Sunday, March 01, 2020

The Psychology of Trading Fast Markets

This past week has seen an explosion of market volatility, with VIX exceeding 40 and daily price ranges of several percent in major indexes.  Below is a chart of the ES futures (blue line), with each data point representing 50,000 contracts traded.  The red line is the 20 period volatility of those volume bars.  (Data go from September 16, 2019 to the present).  Volume in the market has expanded greatly.  For example, on Friday we had roughly 100 bars on the chart; at the start of the year, a day was comprised of about 30 bars.  But notice below that we're getting more price movement per bar currently.  So the market has become extremely fast, with more volume and more movement for each amount of volume traded. 

This can create great opportunity for short-term traders, but it can also create great problems for their trading psychology.  With so many things moving, it's easy to become distracted.  With so much movement, it's easy to quickly lose money.  Rarely do traders properly adjust their trading sizes for the increased movement.  Indeed, some may size up positions, thinking that this is a great trading environment.  With more size and more movement, the volatility of PL can challenge even the most experienced traders.

In the latest Forbes article, I outline three important psychological perspectives on trading the recent market decline.  One point that article makes is the importance of slowing down when markets speed up.  When we face more risk and reward, there is an activation of our fight or flight responses, impelling us to react, rather than act deliberately.  During those stressful occasions, blood flow actually shifts in relative terms away from the brain's frontal cortex--our executive center--and toward our brain's motor centers.  

When we focus our attention and slow down, we shift blood flow in the opposite direction.  Indeed, in hemoencephaolography (brain blood flow biofeedback), we actually measure that shift of blood flow via subtle changes in skin forehead temperature.  We can achieve similar benefits through meditation.  Even a brief break in the trading day in which we focus our attention on imagery, slow our breathing, and remain physically still can make significant changes in our patterns of arousal.  

A great trading psychology technique is to just take a couple of deep breaths and perform a quick gut check before placing each trade.  It introduces a moment of mindfulness in our decisions.  It is difficult to trade with FOMO if you're slowing yourself down and reflecting upon your actions.

The Forbes article highlights the likelihood that volatility will be with us for a while--and what that could mean for the market going forward.  If we speed up with markets, those markets control us.  Slowing ourselves down is a great way of staying in control, even in crazy market times.

Further Reading: