Two Mistakes I See Traders Making

Yeah, mistake number one is getting a haircut at home...damn!

Seriously, though, I see traders making two mistakes that are hampering their profitability:

1)  Setting The Wrong Targets - Traders want to set their reward-to-risk at 3:1 or higher, so they end up doing one of two things that hurt their profitability:  they either set stops too tight and exit the trade on noise or they set the targets too far away and then see positions reverse on them, especially in lower volatility environments.  I find that traders will spend time honing their exits to limit adverse moves, but will put surprisingly little effort into defining targets.  I'm currently working on a project that uses a quant framework to estimate the probability of hitting various targets in given time frames.  It's looking promising, but it clearly shows that if traders will hurt their hit rates and profitability by seeking huge rewards relative to risk.

2)  Sizing Trades Too Aggressively - What happens is that traders have been profitable for a while and then decide that they can make much more if they size trades up considerably and just a couple of losses reverses all the gains they've made.  The reason the trader has been successful is because he or she has operated within a stable regime:  a steady trend, a relatively constant level of volatility, etc.  After that profitability, we see a change of regime and, just as the trader sizes up, the market no longer follows the same patterns.  Sizing up trading is a great goal, but it needs to be done across different market conditions, and it needs to be steady and gradual--not a huge jump in risk-taking that can disrupt profitability and psychology.

The common thread here is that traders can become *so* focused on making money that they no longer take good bets.  If we have a need to make money, our greed will control us.  The more we need something, the more it controls us.  For the developing trader, learning is the top priority.  Once profits become the priority, learning goes out the window--and that derails many a trading career.

Further Reading:

Posts On How To Trade

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Very Important Trading Psychology Insight

Let's take a look at recent posts:

*  This Forbes article examines research on meditation and how meditative practice can make us better traders;

*  This Three Minute Trading Coach video describes a technique for reprogramming our minds by pairing stressful trading scenarios with a calm, focused state;

*  This Three Minute Trading Coach video illustrates a quick technique for entering calm, focused states in trading.

From these three posts, we can identify a very important trading psychology insight:

It's not emotion that interferes with our trading; it's the inability to stay grounded in the present.

Think about it:  Many of the problematic emotions of trading take us out of the present moment.  When we feel fear, we're worried about the future.  When we're afraid of taking a trade, we're regretting a recent loss.  When we're pushing ourselves to size up, we're focused on the future.  When we focus on a missed trade or a poor exit, we're caught in the past.

It's the distraction of the past and present that prevents us from being truly immersed in markets and feeling the patterns that we've studied and observed.  Even if you *could* eliminate emotion from trading, you'd wind up losing your *feel* for markets.  We want that capacity to feel!  But we want to stay grounded in the present, as the observer of our feelings, so that we can distinguish a feeling taking us back to the past or one caught up in the future versus one that comes from a deep, intuitive feel of what is happening here and now.

If you're struggling with discipline in your trading, perhaps it's not emotion that you need to banish.  Perhaps it's mindfulness that you need to boost.  That is a game changer in trading psychology.

Further Reading:

How Meditation Works And Why It Makes Us Better Traders

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Getting Better Before You Get Bigger

One of the very talented traders I work with at SMB recently talked about pushing his trading to get bigger and make more money.  It's a great issue for him to be tackling, as his trading has been remarkably consistent.  So why not focus on getting bigger--and bigger--and bigger to make more and more and more money?

In a recent Confessions of a Market Maker podcast, I joked that pushing ourselves to get bigger in our trading (a common topic among male traders) is akin to pushing ourselves to get bigger in the bedroom.  If there is one formula for diminished performance in both domains, it's focusing on size.

Research suggests that risk-taking is linked to personality traits (particularly extraversion), but is also domain specific.  One can take risks in one area of life and be quite averse in others.  Many traders moderate their risk-taking precisely because they need to maintain an even mindset during their trading.  As soon as they experience the drama of rising and falling P/L, their trading processes become disrupted.  For those traders, thinking big and acting big is a path toward getting small.

