Thursday, April 18, 2024

Positive Trading Psychology - III: Framework


The first post in this three-part series on positive trading psychology emphasized the emotional and physical side of optimal performance, which has been called flourishing.  The second post looked at the cognitive side of trading success, including the development of focus and deeper, faster processing of information.  In this post, we'll examine the importance of developing a framework for understanding markets and creating our trading edge.

In any competitive endeavor, whether it is chess, basketball, or boxing, we have to understand who we are competing against.  Notice that in all these activities, we don't just prepare for success by building ourselves up.  We also study the opposition and their strengths and vulnerabilities.  An important part of preparation for the next game is watching film, studying the opponent, and then formulating strategies and plays that maximize our strengths and take advantage of our opponent's weaknesses.  Because the opposition is always changing, our game prep always varies.

Over the years, I've found that consistently successful traders possess a framework for understanding markets and opportunities.  That framework clarifies three vital components of strategy:  1) who they are making money from; 2) how those other players behave in particular market conditions; and 3) the types of trading that work in those different market environments.  We can think of a trader's framework as the essence of their business plan:  it guides decision-making under dynamic conditions of risk and reward.  As Michael Dell points out above, we need a dream to succeed, and it's our framework that helps us realize that dream in the real world.

Volume is always changing in markets, which means that market participants are always changing.  Volatility is always changing in markets, which means that market moves always vary in how they extend and reverse.  Correlations are always changing in markets, which means that what we are trading varies in its sensitivity to other markets.  Without a framework to make sense of the environment we are facing today, we are as unprepared for game time as the team that never studies its next opponent.  Can you imagine preparing for an outdoor football game without understanding the probable weather conditions at game time?  Without studying how the opponent varies its offensive and defensive alignments and strategies?

This is an important reason mentoring is vital to a trader's development.  When we are exposed to multiple mentors, we absorb different frameworks and ultimately synthesize those into our own.  We develop our own positive psychology when we broaden and deepen our understanding of what to do and why we are doing it.  Take a look at groups that are active in mentoring, such as SMB CapitalBearBull Traders; and My Investing Club.  All feature multiple mentors that enable a developing trader to internalize a framework for making decisions under dynamic conditions of uncertainty.  The result of all this mentoring, for a trader as well as a football quarterback, is what Mike Bellafiore calls a "playbook".

Trading psychology aids our performance, but having a framework for trading grounds our trading psychology.

Further Reading: