I had an interesting situation recently in which a trader wrote to me about a start-up situation. I interpreted the email as a request for advice regarding starting up a hedge fund or other similar money management vehicle. I responded that the initial steps were: 1) set up a viable business plan that explains how the fund will make money in different kinds of market environments and with different kinds of strategies; and 2) identify the people to be hired that would be best for implementing the business plan and maximizing the effectiveness of the trading. Only after figuring out the right plan and the right people, I suggested, should be focus go toward raising capital and finding the right capital partners.
It turned out I was wrong in my interpretation and the trader was simply interested in going live in his own trading account. That's when both of us realized that the advice I had given with respect to starting a fund is just as applicable with respect to one's own, personal trading. In other words, your trading truly is a business and approaching it as such maximizes your odds of success.
So let's pick apart the advice and see how it applies to our own trading:
1) A Business Plan - Imagine that you are pitching your trading business to a venture capitalist. How will you convince the VC that this is a business worth investing in? I'm pretty sure that the average trading journal and the average declaration of "edge" by trading XYZ "setups" would get you laughed out of the room by any experienced VC group. So how would you convince others of your edge and the uniqueness and robustness of your returns? If you can't convince others with a compelling business plan, can you truly expect to trade with your own conviction? You wouldn't invest in someone else's trading if there wasn't a compelling track record and plan. Why should you invest time and money in your own trading in the absence of such documentation.
2) The Right Team - Every successful business I've encountered has started by making the right hires. The founder(s) of the company have identified the right talent and experience to fill their own gaps and to successfully implement the business plan. That means hiring people who share your vision, who work well with you, and who bring something special and unique to the business that makes everyone better. If you are doing your own trading, this is no less important. Your "team" consists of the colleagues and community that you interact with. Do you have "partners" who you learn from and with? Do you have teammates who help make you accountable? The trading community at My Investing Club encourages the formation of TABs: Trading Accountability Buddies. The idea is to team up with a like-minded partner to share ideas and to learn from experience: what you and they have done well and what both of you are working to improve.
Operating in isolation without a detailed plan would not--and cannot--work for any business. Many traders fail, not because they lack proper psychology, but because they never took their trading seriously as a business. If you would not invest in another person's trading if they approached planning and teamwork the way you do, you know that you're not on the right path. Be the kind of business you would want to invest in because, ultimately, you are investing yourself in your trading.
Further Reading:
.
I am finishing the editing of my new book, Radical Renewal, and will be publishing it in the next few days. Below is a bit of a preview.
First off, the book is being written in blog format, which means that each chapter will be a blog post and readers can click from one chapter to another to read the book. Because it's written in this format, there will be many links included in the text, allowing readers to pursue topics of interest. The online/blog format of the book will also enable readers to ask questions and make comments, and it will make it easy for me to respond and update the text periodically. Perhaps best of all, the format allows anyone with an online connection anywhere in the world to download the book free of charge.
It's a way of giving back to a trading community that has given me so much.
The main ideas behind the book are:
1) The major problems we encounter in trading are not just psychological. Rather, they are problems that occur when our egos interfere with our information processing and decision-making. It is precisely because trading is such a profit/loss, materialistic pursuit that it grabs our fear, greed, and needs for validation and status and makes it difficult to simply listen to and follow markets with an open mind.
2) There are many spiritual traditions around the world, including the great religions and belief systems of the East and West, that provide tools and understandings for getting past our egos and grounding ourselves in larger realities. The chatter that makes up our self-talk *is* our ego. Spirituality is all about cleaning out the clutter in our heads and accessing our souls. If there is one key idea to the book it's that great trading comes from the soul, not the ego.
3) When we develop ourselves spiritually, we connect with what we find meaningful in life. We ground ourselves in our strengths: our activities give us energy rather than deplete us. This renewal can be part of an ongoing lifestyle that impacts all areas of life, including our trading, our work, and our relationships. When we spend more time "in the zone" of our flow states, we are best able to detect and act upon patterns in markets. When we are ego-consumed, there is no flow. We end up trading what we want to see or what we're afraid of seeing, not what is actually happening.
4) There are three major paths of spiritual development across the world's traditions that can renew our lives and our trading: the path of radical joy; the path of radical peace; and the path of radical repentance. When we connect with others in communities that affirm spiritual values, we internalize those paths. Much of our access to the soul comes from how we treat our bodies and how we interact with others.
The big message is that how we trade ultimately reflects how we live. We cannot trade in disciplined ways if we live undisciplined lives. We cannot have minds open to markets if we're filled with our internal chatter. It's not enough to write journal entries and perform exercises for a few minutes when we go on tilt.
Trading well flows from living well.
Brett
The market threw a nice curve ball on Friday. While all the world was hanging on Fed Chairman Powell's every word at the Jackson Hole meeting, it was an announcement of tariffs by China along with retaliation by the U.S. President that hit the market hard.
What I found interesting was that some traders were able to jump aboard this development and make money on the short side, while others found themselves relatively confused and even paralyzed.
So when is news a true game changer? How can we recognize when the psychology of the market has genuinely shifted? The charts above, from the excellent Stock Charts site, depict two things that help us identify when news items are truly newsworthy.
1) Volume and Volatility - Notice around the 11 AM time how we got a large bar to the downside on meaningfully increased volume. This is important. The extra volume coming in represents new participants in the marketplace. Typically these are institutional participants who are moving considerable size in the market. The fact that they enter all at one time, driving the market meaningfully lower tells you right away that participation and sentiment has changed.
2) Breadth - As long-time readers know, my favorite moment-to-moment indication of breadth of market movement is the NYSE TICK ($TICK). This represents the number of stocks on the NYSE exchange trading on upticks minus those trading on downticks. Notice how this had opened in negative territory, as many stocks opened lower than their prior day's close. We then saw buying come into the market during early trading, sending the TICK in positive territory. At that 11:00 AM hour, notice how TICK slammed negative, hitting levels of -1200. This is an extremely negative number and can only be achieved when institutions are dumping baskets of stocks (so that everything downticks at once).
When we put those two factors together, we can see that the distributions of price change, volume, and breadth completely shifted around 11 AM. We can then walk forward to see if those distributions continue their new pattern. Sure enough, SPY continues to trade with elevated relative volume and $TICK continues a negative distribution, failing to reach its morning highs. The hypothesis you want to entertain at this time is that the news was indeed a game changer and we could see a trend day, as large participants unwind large positions that can't just be dumped on the market. Notice how selling the first bounce after the 11 AM washout was indeed a good entry, even if a trader failed to hit bids at the first indication of volume and negative breadth.
No one could be expected to predict what happened at that 11 AM hour. Successful trading does not require such prediction. Rather, it requires an open mind and an understanding of what is happening moment-to-moment in the marketplace. A valuable feature on many trading platforms is a playback function that allows you to replay market action to see how the day unfolded. Playing and replaying key market scenarios is a great way to accelerate your pattern recognition abilities, so that you will be sensitive to similar patterns in the future as they emerge. Simply writing in a journal is not sufficient. We need to train the brain for real-time pattern recognition if we are to act in the heat of the moment.
Further Reading:
.
One of the core ideas among the traders on the New York floor at SMB is that of "the playbook". Derived from Mike Bellafiore's book of the same title, the notion of a playbook for traders is similar to that for football or basketball teams. Before each engagement, you assess yourself, assess the competition, and identify the plays that you will run that: a) take advantage of your strengths; and b) exploit the other team's weaknesses. The selection of plays from a playbook then guides drilling and practicing before the competition, preparing the team for optimal performance.
For active traders, each day can be a new competition. Recently, we've seen not only volatility and volume in the stock market, but a reasonable degree of volatility of volatility and volume. Thus, for example, roughly a week ago, we were trading well over 100 million shares a day in SPY, with wide daily ranges. Most recently, we've traded around 50 million shares, with relatively narrow ranges. Each day, we play a new game and face a new team. Without a playbook to guide us in what to look for and exploit in each environment, we cannot take advantage of our strengths and ground ourselves in the opportunity set of each set of market conditions.
For longer time frame traders who are more fundamentally grounded, each day will not bring a new strategy, but it is likely that each week and month will deliver a fresh set of risks and rewards. The notion of a playbook to select strategies to adapt to the changed environment is equally valid. For example, one manager I met with recently identified the environment for his market as trending, but with a declining Sharpe (increasingly choppy). To exploit the trend without having to worry about the back and forth, he drew from his playbook and found an options structure that he could hold and that limited his risk.
The trader who trades one way in all markets is like the dancer who dances the same way regardless of the music that is playing. It doesn't help to sanctimoniously proclaim that break dancing "fits my personality" if the band is playing a slow love ballad.
Interestingly, very few traders develop psychology playbooks. Different market environments may pose different "triggers" for traders: boredom, frustration, over-eagerness, overconfidence, etc. Having a playbook of techniques for grounding ourselves in these different conditions can help keep us in the zone and help us make our best decisions. Can we really make the most of our trading plays if our mindsets are reactive to what markets are doing? A well-rounded trading psychology playbook would include various methods of self-talk, various exercises to increase focus, various techniques to shift mood, etc. Over time, we can recognize the techniques we're most likely to need to perform at our best in the particular trading environment.
What's in your trading psychology playbook?
Further Reading:
.
How do people achieve and sustain very high levels of success? Research suggests that there are several building blocks:
1) TALENTS - These are the competencies we are hard-wired for; our inborn, native strengths. From an early age, most children display areas of relative strength and weakness. Sometimes there is a very high degree of early talent, as in the recent case of Kodi Lee, the blind, autistic singer/musician on America's Got Talent. As a young child, I devoured books on Greek and Roman myths and then became engrossed in books about human potential. Even now, it's what I gravitate to when I have free time.
2) SKILLS - Skills are the competencies we develop as the result of experience. Through ongoing deliberate practice, we can correct errors and build on successes to hone our performance. Skills are what we drill on the tennis court or football field during practice; they're also what we naturally develop when we systematically pursue areas associated with our talents.
3) MINDSET - Our psychology cannot substitute for talents and skills but very much can enhance or hinder our access to these. I outline how this happens in the recent Forbes article, noting that life experience leads us to emotionally encode both patterns of conflict and success. When the relevant emotions are triggered, this can either hamper or facilitate performance.
A very important principle is that we are most likely to maintain optimal mindsets for performance if we are truly aligned with our talents and doing what we do best. Elite talent fuses all three factors, so that our mindset energizes our skill development and that makes the greatest use of our talents. This is why our passions often point the way to our purpose.
Further Reading:
.
It's interesting to see: for quite a while, traders lamented the lack of volatility in the stock market. Now that we're seeing an elevated VIX and larger daily price ranges in the index products, a new set of woes has come to the fore. Many traders are perceiving an enhanced opportunity set, but are having problems capitalizing on it. Here are a few mistakes I see traders making recently:
1) Assuming that patterns that worked when VIX < 12 will work similarly in the higher volatility environment. When we have elevated volatility, the greater movement is present across time frames. What was a good, tight level for a stop loss point will be blown through in the higher volatility environment. Simply adjusting stops linearly with volatility also doesn't work, as each unit of trading volume produces more movement, precisely when volume is expanding. It is not a linear function. Another example is that traders assume that oversold points, for example, will lead to bounces. In the low VIX environment, which is often one of rising prices, that pattern may work. When we get significant downside, short-term oversold can easily lead to further oversold.
2) Overexcitement. Traders equate movement with opportunity. That's not necessarily the case. Movement is only opportunity if we have studied/backtested it and made sense of it. In the heat of overexcitement, traders will size up positions right at a time when their stocks or indexes are already providing more movement. The combination of larger size and higher volatility leads to much larger P/L swings, which can lead to debilitating losses and a much worse mindset going forward.
3) Poor review processes. In the busier market environment, traders do more trading and leave less time for reviewing and studying their trades. At SMB, traders work with the "playbook" concept introduced by Mike Bellafiore. Just as a quarterback and football team works with a playbook to prepare for games, traders have playbooks of the trading patterns that they have tested and successfully employed. Per the first point above, traders forget to update their playbooks when market conditions change, just as football teams change their playbooks to exploit specific opponents. But a changing market environment should call for a doubling down of review, to clearly identify what is working in the new regime. If traders become so busy trading that they spend less time grading their performances, setting goals, and making adjustments, they will underperform the perceived opportunity set.
The key takeaway is that we always play in unique environments. For the professional bowler or golfer, one tournament site is not like another. For the football or soccer player, field conditions can change. Many of the mistakes we make as traders involves failing to make the right adaptation to the environments we find ourselves in. All the self-help mantras and techniques will not help if we fail to identify and make the right adjustments to today's conditions.
Further Reading:
.
Around month's end, I will be releasing my new book, Radical Renewal, which is quite possibly the first book to explore the relationship between trading and spirituality. It will be an online book written on a blog platform, which means that it will incorporate many links and will be free of charge to anyone with an online connection. It's been a joy to write and will be an absolute pleasure to give to the trading community.
