Sunday, October 25, 2020

Are You Taking Enough Risk In Your Trading?

This is going to be a little technical, but please bear with me.  It is super important to your trading.

Imagine a variable that captures danger at one end of the spectrum and opportunity at the other.  Now imagine that life offers most of us a relatively normal distribution of dangers and opportunities, such that we mostly experience small risk and small opportunities in day-to-day life, but once in a great while encounter very large dangers and very large opportunities.  Such a normal distribution of outcomes looks like this when we plot it:

In such an idealized model, we encounter really large dangers roughly 2% of the time and really large opportunities similarly.  Over two-thirds of the time, we're dealing with modest opportunities and dangers.

Odds of 2% seem quite low, but over an annual period, we're likely to encounter a handful of really big risks and really big rewards.  On over 240 of those days, there will be no truly great opportunities or dangers.

Sounds a lot like trading, doesn't it?  

The personality trait of extroversion tends to be associated with risk-seeking.  To some degree, the trait of openness to experience also plays into risk appetite.  Think of a skier who goes after the largest mountains and steepest slopes.  That person is focused at the far right end of the continuum, seeking to capture the greatest opportunities.  Of course, in extreme sports as in trading, seeking those rare huge opportunities can also entail taking significant risks. 

The personality trait of conscientiousness is associated with risk-prudence.  The highly conscientious driver will not exceed the speed limit on highways and will only ski the safest slopes.  That person will generally never have the thrills of extreme sports, but will rarely have bone-crushing accidents.

OK, now we get to the juicy part:

Early in our development as traders, risk-prudence is paramount.  We cannot win the game unless we stay in the game.  At firms where I work, such as SMB Capital, the initial goal is not to become a hugely profitable trader.  The goal is to become a consistently profitable trader.  In skiing terms, the consistently profitable trader is one who can master small hills, then somewhat larger hills, then small mountains, etc.  It is the repetition of success--the consistency of successful experience--that builds confidence and inner security.

Imagine if we were simply risk-seeking and began our trading career by placing large bets.  Inevitably we would also encounter large losses and that would shatter our development of confidence and inner security.  (Recognize that, in trading, risk is relative to the size of our portfolios.  If I limit my daily losses to $1000, that may seem like modest risk-taking, but not if I'm trading a $10,000 account!)

The path toward becoming a highly profitable trader is first becoming a consistently profitable traderIt is consistency of process, mindset, and selection of opportunity that provides us with the emotional capital to go after larger rewards.  I cannot emphasize this too highly.

However, there is a danger that the comfort and security of being consistently profitable can lead us to never go after those larger rewards.  Think of an entrepreneur.  The successful new enterprise requires consistent profitability, but what if the entrepreneur never takes the larger risks of opening new stores, developing new products, or forming new partnerships?  The entrepreneur might end up as a profitable local businessperson, and that might be fine for them, but they will never grow the kind of business that they could eventually take public.

In becoming that consistent trader, we can so emphasize conscientiousness that we never take the greater risks that are associated with larger rewards.  In poker, it would be like being dealt three aces and still placing modest bets.  Once in a while, life--and markets--present us with those 2+ standard deviation opportunities that come along 2% of the time.  When we stand aside on those occasions, we ensure that we will never reap great rewards.

So there it is:  greatness, in any endeavor, is a distinctive blending of general risk-prudence and selective risk-seeking.  Greatness is staying in the game, adapting, and winning--and then pouncing on occasional unique opportunitiesThe mindset of consistent winning is what provides the resilience of big winning.

Now you see why I emphasize trading psychology methods that increase our access to intuition and implicit knowing.  Very, very often, it is that intuitive knowing that alerts us to the larger opportunities, those 2% of occasions when we're meant to take larger swings.  Consistent trading will not help us if we do not also cultivate consistent openness of mind.  Most of the time, the military sniper lies in the weeds and takes little to no risk.  But once in a while, the high value target appears and it's worth taking the shot that may alert the enemy.  The mindset while in the weeds is calm focus and patience, but also extreme openness to and readiness for the high value opportunity.  

So much of the challenge of trading psychology is the challenge of sniping:  blending consistency of shooting and the patience of waiting with the aggressiveness of taking the risks associated with special opportunities.  Once you have learned and mastered the patterns associated with consistently profitable trading, it's time to master the intuitive knowing that alerts us to the greatest rewards.  In my next video, I'll outline a method for cultivating and acting upon this knowing.

Further Resources:


Sunday, October 18, 2020

Turning Your Talents Into Trading Edges

This is a somewhat  long academic paper about the development of confidence and talent among elite swimming champions, but it is well worth studying.  The key point made by the author is that excellence is mundane.  Greatness is not necessarily a function of unique talent or special opportunity.  We achieve excellence step by step, through intensive deliberate practice, where we perform a skill, monitor our performance, make small but steady improvements, and gradually perform at elite levels.  The example I used in my recent presentation for Traders4ACause was the meter that I use to measure my blood glucose levels through the day.  Each day I learn what contributes to high and low readings: the foods I eat, the types of exercise I do, my sleep patterns, etc.  By tweaking each of these, I've been able to stay in my target zone range well over 95% of the time.  Prior to the use of the meter, I never came close to that control. 

When I was a student in college, I would read each professor carefully to see which points were emphasized, what was written on the blackboard, what was included in handouts, etc.  This would guide me in what to study.  When I missed items on a test, I went back to my notes and figured out what I had missed and how I could have included it in my studying.  That then guided my preparation for the next test.  By the end of the course, I was unusually good at figuring out what would be on my exams:  my overall GPA was 3.87.  That wasn't because I was so much brighter than other students.  I simply learned how to play the game.

Great traders learn how to play the game, only there are many potential games to play.  Your edge doesn't come from the game itself, but from the process of mastery that allows you to win at the game.  This is why trading journals have to incorporate detailed analyses of trades and how those trades could have been conceptualized, structured, and managed better, so that you constantly refine what you do.  Many traders simply summarize their day or their feelings in a journal and wonder why they don't achieve mastery.  Mastery comes from the mundane practice of taking one skill after another and honing them until consistency is achieved.

Talent is inborn, but it develops through exercise.  What builds our trading performance is what builds us up in the gym:  the steady tackling of challenges performed the right way.  This is why there can be no trading edge without our pursuit of discomfort.  Honing performance means embracing our shortcomings and turning those into learning and development.  When that honing becomes an ongoing process, great things can happen.

Further Resources:

Trading and Spirituality - Free Blog Book

Sunday, October 11, 2020

Making Friends With Discomfort

Life is a gym.

Every day is an opportunity for a workout, to make ourselves stronger, more fit.

We can exercise our relationships, our patience, our focus, our persistence, our discipline, our learning, our trading--or we can go through the motions and never build ourselves up.

A good workout on the treadmill has us breaking a sweat.

A good workout on the weight machines has us straining to finish that final set of reps.

If a workout doesn't challenge us, we don't grow.  If we don't experience discomfort, we don't change.  Indeed, if we don't use a capacity, we lose it.  

Successful people are always working out, always growing their capacities.  That means that they make friends with discomfort.

No one has ever grown by remaining in their comfort zones.

Trading success is so much more than "following your process."  Your premarket preparation, your trading activities, your reviews and goal-setting for the next day's trading--all must be workouts, not rote processes.  

Those who don't workout are quickly out of work.

Further Resources:


Tuesday, October 06, 2020

You Are Your Own Role Model


Here's a great exercise:

Look at how you prepare for the trading day from the moment you wake up.  Look at how you approach your trading, how you make your decisions, how you deal with the ups and downs of P/L.  Look at how you review your trading day and how you spend your time outside of markets.  

If someone were filming you throughout all of these parts of your day, would you be proud of the film?  Would you want to show it to developing traders as a role model for how they should approach their craft?

We internalize what we do.  We are always our own role models.  If we would not be proud to display our lives to others, what does it say about what we're willing to accept for ourselves?

Think of all the qualities you associate with good trading and be those things in your day to day life.  There is so much more to preparing for success than jotting notes in a journal.

Radical Renewal:  Spirituality and Trading


Sunday, October 04, 2020

How To Make Big Changes In Your Trading Psychology

Hate can be your ally in making changes.

If you get to the point of actually *hating* your trading problems, you push those problems away from you.  You don't identify with them.  You don't lazily fall into them.

If you *hate* frustration and what it does to your trading, you're not likely to mindlessly fall into a frustrated mode.

What if you visualized your trading problem as being the one thing standing between you and success, between you and a bright future?  If a person stood in the way of your fulfillment, you would hate that person and fight them with everything you had.  Suppose that was your attitude toward your overtrading, your trading on TILT, your reluctance to take signals?

You can make big changes in your trading psychology when your priority is conquering your enemy, not making money.  The P/L is the payoff; the battle is with your enemy.  

You cannot truly love your success without hating what stands in its way.

This week's Three Minute Trading Coach video provides some perspective on how we can win our battle with our enemy.