For many traders, we want to get better and better before we get bigger.  And we want to get bigger, not necessarily by taking more risk per unit of capital, but by increasing our capital base.  In other words, if I'm trading stock index futures and leveraging my best trades by three-to-one, the answer to getting bigger is not necessarily to go to five- or ten-to-one.  The answer is to increase my capital base and keep doing my consistent thing with 3:1 leverage.

The best path to a consistent trading psychology is consistent trading.  And the best path to growing your trading is to do so sustainably, maintaining consistency of trading and mindset.  Pushing yourself to get bigger, putting outcome ahead of process, too often means that our egos have hijacked our trading.  If we fill our minds with P/L concerns, what room is left to process markets?

Further Reading:

How to *Stay* Passionate About Our Trading

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How To Stay Passionate About Your Trading

All too often, I see traders begin their careers with passion and energy and then gradually lose the spark.  I see it in people's romantic relationships as well.  What starts out with energy and excitement eventually becomes routine.  And no one ever felt passionate about routine.

I recently discussed with a savvy trader how he has changed up his review process to make it more challenging and meaningful.  Tackling the right new challenges *gives* us energy.  It's something we look forward to.  As I discussed on the Confessions of a Market Maker podcast recently, we stay passionate about our trading when we have fun with what we're doing; when what we're doing is meaningful to us; and when we're connected to people through what we're doing.

What a great report card for evaluating ourselves:

*  Am I having fun with my trading?

*  Am I learning new and meaningful things in my trading?

*  Am I energized by my trading processes?

*  Am I connecting with the right people in my trading and do we make each other better?

Research suggests that we perform best when we are in a positive mindset:  when we are energized and engaged.  Yes, it's great to write journal entries and scan charts and review performance.  But all that can eventually become routine.  How are you going to stay passionate about your trading?

The Three Minute Trading Coach:  How to Shift Your Trading Psychology

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Training Your Mindset For Success

The most recent Three Minute Trading Coach video demonstrates a simple technique we can employ to return to a focused, mindful state during the heat of trading.  Where we get the greatest value in mastering our trading psychology, however, is not through the occasional use of techniques or reading pieces of advice.  We master our mindset through regular, disciplined training.

What that means is that any technique has to be practiced again and again and again before it truly becomes a part of us.  It could be a golf stroke, a baseball pitch, or a way for a singer to hit a very high note:  only repeated practice makes the new skill part of us.  But once we master the skill, we have it for life.  The key, as Muhammad Ali points out, is having a burning vision of being a champion that is so inspiring and motivating that it drives us through the suffering of day-after-day practice.

In coming videos, I will outline research-backed strategies for practicing ways of improving our mindset.  But the videos won't matter if you don't have that burning desire to "live the rest of your life as a champion."  Goals and practice channel our efforts, but it's vision that drives our efforts to train ourselves for success.

Hell is not just an afterlife.  We can find hell on this earth if we look back at our lives and find ourselves filled with the regret of, "I could have been a champion."  At SMB, very successful traders earn a shirt, which is presented to them in a group happy hour.  At one level, you could say, "WTF, all that work for a shirt??"  But, of course, that misses the point.  The shirt is a step on the path toward living your life as a champion.  The shirt is a tangible goal that focuses our efforts to be our best selves and train, train, train ourselves for success.

What is your "shirt"?  What is your tangible, visionary goal that will drive tomorrow morning's practice?

The Three Minute Trading Coach

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The Key To Successful Trading Psychology

We generally think of the sleep and waking states as binary.  We are either asleep or we are awake.  A very important recognition, reflected in the recent Forbes article, is that sleep and waking are a continuum.  Much of the time, we are not fully awake and we are not fast asleep.  Our bodies are awake and we talk and act and trade, but we are not self-aware. We can drift from thought to thought, habit to habit, routine to routine quite mechanically, seemingly awake but not awakened.

A paradox in trading is that we need routines and processes to trade with consistency, but this same immersion in routine can leave us lacking self-awareness.  Most of us have had the experience of making poor trades and then, at the end of the day, wondering, "How could I have done that?!"  Quite literally, "I" did not do that.  It was "me" reacting.

Without self-awareness, we are reactive.  Action requires intention: the "I" must be in the driver's seat.  Trying to get rid of emotion in our trading, in and of itself, will not build our capacity for intentional action.  We can be just as reactive in quiet boredom as frustrated fury.

Experienced trading psychology coaches recognize this:

*  The AlphaMind Podcast, with Mark Randall and Steven Goldstein, emphasizes mindfulness as an important component of performance, facilitating self-management and even pain management.

*  Yvan Byeagee, in his Trading Composure blog, describes a process for mindfulness and its ability to "detach" us "from unfruitful patterns of behavior".  

*  Adam Grimes, on his site, explains that meditation, a key path toward mindfulness, helps us "work toward a state of clarity and...the stopping of random thoughts and influences."

*  Gary Dayton, speaking with Andrew Swanscott and the Better System Trading podcast about mindfulness in trading, notes that even traders with many years of experience feel emotions related to profits and losses and that suppressing and controlling emotions doesn't work.

What the Forbes article adds to these valuable insights is that the development of our intentionality is enhanced when we operate within an intentional community.  It is not coincidence that serious students of meditation learn within communities headed by a master teacher.  Nor is it coincidence that peak performance, whether from an Olympic athlete or a performing artist, is never developed in a vacuum.  There are always schools, always coaches and mentors, always supervised practice and structured feedback.  Operating within a high performance community keeps us continually mindful of what we need to do to perform at our best.  It is no coincidence that, at trading firms such as SMB Capital, preparing for the day, searching for trade ideas, and reviewing performance is all undertaken in a team context, where being around awake people helps keep each trader from falling asleep at the trading wheel.  

Viewed from this perspective, every single day offers a potential workout of our intentional muscles.  Each day lived purposefully cultivates our capacity for self-direction and true wakeful living.  The key to successful trading psychology is living life purposefully, expanding our capacity to sustain direction and intention.  At root, all bad trading is mindless trading.

Further Reading:

Why It Takes More Than Goal Setting to Reach Our Goals

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Why We Need A Checkup From The Neck Up

The most recent Three Minute Trading Coach video explains how we can take our emotional temperature and keep ourselves in the calm, focused zone in which we best see market patterns and act upon them. 

Why is this particularly necessary for traders?

Trading appeals to competitive individuals and the competition for trading profits is an ongoing and fast-paced one.  The stronger our competitive drive, the more susceptible we become to frustration.  Frustration occurs when an important goal is blocked:  when we want and need an outcome and something gets in the way of achieving it.  

It is not possible to eliminate frustration altogether, nor is it even desirable.  Frustration can be channeled in such as way as to spur new searches for ways of reaching our goals.  For the experienced trader, frustration often contains information.  The market we're trading right now might not be acting the same as the one last week or last month.  For the self-aware trader, frustration pushes us to re-examine what we're doing and how we're doing it.

But we can't channel frustration if we're unaware of it in real time.  That is why the simple three-item checkup from the neck up described in the video is helpful during trading.  As Ziglar points out, without such a checkup, we are all prone to "stinkin' thinkin'" and "hardening of the attitudes".  We fail in trading when we fail in sustaining an optimal mindset.

When we're in the calm, focused mindset, we want to be completely absorbed in markets.  When we're frustrated, we want to be completely aware of our state so that we can take the necessary breaks and return ourselves to our zone.  In the next video and blog post, I will describe a powerful technique that can quickly restore our optimal trading mindset and provide us with the perspective to learn from our frustration.  With the right, proven techniques, we can truly become our own trading coaches.  And it all starts with sitting back and conducting our checkup from the neck up.

Further Resources:

How Working With Others Can Enhance Our Trading Psychology

Taking Your Emotional Temperature

Navigating Stress and Distress

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How To Stop Forcing Trades

We often hear the term "overtrading", but what *is* overtrading?  Quite simply, it's trading that no longer has any probabilistic edge.  An example would be a poker player in Vegas who feels a need to bet a chunk of his or her stack despite holding a mediocre hand.  When we overtrade, we trade for psycho-logical reasons, not logical ones.  

A common form of overtrading is "forcing" trades.  That's where we become so convinced about an upcoming opportunity that we don't wait for a sound risk/reward place to enter the market.  Rather, we push too much size and try to predict the next move rather than wait and *identify* when it's occurring.  Forcing trades is a great example of how our egos can get in the way of our making money:  we are so eager to be right that we overplay our hands.

So how do we stop forcing trades?

The important concept to keep in mind is that when we quiet the mind, we also quiet the ego.  As Radical Renewal discusses, our stream of self-talk *is* our ego.  To focus on markets and trade them well, we don't want to be chattering to ourselves positively *or* negatively.  Rather, we want to quiet the chatter and simply "listen" to markets the way we would listen to someone we care about during a conversation.  A good listener doesn't "force" the conversation by constantly jumping in with what he/she wants to say.  The good listener is attuned to the other person and knows what to say and when because of *understanding* that other person.

To stop forcing trades, we need to be quiet enough in our minds that we can sit and sit and sit and let the market make sense to us.  Then we will know what to do.  Meditation, where we learn to sit still, breathe regularly, and focus our minds on a single thing, is actually a training in quiet mind.  Meditation is practice in not forcing; it is training in *not doing*.  Meditation quiets the chatter of self-talk and that keeps our egos our of our trading.

In a coming Three Minute Trading Coach video, I'll demonstrate a simple meditative exercise that can quickly return us to the "zone" where ideas come to us and we no longer need--or want--to force.  It's amazing how much we can see in markets when we simply open our minds.

Further Reading:

Using Your Body to Program Your Mind

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The Three Minute Trading Coach: When Should We Take Trading Breaks?

The Three Minute Trading Coach is a new video series that features specific trading psychology challenges and techniques for mastering those.  Every video will have a practical takeaway idea that can help your trading.  Over time, the videos will form the backbone for an online course in trading psychology, accompanied by a how-to handbook.

Many new traders are flocking to financial markets, no doubt as a response to the work-from-home trend and growing unemployment.  My hope is that these videos and the soon-to-come handbook will help these new traders with their learning curves.

Here's the first installment of The Three Minute Trading Coach:

How and When to Take Breaks From Your Trading

Thanks for your interest and support--

Brett
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How To Adapt To Changing Markets

Show me a successful trader during 2020 and I will show you someone who has adapted well to massive changes in the trading environment.

Above is information you normally don't see on your trading screens.  This is the amount of movement that we are averaging for each unit of volume that we're trading.  The blue bars on the chart represent 50,000 contracts traded in the Standard and Poor's 500 futures (ES) from the start of 2020 to the present.  The red bars are a 20-period average range per bar.  Note that, as the market fell and volume increased, the amount of movement for each unit of volume rose exponentially.  Similarly, as volume has come down recently, we have also seen less movement for each amount of volume.  In short, we've seen a great volatility expansion in 2020 followed by a great volatility collapse.

One of the great misconceptions of trading is that all we need to do is find our edge in markets and then all the rest is psychology and staying in the right mindset.  The reality is that markets are ever-changing and so are the edges in trading them.  The market we saw at the start of the year was very different from the declining market of mid-February through mid-March and that market was very different from the present market.  The breakout trades that worked wonderfully and made people so much money when the VIX was north of 50 are now working far less reliably.  The successful trader understands the market environment and finds edges appropriate to what the market provides here and now.

Much of the frustration traders experience is the result of an inability to adapt.  It is a great example of how poor trading can negatively impact our trading psychology.  The answer to this situation is not merely to calm ourselves; we have to adjust to the trading environment we're in.

In a talk with SMB traders, I shared an interesting statistic:  the correlation between yesterday's market volume in SPY and today's volume is a whopping +.82 since the start of 2018.  Think about that:  volume tells us *who* is in the market.  The odds are good that the players who dominated yesterday's trade will also be dominant today.  If we want to find out what the upcoming market will look like--and the opportunities likely to present themselves--we need to actively study the last few trading sessions.  More specifically, if we want to figure out how to make money in today's market, we need to closely examine what worked for us yesterday and the day before.  Playbooking the most recent days' trades will provide us with the practice in pattern recognition that can prepare us for today.

Of course, if we get a genuine catalyst and volume today expands meaningfully above the most recent volume, we know that new players have entered the market and consider the catalyst to be trade-worthy.  That is important information and often precedes momentum moves higher or lower.  Being able to see the new traders in a market or stock and which way they're leaning can itself provide a meaningful edge.

Further Reading:

Why Volume Is So Incredibly Important in Trading

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Cultivating a Mindset of Plenty

A trader recently wrote to me about missing a couple of trading opportunities on the day.  He shrugged those off, found fresh opportunity, and finished with a nicely profitable, low stress day.

How did that happen?

It's no coincidence that this trader looks at an unusual number of stocks and instruments to trade during the day.  He also scans across multiple time frames and programs multiple alerts.  This means he has a vastly expanded opportunity set relative to other traders:  he's mining in more locations and thus is more likely to strike gold.

But there is an important psychological component to this.  Because he has studied so many markets and time frames and opportunities, he comes to trading in a mindset of plenty.  His framework is one of abundance, not scarcity.

If you have a very scarce opportunity set, any missed opportunity is a threat and a source of potential great frustration.

If you have an immense opportunity set, any missed opportunity is no big deal.

In other words, the best thing for your trading psychology is a highly diverse playbook.  There is little reason for frustration and tilt trading if fresh opportunity is around the corner.  When you have multiple ways of making money, you can enter any set of market conditions with a constructive mindset. 

What's your outlook on trading?  On life?  One of abundance and plenty, or one of scarcity?  It doesn't matter how large your account size is:  you'll be happier in a full cabin than an empty castle.

Further Reading:

Psychological Scarcity and Abundance

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How Is This Pandemic Making You A Better Person?

I have often written that good traders have two kinds of trades:  one that they profit from and another that they learn from.  In losses, great traders find learning and growth.  The key is managing those losses so that we can ultimately benefit from our learning curves.

Now we have a much more serious crisis on our hands.  Some people I see are frustrated, emotional, and defeated by the prospect of a continuing pandemic.  Others are using the crisis as an opportunity to grow, to do things they normally would never have done.  Sometimes it's by learning new things; sometimes it's by getting closer to family; sometimes it's by finding opportunity in markets despite limited opportunities elsewhere.

Tomorrow I will be speaking with employees at a firm where I work.  I will be making myself available as a psychologist to help them and their families survive and even thrive during the pandemic.  I won't bill the company for these visits.  I won't invoice the families.  It's what I have to do.

I look at myself staying safe at home and then I look at the many nurses, doctors, and other healthcare staff that put themselves on the line every day.  It makes me ashamed.  It makes me want to man up and put myself out there in some fashion to make this time better for others.  

So my schedule will get busier.  I'll get less sleep and more calls.  I'll get over it: there are people with real problems, real suffering out there.  This pandemic has led me to reach out to people in ways I never would have before.  I can't control how this will play out ultimately, but I can make sure it makes me a better person.  The virus only wins if it kills our souls as well as our bodies.

How is this pandemic making you a better person?  The goal is to emerge from this difficult period as much better versions of ourselves.  Here are five ways people I'm working with are using this time creatively and constructively:

1)  Trying out a new, different charting platform that gives access to new market information and studying new and different edges in the market.  Imagine you and three other like-minded traders doing this on your own, each coming up with new market approaches and perspectives and sharing those within your group.  

2)  Taking classes and learning totally new things.  So many sources of online learning out there:  we can literally go back to school and become part of a passionate learning community.  Couples can take a class together and share in the learning:  how about a cooking class or an exercise class?  How about learning a new language and preparing for a future trip overseas?

3)  Giving back.  So many religious communities and community groups are holding events and meetings online.  Some of these are social; some are focused on improving the community.  Many communities are focusing efforts on helping out vulnerable populations:  what can you contribute?

4)  Building your fitness.  Most of us have time to be able to take the jogs, do the stretching, lift weights, and raise our level of fitness.  What a great way to make sure that staying-in-place is not a time of passivity and deterioration!  And how about cognitive exercise??  I've returned to new biofeedback routines to improve my concentration.

5)  Building your relationships.  It could be little things, such as the new foreign films Margie and I watch in the evening, or fun projects like a family-wide Mother's Day call coming up.  It could also be larger things, like improving your teamwork at home; doing new and fun things with your children; or using Zoom time to spend quality time with friends.  Social distancing may continue for a while, but we can stay connected and actually deepen our relationships.  

It all starts with a vision:  Creating an image of the better person you'll become at the end of all this!

Further Reading:

How to Make Life Changes That Last

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How To Overcome Trading On Tilt

Are you the pilot of your trading, or do markets take you for a ride?

When we go on tilt, we are no longer the pilot.  Our emotions--particularly frustration--get the better of us.  That leads to decisions and actions that we would *never* take in our normal mindset.

That is a key recognition:  Being on tilt--trading out of control--is triggered by our emotional state.  We cannot overcome this problem simply by telling ourselves to be more disciplined, etc.  We need to be able to reprogram our emotional states in real time.

Here's how to do that:

As a first step, please review the most recent Forbes article.  It describes exactly how we can make lasting changes in our thoughts, emotions, and actions, according to psychological research.  What I will explain below will make a lot more sense if you have the background from that article.

To change your state of frustration--or prevent such a state from occurring in the first place--you need to enter a state of mind and body that is incompatible with frustration. 

So what we do, beginning with practice outside of trading hours, is rehearse a simple relaxation strategy in which we close our eyes, sit very still, listen to peaceful and relaxing music, and slow down and deepen our breathing.  The idea is to focus entirely on the music and breathe slowly and deeply for at least 5 to 10 minutes--until you get yourself into a focused zone.  In the beginning, it may take more time than that.  No problem.  As you practice this exercise (I recommend practice at least twice daily), you will become quite good at getting into your zone.  Eventually, it will only take a matter of seconds for you to close your eyes, adjust your breathing, imagine the music and get yourself calm.

It takes practice, but is very doable.

Once you've gotten the knack of entering your zone, you then want to take a step-by-step, gradual approach to change as the article describes.  You do this by returning to your relaxation exercise, but now while imagining very mildly frustrating trading events.  Perhaps you're imagining getting a price that's not so good or getting out of a portion of your trade a bit too soon.  While you vividly imagine these mildly frustrating events, you're keeping yourself calm and focused with the breathing and the music in the background.  You keep doing the relaxation work until the frustrating scenarios no longer lead to any sense of frustration.  Again, this takes some repetition.

Once you've extinguished the frustration for the mild scenarios, you then create more moderately frustrating ones to rehearse in the same way.  Perhaps you'll imagine missing an opportunity or entering your position incorrectly and losing some money.  Again, you visualize such scenarios vividly while doing your deep breathing and while immersing yourself in the music.  You repeat this until these moderately frustrating situations no longer affect you.

Finally, you'll continue the mental rehearsals but now using very frustrating situations to walk yourself through while listening to the music and keeping your breathing deep and slow.  For example, you might imagine getting stopped out on the day or having a winning trade reverse against you and cause a loss.  Just as before, you keep yourself in your zone while vividly imagining the frustrating scenarios until they no longer evoke any upset.

At that point, you can take your exercises to real time.  While you are trading, you play the music in the background.  The music has been associated with your calm, focused state through the process of anchoring, as explained in the article.  Once you start feeling even a bit frustrated during the trading day, you immediately close your eyes briefly and do your deep breathing.  That places you in a state of mind and body that is incompatible with frustration and the tilt that results.  

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For a different exercise that can be used in a similar reprogramming way using your visual field rather than the breathing, check out this article, which was brought to my attention by the ever-alert Tadas Viskanta of Abnormal Returns.  In this case, the visual shift helps place us in a state incompatible with tilt.   

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Quite literally, you've retrained your emotional response patterns so that you don't go on tilt when frustrating events occur (as they do for all of us!).

It's all about the practice, repetition, and positive habit-building that make you the pilot and put you in control.  All the writing in journals and reading of superficial tweets about discipline and planning will not reprogram your mind and body.  We can change, but not by doing the same old things and staying locked in our same old states of mind and body!

Further Reading:

How to Make Life Changes

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