In a recent podcast with Steven Goldstein and Mark Randall, we explored a few basic ideas of trading and spirituality. Here are three big ideas from the coming book:
1) Many of the problems of trading do not come from diagnosable psychological disorders, but rather come from intrusions of the ego into the trading process. It is when we become self-focused and focused on P/L that we are most likely to lose our feel and understanding for markets.
2) The answer to our trading problems is not so much self-help and self-improvement, but rather self-transcendence. We need to transcend our "small selves"--who we identify with in day to day experience--and step back to find our larger selves. Tapping into our larger identities provides us with meaning and energy. Our best trading comes from the soul--the larger self--and not from the ego.
3) The major spiritual traditions of the world provide techniques and paths for us to cultivate our spirituality and access our larger selves. Our strengths define our essence: what we are good at and what speaks to us. A spiritual life taps into those strengths to ground us in an overarching life purpose.
There is much more to spirituality than doing a meditation exercise a few minutes each day. I look forward to exploring this with traders in an interactive format and in a practical fashion. Thanks to Steve and Mark for the opportunity to discuss some of these ideas!
Further Exploration:
.
How do we achieve mastery in a performance field? Let's use athletics as an example.
One path to mastery is learning from experience. That is why coaches sit down with teams after a contest and review game film. Watching the film in slow motion and keying on what team members did right and wrong helps cement goals for improvement in the minds of the players. That intensive review is common among chess champions. It is also something I've seen among successful traders. They will replay the market day after a long day of trading and walk themselves through the "game film", noting areas of good trading and areas needing improvement. That review turns every day of experience into a day of learning, doubling our exposure to key patterns that might set up the next day. Learning from experience also takes place among traders when they share their lessons. This occurs among the teams I work with at trading firms and is also shared online as learning lessons by the teams at SMB. Online trading communities, such as those mentioned in my recent post, are also great forums for learning from the experience of others.
In short, the first path to mastery is accelerating our learning curves by reviewing our performance and viewing the performance of others.
A second path to mastery is increasing our overall capacity for learning. Again, we can turn to athletics for an example. Much time is spent between games doing physical conditioning and running drills. When we hone our skills and improve the shape we're in, we can make the most of our experience. Recently we've seen an explosion of brain training applications for athletes, helping them master their psychology and also master actual brain functioning. We're in very early days of understanding the brain activity that contributes to successful trading. By conducting exercises to increase our attention/focus (such as meditation) and our processing of information, we create drills that can prepare us for "game time". Again to use an analogy from sports, we can develop the best plays and review them but we won't win if we're out of shape. Drilling the right brain functions may be the next edge in performance mastery for traders.
I've often mentioned that successful performance professionals spend more time working on their game than in actually playing. Years of preparation and training go into the making of an Olympic athlete, dance pro, chess grandmaster, or basketball star. For every hour of game time, there are many hours of practice, drills, and review. That is how we achieve mastery. We often focus on what we're doing during market hours, when it's the hours outside of competition that make us champions.
.
I've been engaged in an intensive research program exploring unique edges in the market. The gist of the research is an identification of "who is trapped" in the market when buyers can no longer lift the market and sellers cannot push it lower. The research is promising (note the recent post on market strength), but it has come with a unique challenge. The anticipated unwinds of buyers and sellers play out over multiple days and rarely in a straight line. That means that anyone seeking to benefit from those unwinds has to endure temporary, but very uncomfortable, adverse movement and drawdown.
That really is a challenge, because sometimes the trade idea itself will be wrong. In such a situation, it can be difficult to distinguish between normal adverse movement and just plain being wrong. The fear of failure and loss makes it easy to cut the winning ideas short or stop out of eventual winners. As I recently tweeted, conviction in our trades matters little if we lack the courage of our convictions.
