BRETT STEENBARGER'S TRADING PSYCHOLOGY RESOURCE CENTER

Contact For Trading Firms and Media:  steenbab at aol dot com

My Twitter Feed:  @steenbab

RADICAL RENEWAL - Free blog book on trading, psychology, spirituality, and leading a fulfilling life

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The Three Minute Trading Coach Videos

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Forbes Articles:

https://www.forbes.com/sites/brettsteenbarger/
  

My coaching work applies evidence-based psychological techniques (see my background and my book on the topic) to the improvement of productivity, quality of life, teamwork, leadership, hiring best practices, and creativity/idea generation.  Trading firms, teams, and portfolio managers interested in performance coaching and help with hiring processes can email me at steenbab at aol dot com.  Please note that my work is limited to trading and investment firms, so I cannot provide online advice or coaching services to individual, independent traders. 

FURTHER RESOURCES

*  A Creative Way to Use TraderFeed 

*  Brett Steenbarger Bio and Contact Info

*  Brett's Books on Trading Psychology

I wish you the best of luck in your development as a trader and in your personal evolution.  In the end, those are one and the same:  paths to becoming who we already are when we are at our best.

Brett
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The Most Important Piece of Information for Active Traders

 

Just about everyone looks at volume, but do they actually *see* volume?

Volume tells us who is in the market.  Who is in the market determines how the market will move.  

Since 2019, yesterday's volume in SPY correlates with today's volume by over .80.

Since 2019, today's volume correlates with today's high-low range in SPY by a little under .60.

When volume expands, it's a sign that institutional participants are active in the market.  Because many of them trade directionally, their involvement/non-involvement contributes to volatility and the ways in which moves continue or reverse.

Since 2019, daily SPY volume correlates with VIX by over .80.

When we look at relative volume (how today's volume at a given intraday period compares to average volume for that time of day) and track its evolution through the day, we can clearly see--in real time--who is playing at the poker table and who isn't.  That helps us handicap the odds of moves continuing or not.

When we note the price levels at which relative volume expands or contracts, we gain a window into the intentions of other traders.  This is where Market Profile can be quite useful.

If you're an active trader, track your P/L as a function of time of day.  Odds are good that your profitability is related to the volume patterns for that time of day.

When we have stable volume trading day over day, the odds are increased that the cyclical behavior of recent markets will continue in the near future.  There can be a tremendous trading edge in this information.

The market magician has us looking at the hand that waves price in front of us.  But the magic is being done with the other hand, the volume hand that few people truly see.

Further Reading:

How Active Traders Achieve Diversification

Where Trading Stress Comes From

My Trading Framework

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Three Causes of Trading Stress--And What to Do About Them

 

Indeed, being stressed is no treat!  Stress typically occurs when we perceive threat.  That places our bodies in the classic flight-or-fight response, mobilizing for coping with the threat.  That mobilization draws blood flow away from our brain's frontal cortex, leaving us least grounded in our center of planning and reasoning just when we most need our rationality.  This becomes a particular problem when stress turns into distress:  anger, frustration, anxiety, etc.  As I emphasized in an earlier post, our first response to stress should be to identify where it is coming from.  In general, there are three sources of trading stress:

1)  Markets have changed, no longer behaving in ways that match our expectations.  In such an event, our stress represents information.  Just as we might feel uncomfortable if we should walk from a safe place to a high crime area, our stress in the new market environment alerts us to potential danger.  The proper response to this stress is to pull back from trading, reassess our environment, and revise our plans.  We need to adapt to the new environment.  The best trades come to us; that requires an open, focused mind.  The best trade ideas are of limited value if we trade them in a distracted mind state.

2)  Our stress is self-generated, reflecting pressure we're putting on ourselves.  It is easy to be our own worst critics.  When our self-talk focuses on everything we've done wrong or should have done differently, that negativity creates anger, frustration, and discouragement.  Perfectionism is a great example of such negative self-talk:  good is no longer good enough.  Cognitive techniques can be extremely effective in changing our self-talk, as described in The Daily Trading Coach; see also this series of three articles.           

3)  Our risk exposure exceeds our psychological tolerance.  Many times traders feel a need to make money and convince themselves that a huge opportunity is at hand.  They oversize their positions, creating volatility of P/L.  When the market itself becomes more volatile, the moves in the trading account can be difficult to tolerate.  The perception of threat that creates the stress is a function of the risk being taken.  Each of us has a different tolerance level for risk; the key is trading with a sizing that is not emotionally disruptive.  To be sure, we can have the opposite problem and not take enough risk in our trading.  That creates a different kind of frustration and distraction.  Good risk management is essential to good self-management.     

