One practice I have noted among successful discretionary traders is their review of price action in markets. Some have used replay functions on their charting platforms to see patterns unfold in the market, making them more sensitive to the occurrence of these patterns in real time. Especially among daytraders, I've noticed that their trading is largely based upon visual and numerical information on screens. What they are looking at amounts to patterns in market behavior, just as physicians look for patterns among symptoms and test results to make diagnoses. For instance, a trader might observe that prices are breaking out of a narrow range with increased volume and increased lifting of offers on a depth of market screen. That might be an indication that the market is establishing a new, higher level of value.
Pattern recognition, however, is a trap as well as a gift. We can identify patterns where nothing meaningful is actually occurring. Many chart patterns that traders look for have no causal relationship to price movement and ultimately lead to frustrated and unprofitable trading. Promising patterns in markets are ones that capture an understanding of what is going on between buyers and sellers.
Physicians learn the pattern recognition of diagnosis through repeated experience. A radiologist may need to look at many, many images in order to detect malignant growths or hairline fractures. A psychiatrist may need considerable experience to identify when a mood swing is part of a depressive disorder, anxiety disorder, or bipolar disorder. Case studies and years of training provide the repeated exposure that allow for accurate pattern recognition.
What if a major reason for the failure of developing traders is not a lack of discipline or disruptive emotions, but rather the lack of repeated exposure to meaningful patterns? Traders review their trading and look over charts, but is this really the same as training oneself to identify patterns in real time? Would reading books or reviewing medical charts substitute for observing actual patients for doctors building expertise in diagnosis?
I recently had a worthwhile conversation with Al and Kunal, the principals of TradingSim, a platform that allows traders to replay stocks and markets from any recent period of time in order to practice trading skills. Joining us was Andrew, the leader of the BearBulls online trading community. One of the intriguing topics we explored was the use of a feature-rich trading simulator as a way that independent traders could drill their trading skills. This strikes me as having tremendous potential, as it potentially provides a level of intensive practice not typically available to individual traders.
I recently suggested that a major component of trading success is the capacity for sustained focus. What if the right kinds of trading drills become ways of cultivating the capacity for focus, so that we become better pattern recognizers over time? In that scenario, trading psychology follows from superior training. Intensive practice may lead to trading expertise, and it also may build the brain states most likely to result in sound trading.
Further Resources:
Training Your Trading Psychology - video
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