So how do we deal with this discomfort and overcome the fear of failure? Here are three approaches:
1) Adjust the Trading - We're accustomed to thinking about how our mindset affects our trading, but how we trade also impacts our psychology. When we extend our holding period, we are increasing the variability of our returns. In essence, holding trades longer is sizing up. If we trade too large over a longer holding period, the adverse movements may not be tolerable. We need to size positions so that they will matter if they work out, but won't debilitate us if they don't. We can't win the game if we can't stay in the game. A second trading adjustment is that I will put on small size initially and only add if I see growing evidence that a top/bottom has been put into place. I'm not trying to call precise tops and bottoms. If I am anticipating a good move in the market, I don't need to capture every tick. Finally, I find it helpful to distinguish between the trade and the idea underlying the trade. The trade is simply a way to structure good risk/reward in pursuing the opportunity of the idea. If the trade doesn't work out, I want to stay on the front foot intellectually and ask myself what I would need to see to re-enter the market. That's only possible if the initial trade is sized moderately, giving room to re-enter. In short, we want to trade with full awareness of the possibility that this particular trade may not work out, so that stopping out is not failure, but an opportunity to reevaluate the idea.
2) Adjust the Body - I'm a big fan of using deep breathing and visualization exercises to prepare for adverse outcomes. The idea is to visualize what we're afraid of in vivid detail (getting stopped out, for example) while we do two things: a) breath deeply and slowly and keep ourselves calm and focused; b) continue the visualization to include how we would deal with the stop out, how we would talk to ourselves, etc. This trains mind and body to not overreact to setbacks, normalizing our responses and making it easier to accept losses as part of a bigger picture of winning. Performance anxiety occurs when fear of outcome interferes with the process of doing. If we can train ourselves to not overreact to negative outcomes in our pregame preparation, that training carries over to our actual performance. When trades move against us, we can take deep breaths, place ourselves in a state incompatible with anxiety, and then visualize how we will deal with the situation. The key is normalizing setbacks so that they don't feel like catastrophes.
3) Adjust the Attitude - It's important to get to the point where it's possible to embrace our losses, because those can be our greatest learning opportunities. Our losses are there for a reason. They can teach us to become better. Perhaps we need to improve our trading ideas. Perhaps we need to improve how we express those ideas as trades. Perhaps we need to improve our sizing and management of the positions we enter. Perhaps it's our lifestyle and states of mind/body that need work. What can we take away from losing that will bring us to winning? If we can use our losses to study our game in greater detail and make incremental improvements in our processes, then those losses are no longer threats. They are our teachers. We won't overreact to losses if we can embrace them. We are fallible. We will fall short at times. Those can be great opportunities to start again, smarter and wiser.
Very often, traders will have good ideas but will set stops so close that they never participate in the anticipated movement. They are playing to not lose, not to win. Their journals reflect frustration, not learning. It's one of the paradoxes of performance that we are ready to win when we are no longer threatened by loss.
.
I've received a number of emails and comments in response to the most recent Forbes article describing the pain of losing in financial markets. We don't usually talk about losing and how difficult that can be. It's more fun to speak about success and profits and always getting better. But that's not the real world. As the article makes clear, not all who pursue trading can make a living from their craft. If I'm a tennis player, I may not make the cut for pro tournaments, but I can enjoy my sport at a local club, playing against local competition. If I'm just average as a trader, I consistently lose money. That is not sustainable.
Many entrepreneurs build a number of start-ups before they hit upon a winning idea and execution. Years of ups and downs, wins and losses, precede any appearance in the Olympics. In most performance domains, losing is a necessary part of winning.
If you have been drawing down in your trading, what is most important is to step back and ask yourself a couple of key questions:
1) Am I looking for opportunity in the right places? So often, the difference between success and failure lies in what you are trading. As I mentioned to a young trader recently, you can be the best well-driller in the world and, if you're looking for oil in the wrong places, you'll go broke. The restaurant that works in the downtown location might fail in suburbia. You can only know what works by studying traders who are actually successful and seeing first hand what they're trading and how.
2) Is trading truly my area of opportunity? As I describe in the book I'm writing (due out later this month), sometimes it's our strengths that derail us, not our weaknesses. When I tried trading full-time, I found myself interacting with other traders and helping them--and losing trading opportunities in the process. The reality was that I became a psychologist for a reason. Being a meaningful part of people's lives is what really gets me up in the morning. When trading took me away from who I actually am, my trading suffered.
In the Forbes article, I link to a number of training resources and communities that can help us make the most of our trading. That can help you determine if there are niches in markets that capture your strengths. But before you worry about winning make sure you're playing the right game. What are you really good at? What gives you your happiest and most fulfilling experiences? Your wins in life--inside and out of markets--can educate you about who your are and what you do best. Your losses can be a wake up call, a nudge to become the best version of yourself that you can be.
.