The most important point is that stress can impact our trading for many reasons.  By clearly identifying the source of our stress, we can best figure out how to move forward constructively.  A surgeon would not want to be stressed out during a procedure; peak performance requires peak focus.

Further Reading:

Using Your Body to Program Your Mind

Handling Performance Pressure in Your Trading

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Finding Success By Diversifying Your Trading

 

A lot of trading wisdom repeated by traders is surprisingly unintelligent.  A good example is the mantra that it is important to "have a process" for your trading and follow that process religiously.  Sounds great--until markets change and the process that worked in one kind of market no longer works.  If a business repeated a process endlessly, it would never adapt to changes in consumer tastes, new opportunities, etc.  Similarly, a singular focus on "discipline" is shorthand for a failure to innovate.

Which brings us to yet another piece of common wisdom that masquerades as wisdom:  Be patient and only put on your very best trade ideas.  Sounds great!  Don't overtrade and wait for the really good "A+" opportunities.

Not so.

In the most recent post, I outlined my approach to trading, highlighting finding opportunities in which detecting market cycles allows for good risk/reward entries in established trends.  What is interesting about this approach is that it applies across a very wide range of time frames.  Thus, one could look at long-term data and trade dominant cycles within broad trends, or one could implement the approach intraday.  As a rule, variability of price action increases as time frames increase, so it's unlikely that one would obtain the same risk-adjusted returns trading long-term vs. intraday.  By the logic of the idea of "be patient and only put on your very best trade ideas", we should only trade the time frame that yields the best results.

The problem with that view is that opportunities differ across time frames, as well as across instruments.  While it could make sense to trade a short-term pattern from the long side, this might be a mere blip for a good longer-term short trade.  When we trade multiple patterns that are relatively uncorrelated (or perhaps even negatively correlated), we as traders achieve the diversification normally associated with investing.

We can think of it this way:  an investor diversifies holdings at a given point in time.  The investor might hold in a portfolio relatively uncorrelated positions in currencies, rates, stocks, etc.  That diversification allows trades with a decent Sharpe ration to create a portfolio with a truly superior Sharpe.  If you put enough different edges together in a portfolio, the portfolio will show relatively smooth positive returns, because some ideas are always working when others aren't.  That's the beauty of diversification.

The active trader tends to participate in fewer opportunities at any given point in time, but over time will trade multiple cycles and trends, some shorter-term, some longer-term, some in one instrument, some in another.  Note:  A flexible trader might put on multiple long and short trades during the day, achieving over time what the investor structures all at once:  diversification!  

The successful active trader will have multiple, promising patterns ("setups") to trade, creating multiple, independent edges.  That is the beauty of Mike Bellafiore's idea of "playbooking".  Like a football or basketball team, the trader practices many different "plays" and thus can adapt to any environment.  Can you imagine a basketball team consisting of players that won't take shots because they don't have the wide-open look at the basket?  Any team--and any trader--is competitive only if they can find multiple ways to win.

Sitting passively and not trading until the perfect trade presents itself is not discipline; it's the essence of being a one-trick pony.  And when the market changes, the one-trick pony becomes a lame horse.  Many different edges of different quality and different instruments and different time frames creates what we might call a "trader's portfolio".  It's a lot harder to lose when we have many ways to win.  

Good traders have an edge.  Great ones constantly find new ones.

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Further Resources:

The Daily Trading Coach - Trading psychology self-help methods

The Three Minute Trading Coach - Short videos on trading psychology

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A Framework for Trading and Trading Psychology

 

If you were to listen into the conversation of a basketball coach with a player, you would hear quite a bit about how to play the game.  The coach might talk about getting back on defense or working harder to get position on rebounds or taking the high percentage shot, but the conversation would be about playing better.  Whatever needed to be addressed in terms of psychology would be embedded within the coaching regarding the playing.  

For example, if the player is not taking the high percentage shot at the top of the key (a failing for which I vividly recall being taken to task), the coach will address the psychology by making it abundantly clear that he believes in you and that you will never be blamed for missing a high percentage shot.  The coach might also include a ridiculous number of top of the key jumpers in the next round of shooting practice.  Such coaching *very* much addresses psychology, but in the context of actual playing.

Oddly, trading psychology is rarely approached in such a fashion.  I find it refreshing (and unfortunately rare) to hear a trading coach talk about actual trading.  It is as if the game inside the trader's head is completely separate from the game of trading and somehow, magically, the two are supposed to converge.  I can't think of any other performance field where psychology is so completely decontextualized.

In coming weeks, I will be returning to regular trading and, yes, I will be reviewing my performance and coaching myself.  You can be sure that I will not be exhorting myself to perform positive affirmations; nor will I be telling myself--in generic fashion--to follow my process and trade with discipline.  I will review each trade like a basketball coach reviews game film with a team.  In so doing, I'll address my psychology within the context of what was done well and what needs improvement.  That is what deliberate practice is all about.

I look forward to sharing what I'm learning, in markets and in psychology!

So let's start with trading.

My framework for trading is to break the market down into three components:

*  Trend

*  Longer-term Cycles

*  Shorter-term Cycles

Trades are placed based upon the assumption that the trend and cyclical components that characterize the most recent market action will continue into the immediate future.  That assumption of what is called stationarity is based upon an assessment of the stability of market participation from one time period to the next.  It is for that reason that I trade at certain times (which, historically, tend to be stationary/uniform) and avoid trading at other times.

The charts of market action that I track are based on events, not time.  When we look at bars on a chart that are denominated by volume, trades, ticks, etc., we create more stationary data series.  That enables us to find more uniform cyclical behavior within markets.

Trends and cycles are two primary dimensions of market behavior.  A third dimension is rotation.  Most markets display a rotational component where certain sectors and industries within the market are relatively strong; others relatively weak.  Trend determines the direction of the trade; cycles determine when to trade.  Rotation is crucial in identifying what to trade.  A significant portion of overall profitability comes from trading the right instruments.  

Note that trades in a very strong rotational market can be structured in relative terms--long the strongest market segments, short the weakest--to create trend trades.  There are also situations in which volatility is priced cheaply in a market that has the potential for a meaningful directional move.  Structuring the trade idea with options can provide particularly favorable reward relative to risk.  Trade structuring is a fourth dimension of trading.  A significant portion of profitability comes from optimal structuring of a market idea.     

At the end of the day, I am looking to buy troughs of cycles in rising markets and sell peaks of cycles in falling markets.  An important way I identify those potential troughs and peaks is by determining regions of market activity where bears have been dominant and cannot push the market lower and where bulls have been dominant and can no longer lift the market.

In posts later this summer, I will illustrate my trading--and my trading psychology.  The focus in these posts will be the integration of psychology with the actual trading.  

Key lesson:  We develop psychologically by doing things differently.  There is no meaningful psychological development apart from doing.

Further Reading:

Learning to Trade:  Cycles

Reading Market Cycles

Identifying Trend Days in the Market

The Essential Difference Between Trading and Investing

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The Difference Between Trading and Investing--And Why It Matters

 

Trading and investing are fundamentally different activities (pun intended).  Many trading psychology challenges occur when market participants fail to respect the differences between the two.

Trading is a bottom-up activity in which we assess supply and demand moment to moment to determine when buyers or sellers are dominant.  This enables us to place short-term trades with favorable reward relative to risk.  For example, readers know that I track the upticks and downticks among all the stocks in an index, so that I can see, minute to minute, if there are significant shifts in buying or selling activity.  I might see relative volume (volume as a fraction of the usual volume for that time of day) spike and upticks jump as well.  That tells me that new market participants have entered the market as aggressive buyers.  On the first hint of downticks that fail to push the market lower, I might go long to ride the upside momentum.

Investing, on the other hand, is a top-down process in which we assess company fundamentals and broad economic, monetary, and geopolitical conditions and infer from shifts among those whether valuations are low or high and whether they are likely to rise or fall.  The investor doesn't focus on what is happening moment to moment.  Rather, the investor is concerned with fundamental factors that impact the valuation of assets.  For example, the investor might read research suggesting that inflation will go higher through the year and might infer that this would put pressure on central banks to raise interest rates.  A scan across central banks and inflation trends across countries could lead to a view that one particular country's rates are unusually low relative to anticipated price rises.  Shorting the bond market of that country could be a worthwhile investment.

Market participants who are better wired to function as fast thinkers and pattern recognizers are generally best suited as traders.  The slower, deeper thinkers who possess stronger analytical skills are often ideally wired as investors.  Of course, there can be mixtures of the two modes, as in the case of hedge fund portfolio managers who trade actively.  Those active investors often have separate analytical and trading processes to draw upon each mode.

Problems occurs when market participants veer from their strengths and approach markets in ways that provide them with no edge.  The short-term trader will latch onto a big picture market view and will become inflexible as supply and demand conditions shift.  The macro investor will become anxious about market action and will find themselves staring at screens and managing positions based upon noise.  Usually, the short-term trader will latch onto superficial fundamental information when expanding their view, turning them into poor investors.  Similarly, the investor caught up in the minute to minute action of the markets typically lacks analytical tools for assessing short-term shifts in supply and demand and thus becomes a poor trader.  

This is why our greatest edge in markets lies in knowing ourselves and how we best process information.  What we genuinely see and understand in markets provides the conceptual underpinning of our success.  Just as the sprinter and distance runner cannot win in each other's Olympic events, so the trader and investor need to ensure that they are consistently playing the game that they can win.

Further Reading:

How Our Relationships Shape Our Trading

Spirituality and Trading

The Spirituality of Trading

Radical Renewal:  Tools for Leading a Meaningful Life

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Intrinsic and Transactional Relationships: Why They Are Important to Trading

 

In these posts, I attempt to provide perspectives in trading psychology that go beyond the usual platitudes and generalities.  Today's topic may seem unusual:  how our relationships shape our trading.

Consider the distinction between transactional relationships and intrinsic ones.  A transactional relationship is one in which each person agrees to do something for the other.  In that sense, it is like a business transaction.  For example, a couple could get married if one partner promised money to the other and the other promised social status.  Employer-employee relationships necessarily have a transactional basis:  one party provides a salary and benefits; the other performs expected work.

An intrinsic relationship is one in which there is a commitment to the other person, not for any specific things they are expected to do, but for who they are.  When a baby comes into a family, we expect nothing from the little one.  We love her out of an ongoing bond.  Similarly, in a good marriage, the parties are special to one another because of who they are.  

Transactional relationships are unusually fragile.  As soon as needs and interests change, or as soon as one person's ability to meet the needs of the other is diminished, the basis of the relationship is threatened.  If I've married a person for their looks, I may become less interested in them as they age.  If I lose my job, my partner may become disenchanted if money was central to their expectations.  At an intuitive level, we recognize that transactional relationships are selfish and ego-driven.  They are only as solid as certain conditions can be met.

Many relationships are mixtures of transactional and intrinsic modes.  Yes, there is a transactional aspect to working at a trading firm, but we are most likely to be loyal to an employer if they also display an intrinsic interest in our growth and well-being.  I can think of hedge funds that have portfolio managers who have stuck with them for years and years because of a personal commitment shown by management.  I can also think of funds that are known for firing traders as soon as they lose money.  Those funds generate little loyalty and have great trouble in retaining employees.

Even intimate relationships have their transactional aspects.  Yes, Margie expects certain things of me in terms of responsibilities at home and commitment to family and I have similar expectations of her.  But in a lasting, loving relationship, the bond goes beyond that.  I am confident that if Margie or I were to no longer fulfill our expectations due to illness or disability, the relationship would lose no element of love and commitment.  To use the terms of the Radical Renewal blog-book, intrinsic relationships come from the soul, not the ego.  Intrinsic relationships are necessarily unique, because they are grounded in what is special about the other person.  That is why, Fitzgerald notes, there can never be the same love twice.

So how are these ideas relevant to trading psychology?

If our interest in markets is purely transactional, based on what markets can give to us in terms of profits, then we will be unable to thrive during periods of inevitable drawdown.  You can always tell when a trader's interest in markets is predominantly transactional.  They talk about P/L, getting bigger in their trading, making more money, finding more opportunities, etc.  They rarely if ever talk about their fascination with markets, what they are learning from their trading and research, and how they are contributing to the development of other traders.  Once drawdowns occur, they experience emotional disruption, not because they lack discipline or because they're trading poorly, but because they cannot tolerate the frustration and emptiness of unfulfilled needs.

When our interest in markets and trading is intrinsic, we find value in our learning and development.  We are also motivated by the intellectual curiosity of finding opportunity in ever-changing circumstances.  Similarly, an intrinsic interest in trading is one that we're eager to share with others, fueling rewarding teamwork.  That fuels us--and our growth--when times are tough in markets.  I can not only survive during drawdown, but thrive, because it's not simply about how markets pay me out here and now.

Transactional relationships are about me; intrinsic relationships are about thee.  Often, we fail in trading because we make it about us.  Transactional relationships in markets are as fragile as they are in our personal lives.  No amount of time spent on working on mindset or setups can help us if we're trading to fill voids in our lives.

Further Reading:

Taking the Ego Out of Trading

How Our Bodies Become Our Souls

Radical Renewal:  The Spirituality of Trading

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Listening as a Core Trading Skill

 

Last week, we took a look at the challenge of trading markets that are ever-changing.  What that means in practice is that good trading begins with open-minded observation.  Are we seeing a continuation of previous market behavior, or are we seeing a change?  Markets trade thematically.  Sometimes the theme is risk-on and everything is trading higher.  Other times, we trade in a risk-off fashion, with pretty much everything declining.  Most of the time, the themes are expressed in relative terms, with certain asset classes stronger, others weaker; certain sectors of the market strong, others weaker.  Before we put our hard-earned money to work, we want to identify themes that are in play for the market.  That means that we don't blindly predict what we think will happen, but instead listen carefully to the market's communications and detect what *is* happening.

If you want to get on the floor with your partner and dance, you don't just start dancing.  You wait for the music to begin and adapt your dancing to what is being played.  

If you want to help a person in need, you don't just start giving advice.  You listen to what is going on in their life and adapt your response accordingly.  

As this post emphasizes, silence and a quiet, open mind are crucial skills of trading psychology.  Good trading requires emotional intelligence, not just cognitive complexity.  Every day, the market talks to us, and it is up to us to read the themes and make our decisions accordingly.  

The active trader who begins the day with preformed ideas--and who scouts for every possible "setup" that could confirm the ideas--is like the person you talk with at a party who is figuring out what they want to say before you've finished speaking.  Conviction makes convicts:  we become imprisoned by our expectations.  If markets are ever-changing, then we must be ever-open to change.

An important part of trading process, too often ignored by developing traders, is the maintenance of an open mind and the ability to quickly spot themes and shifts in themes.  Looking at chart patterns in a single asset misses the thematic nature of movement across markets.  First we find the themes; then we find the specific "setups" that provide us with a good risk/reward trade.  Once we place and manage the trade, we return to open-minded mode to detect further changes or trends.

Good trading does not replace negative self-talk with positive self-talk.  It replaces all self-talk with listening.

Further Reading:

Trading With Clarity

Relative Volume and Other Indicators I Find Helpful

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The Challenge of Adapting to Changing Markets

 

A stationary time series is a set of data derived from a single underlying process.  A simple example of a stationary time series would be the distribution of values from the rolling of fair dice.  Any given roll is not predictable, but the distribution of values over time would be stable.  

Suppose, however, that we used weighted dice and then changed the dice at random intervals.  Now each roll would not be predictable, but the distribution of values would also be random.  The distribution would no longer be stationary, as it's generated from multiple processes (dice).  

The stock market--and, indeed, financial markets in general--does not yield stationary time series.  This has been evident in recent markets.  If we compare the market from the past couple of months with the market from, say, the same months in 2019, we see very different patterns of trend/price change and volatility.  Correlations among stocks and sectors vary from time period to time period, as well.  

What this means is that markets are ever-changing.  This shouldn't be surprising.  Simply observing the differences in volume across various market periods tells us that the participants in the marketplace are not constant.  

The ever-changing nature of markets has a couple of important implications:

1)  Simply looking for patterns across various historical periods is apt to yield weak results.  Similarly, trading volatile bear markets with the same methods and "setups" as were used in range markets or low volatility bull markets is not likely to be useful.  A more intelligent process would be to identify a few key regime variables, study markets in those regimes, and identify trading patterns specific to particular market conditions.  A very simple analogy would be a football team that has to play different opponents and play in very different field and weather conditions.  The successful team will adapt to each set of circumstances with unique game strategies.  The successful team will not adopt the same strategy for all opponents and field conditions.

2)  Psychological disruptions often reflect poor trading processes.  It is commonplace to hear coaches and gurus insist that trading is a mental game and that the right mindset will yield consistent, profitable results.  If you understand point number one above, you'll recognize that the idea that poor trading comes from poor psychology is a limited perspective at best.  What commonly occurs is that we adopt one set of trading practices and strategies adapted to a particular environment, only to find that environment changing.  When the trading strategies that used to work no longer produce consistent profits, we become frustrated, fearful, etc.  The problem is not the emotions attached to trading:  those are the consequences of the more fundamental problem of not identifying and adapting to changed market conditions.

It is a commonplace observation that successful traders follow a disciplined "process".  If trading were like manufacturing widgets, that would be all that traders would need.  In an ever-changing environment, however, a successful trading process would need to include an assessment of the current environment and the opportunity set specific to that environment.  The successful trader is much more like the entrepreneur than the manufacturer of widgets.  Identifying and adapting to changing markets is central to success.

The changing nature of markets impacts active traders as well as investors.  The markets behave differently at different hours of the day, as we see different volume/participation and different event/catalysts across times of day and time zones.  Similarly, would we invest in the markets of the 1970s the way we invested during the 1990s?

And might it be the case that some market periods are simply not tradeable, if they change more rapidly than we can adapt our strategies?  

An important source of trading psychology woes is holding positions across non-stationary market periods.  Key to successful trading is knowing when to hold 'em and when to fold 'em.

Further Reading:

Common Mistakes Traders Make:  I

Common Mistakes Traders Make:  II

Common Mistakes Traders Make:  III

Pathways to the Heroic

Why I Am Proud to be a Trader

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Common Mistakes Traders Make - 3: Reacting Rather Than Acting

 

It's a common misconception that acting rationally means eradicating emotion from our thought processes.  Indeed, the opposite is the case, as psychologist Nathaniel Branden observes.  Our greatest ideas are ones that we feel deeply, that resonate with us.  That is what traders mean when they refer to having "conviction" in a trade.  Our worst trading occurs when we feel things and react to those impulsively.  In those cases, our reacting prevents us from reflecting and thinking clearly.  Everyone feels uncomfortable when markets move against us.  The question is whether you use those emotions as information or allow them to control your next actions.

Most traders have had the experience of looking at market information, discussing ideas with others, and scouring research and suddenly see where things are lining up and making sense.  That aha! moment is a great example of feeling deeply.  Our greatest ideas are ones that come to us with that deep sense of recognition.  Those are the ideas we're meant to act upon.  Acting means directing ourselves toward a chosen end based on all the information available to us:  factual information and also information from our deepest feelings.

When we react, we are not directing ourselves toward a chosen end.  Rather, we are allowing events to control us and dictate our actions without planning and without conviction.  Little wonder that some of our worst trades come from decisions made out of fear, greed, FOMO, etc.

We think most deeply when we quiet our minds and shut off our internal chatter.  It's when our minds are still that patterns in the world can come to us and give us that sense of aha!  A quiet mind is an open mind and an open mind is ready to feel deeply.  One of the greatest edges in trading is the ability to approach markets with a still, quiet mind.

Further Reading:

Why Trading Psychology Matters

Blueprint for an Uncompromised Life

Radical Renewal

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Common Mistakes Traders Make - 2: Acting Before Understanding

 

In the first post in this series, we took a look at how traders often lose their ideas when their stop levels are hit.  In this post, we'll examine a different, but related, cognitive mistake.  Many traders will place trades based upon price patterns and "setups" without truly understanding how their market is behaving.  This is a particular problem when market regimes change and markets change their behavior.  Knowledge is necessary, but not sufficient, in trading success.  We also need to understand what is happening in our markets so that we can profit from the behavior of other market participants.

One variable important for understanding is volume and especially changes in trading volume.  If volume is increasing in a stock, index, or other instrument, it means that new participants have entered the market.  We want to examine how our market responds to this expansion of participation, because that will provide us with important clues as to who is in the market and how they are leaning.  For instance, if we're trading a small cap stock with a relatively small float, a meaningful expansion of volume almost certainly indicates speculative interest among small traders.  These traders are active as daytraders and often pile into momentum when a stock moves.  Knowing this, we can get ahead of their activity.  A large cap stock, on the other hand, is dominated by institutional traders who will wait for good prices and execute their orders over a period of time.  If we can study the stock and see how it has moved on high volume in the past, we can reverse-engineer the execution algorithms used by the large traders and front-run their accumulation of shares.  Stocks index volume is often significant as a function of time of day, as different participants are active at different time zones and times within each zone.  When we see volume expanding and a breakout early in the U.S. session, this often has implications for trending through the day.

Another variable important for understanding is the correlation among related market instruments.  If an auto stock is making a move, it pays to check out other auto stocks and the broader list of industrial shares.  We want to determine if this is an idiosyncratic move, specific to the company, or whether institutions are accumulating shares in particular industries and sectors.  Seeing how sectors behave before we trade can help us distinguish between rotational environments, which are often rangebound, and trending environments.

A football team would never call a play without checking out the defense of the opponent.  Similarly, we want to understand the market environment before we call a play with our capital.  When we act before we understand, we implicitly assume that all price patterns are equal in their meaning and significance.  If that were true, wouldn't sophisticated algorithmic participants already have mined such simple "setups"?  It is precisely the complexity of movement at different levels of participation, different times of day, and different co-movements of instruments that makes trading challenging, even for the algos.  Great traders don't have a passion for trading; they have a passion for understanding markets.  That's what makes professional trading different from gambling.

Further Reading:

Learning to Trade:  Market Cycles

Learning to Trade:  Building Our Understanding

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Common Mistakes Traders Make - 1: Losing Ideas When We Stop Out Of Trades

 

Yes, it's true that problems with our mindset can interfere with good trading.  It's equally true that bad trading can interfere with our mindset.  In coming posts, I will highlight mistakes I see traders make and what we can do about them:

The first mistake I see traders make is confusing the idea being traded with the actual trade that is placed - Traders develop ideas about the markets or stocks they're trading.  Those ideas often reflect what is happening over time with growth and other fundamentals, price action and trends or breakouts, etc.  For example, I might develop the idea that a data release is a game changer for the stock market and should lead to new highs in SPX.  Once we develop an idea, we have to translate that idea into a specific trade.  What will tell us that traders and investors are acting on this idea?  What will give us favorable reward-to-risk in putting on a position to profit from the idea?  Too often, traders will get stopped out of the trade and stop following the idea--only to see it play out subsequently.  The trade is not the idea.  A trade that doesn't work doesn't necessarily mean that the idea is invalid.  It simply means that market participants, right here and now, aren't acting on the idea.  When we stop out of a trade, we need to review:  Is my idea still valid?  

If my idea was that we're breaking out of a long-term range and should head meaningfully higher due to economic growth and positive earnings , but then a Federal Reserve action is announced that drives the market lower, it may well be the case that my idea is invalidated.  We're not breaking out of the range to the upside and an important catalyst is now threatening a downside break and perhaps economic weakness.  

Conversely, if my idea was that we're breaking out of a long-term range and should head meaningfully higher and I then buy the next move to the upper end of the range only to see the market move back into the range, my breakout trade is wrong and I may very well stop out, but nothing has invalidated my idea about growth and positive earnings.  In such a case, I may retain the idea even as I jettison the trade and will ask myself what I need to see to re-enter a position.  Perhaps next time, I'll wait for an actual breakout to occur on increased volume and then I'll join the price action for a momentum move higher.

The psychological mistake we can make when we stop out for a loss is that we can become frustrated and, out of that frustration, toss aside the idea we were considering as well as the trade.  The wise trader looks at a losing trade as information.  It might provide information about what we need to see to make the good idea a good trade; it might provide information that the idea isn't so good after all.

Bad trading is sticking with ideas out of stubborness.  Good trading is sticking with ideas when they have not been invalidated.  This is why risk management is important.  If we control our bet size, we give ourselves plenty of room to go back and express ideas in new ways after initial trades don't work.  Conversely, some ideas end up being incorrect.  Knowing what will disconfirm your idea is just as important as knowing what will disconfirm your trade.

Further Reading:

Radical Renewal - A Blog Book on the Spirituality of Trading

Two Mistakes I See Traders Making

Three Common Mistakes Traders Make in Their Trading Reviews

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How to Change Your Life

 

An important key to psychological change is turning desired patterns of thought, feeling, and action into positive habit patterns.  We don't do this through motivation.  We do this by finding ways of being who we want to be every single day, with each day building on the next.  Over time, we internalize those changes:  they become natural parts of us.

In short, paraphrasing Aristotle, we become what we consistently do.

If I want to become a more caring, less self-centered person, I will perform an act of caring each day.  If I want to become a more disciplined trader, I will carefully plan my next trade and make sure it is grounded in sound research and understanding.  If I want to become a more energized person, I will incorporate into my morning routine something stimulating and meaningful.

We climb the ladder of our ideals one rung at a time. 

In what way will you be your best self today?

What will you do today that you'll be proud of as you get ready for bed?

You're writing your own life story day by day.  Be the heroine or hero of that story, not an incidental character.

To achieve greatness in life, we must do something greatly each day.

What are you doing greatly today?

Further Reading:

Greatness in Life and Trading

Greatness, Creativity, and Trading Success

Radical Renewal:  Tools for Leading a Meaningful Life

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Why Am I Losing Money In The Market?

 

I have had a record number of people reach out to me asking for coaching help.  Why?  The majority have developed their trading in a bull market and have learned to buy market dips.  And so they have bought, and bought, and bought--and they have lost a lot of money in the past month.  In my view, this is not a problem of psychology.  It is a problem of not knowing how markets behave under different conditions of volatility, correlation, and monetary/fiscal environment.

As you may have noticed from my recent post, I am quite the optimist and believe in the power of making fresh starts--in life and in markets.  To continue risk taking without knowing what you are doing, however, is not a formula for optimism.  We have to learn from our experience before we can benefit from it.

So let's begin with two basic concepts of financial returns:  the average return over a period of time and the variability of those returns over that same period.  Too often, traders focus on the first and neglect the second.

Here's a current example from my database:

As of Friday's close, we had fewer than 20% of all stocks in the SPX close above their 3, 5, 10, and 20-day moving averages.  That is unusually weak short- and medium-term breadth.  Indeed, since the start of my database in 2006 (approximately 3900 trading days), only 179 days have met those criteria.  In other words, the market is not only broadly oversold, but more oversold than on 95% of all occasions.  Right away, that tells us that this is not just a normal market pullback, but something more extreme.  But of course we only know that if we make the effort or invest the resources to create such a database.  There is certainly no guarantee that the future will mirror the past, but pursuing the future with ignorance of the past is not a winning proposition in any field.

So let's take a look at the 179 occasions when we've been broadly oversold at these intervals and see what the SPX has done afterward.  Sure enough, we find that the market, on average has been up +.75% compared to an average gain of only +.18% for the remainder of all occasions.  Surely, therefore, we are due for a bounce and should be long going into next week!  That is what I've been hearing from traders of late.

If we look a bit deeper, we find that the market rises after such oversold conditions 64% of the time, compared with 60% of the time for the other occasions.  That doesn't look like such a great edge.  When we look at the variability of returns, however, we see that the standard deviation of next five-day returns for the oversold occasions is more than twice that than for the rest of the sample (4.81 vs. 2.32).  What does this mean?  It means that, following such oversold markets, we have had significantly more volatile returns going forward.  So, for example, in August of 2011, we would have made well over 7% over the next five trading days.  In November of 2008, we would have made over 19%; in March of 2020, we would have made over 16%.  But in October of 2008, we would have lost almost 19% over that next five-day period.  In early March of 2020, we would have lost over 13%; in early August of 2011, we would have lost over 13%.  

The important point here is that we have to be aware of the range of possible returns and not just the average return if we are to place intelligent bets.

Suppose I told you that I would make you a bet where you had 80% odds of winning $10,000.  Would you take that bet?  A not-so-smart trader would say, "Sign me up!"  The risk-savvy trader would ask, "What happens the other 20% of the time?".  Well, in this case, the bet is to go to an interstate highway at 2 AM and cross all lanes blindfolded with earplugs.  At that time of the morning, you'd have an 80% chance of reaching the other side free and clear.  The other times, you'd be hit by an oncoming vehicle and either crippled or killed.

Not such a great bet after all.

"We're due for a bounce" is not a substitute for a rational assessment of markets and their possible outcomes.  No amount of trading psychology techniques can substitute for knowing what you're doing when you put capital at risk.  People who tout their "passion for trading" most often need to trade and that leads them to take undue risk.  Far better to have a passion for good bets.  If you know that broadly oversold markets move a lot on average, the smart bet is to shorten your time frame, reduce the volatility of your returns, and find short-term bets that pay well without a scary downside.

Further Reading:

A Dozen Reflections on Life and Markets

Why I Am Proud to be a Trader

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Making a Fresh Start: Lessons From Molly Ruth

 

Well, it's been about a three-month break from blogging and social media, and I have to say it's been rejuvenating.  In any life activity that is important, there is a time for stepping back, taking a good look at what you're doing, and making a fresh start.  When we make a fresh start, we can make major life changes, because we've broken old patterns and are now ready to build new, positive ones.

Above we can see a picture of our newest rescue cat, Molly Ruth, who is a khao manee, a relatively rare breed of cat.  We found her in a shelter, afraid of people and cowering in a corner.  Her time in our home has been a fresh start for Molly and she has come out of her shell.  We can now play with her, and she has grown fond of the other three cats.  What she needed was new experience:  she needed to be safe and feel safe and just explore her environment.  As that has happened, her personality has blossomed.

Sometimes traders become overwhelmed too, and sometimes they take losses that rock their sense of safety.  Sometimes, after hard work, markets change and it seems as though all their progress has disappeared for good.  It's tempting to push forward and push forward, but often that compounds the problem.  The better strategy is stepping back, finding new edges in markets, and then--like Molly--making a fresh start.

I'll be making a fresh start with this blog, taking advantage of the break, and hope that the new slant will be helpful to traders.  As long as we can make fresh starts, we can always stay fresh--in trading, in relationships, and in our work.  

Further Reading:

Overcoming Trauma

Making Your Energy Level Your Priority

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