can detect transitions in the relationships among price change and volume change to profit from cyclical movements that capture bull and bear psychology.

Further Reading:

Why Relative Volume Matters for Trading

TraderFeed Home Page and Index

.

Why It's So Tough To Get Bigger In Your Trading

A common view is that our psychology is a prime determinant of our trading.  If we can master our psychology and follow our plans, we should be more consistent and we can trade larger.  Profits should flow.

I beg to differ.

What if the direction of causality is the reverse?  What if it's markets--and our trading of them--that impacts our psychology?  What if it's the markets themselves that make it difficult to get bigger in our trading?

One thing I've noted so far in 2019 is that many, many market participants are not doing as well as they might have predicted they'd do in a trending stock market environment.  That includes portfolio managers who invest in stocks, as well as traders who move in and out of stocks.

Why might that be?

I propose that the central challenge of recent markets has been the relative instability of market volatility. 

Here is a stark comparison:  During January, SPY averaged a daily volume of a little over 97 million shares.  During March, that average daily volume dropped to 80 million shares.  Daily volume ranged in January  from a high of 144 million shares to a low of 59 million shares.  Daily volume in March ranged from 122 million shares to 56 million shares.  Yesterday's volume was around 40 million shares.

Why is this important?

Since the start of the year, the correlation between daily volume in SPY and the daily true range of SPY has been .81.  In other words, well over 60% of all market volatility has been a function of volume traded.  Volume has been declining over time and this has helped account for a VIX that has moved from about 23 to 13 thus far this year.

But that's only part of the issue.

The standard deviation of daily true range in 2019 has been half as large as the average true range itself.  That creates a situation in which, during March alone, we can have days with ranges as much as 1.99%, 1.82%, 1.64%, and 1.52% and as little as .40%, .42%, .48%, and .49%.  In other words, volatility itself has been volatile.  Using recent history to gauge how much the market can move in the near term has been quite difficult.

But, wait, it gets worse.

I maintain my own measure of "pure volatility" which assesses the average amount of movement per unit of trading volume.  It tells us how much "juice" we can expect for every amount of volume traded.  So far in 2019, that pure volatility measure has been more than cut in half.  So not only are we getting less trading volume; we're getting less movement for each unit of volume traded.  This helps to explain why traders feel as if volatility has gotten "crushed".  It's a double-barrel effect:  less volume and also less movement for every unit of volume traded.

And it gets worse still!

During the past month alone, pure volatility has declined by well over 50%.  In the past month, we've had readings above 17 and readings around 10.  So not only is volume shifting quite a bit from day to day; the amount of movement created by that volume has been shifting.  That makes it very difficult to estimate how much a market can move going forward.

If we have instability of movement, it is extremely difficult to set rational stop out levels, price targets, place to add to or reduce positions, etc.  That makes it tough to manage positions and maintain favorable risk/reward--and it also makes it difficult to size up positions.  Just when traders think they have a stable environment and make some money, they size up their trades, only to have volume and volatility shift--and potentially work against them.  

Imagine a football quarterback playing a game on a field where the weather changes radically from quarter to quarter, minute to minute.  The running plays that worked well in the first quarter when conditions were dry now work poorly when the field is wet.  The passing plays that worked in warmer temperatures become harder when it's very cold.  Yes, the quarterback would get frustrated and lose confidence, but the fundamental problem is not one of psychology.  The quarterback needs a real time meteorologist, not a shrink.

Very few traders that I know have real time tools to help them gauge the volatility environment of the stocks, indexes, or markets they are trading.  As a result, they assume that patterns observed in the recent past will persist in the near-term future.  My analysis of volume, volatility, and pure volatility suggests that this is a faulty assumption.  The equivalent of the quarterback's real-time meteorologist would be real-time tools to assess who is in the market, what they're doing, and how that is impacting price movement.  From this regularly updated information, we could make more informed decisions about price targets, sizing, etc.  

It is not clear to me that staying calm, focused, and composed and sticking to pre-existing plans is a formula for success, either on changing football fields or in radically shifting markets.  In fast-changing circumstances, we need to develop the ability to think, plan, and execute on the fly--and we need the tools to help us make continuous adjustments.

Further Reading:

Three Questions to Ask About Any Market

TraderFeed Home Page and Index

.