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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Taking A Break From Blogging And Social Media

 

Thanks for all the interest in TraderFeed, my books, and the Three Minute Trading Coach videos.  There's quite a library of material available there, and a lot more on performance psychology through the Forbes articles and the spirituality of trading, via the online book Radical Renewal.  

I'm working on a big new book project and have decided to focus all my efforts there.  I'll continue to Tweet every so often, but will be taking time off from writing about markets and trading psychology otherwise.  

I appreciate all the support and look forward to very interesting markets going forward!

Brett

Stages In A Trader's Development

 

A beginning trader starts with eagerness and passion and focuses on winning.  The beginner's great fear is to miss opportunity and so the beginner overtrades and eventually takes significant losses.  Many traders never move beyond this stage.

With experience, the beginning trader recognizes that the goal is not simply making money, but making more money on winning trades than losing ones.  Instead of focusing solely on winning, the more experienced trader also focuses on not losing and containing risk.  The goal is thus consistency of trading and profitability and, above all, staying in the game.  This is when the beginning trader becomes a good trader.

Now, however, the good trader faces a new stage of development:  growing that consistency of trading.  The good trader grows laterally, expanding their expertise and skills and finding a broader range of opportunity.  The good trader also develops depth in their trading, finding superior ways to manage positions and their ever-evolving risk/reward.  The good trader becomes a great trader by exercising skills and experience in different market environments and finding a balance between assertively seeking opportunity and mindfully managing risk.

Good traders become better and better at playing the game.  Great traders find new and promising games to play.  

I recently spent an intensive period of time studying the stock market on a daily basis from 2014 to present.  I tracked cycles in a new way and explored ways of taking best advantage of phases of those cycles.  Instead of regularity of time, I looked for regularity of structure in defining the cycles.  That has led to new trade ideas.  Early days, early days.  But we always have the power to innovate and develop what is good into what is great.

Further Reading:

Trading Psychology 2.0 and the role of creativity in our development as traders

Reading Market Cycles

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Trading With Clarity

 

It has become clear to me that clarity underlies my best trading.

If I sit and sit and watch and watch and process and process what the market is doing, eventually it will become clear what is going on.  I can see that sellers are active and cannot push price lower; I can see that fresh market participants have entered the market at price levels making it unlikely we will return to those prices.  I can see a rotational trade between market sectors; I can see when volume and volatility are so low that sustained directional moves are unlikely.

It isn't just patience; it's immersing myself in the market information I understand and letting the market tell its story.  It's the same thing I do as a psychologist.  When I first meet a person, I have no clue what they're going through, so I listen and listen and ask questions and eventually clarity hits.  Success as a psychologist requires comfort with that initial cluelessness.  

For the curious, there is joy in discovery.  For the incurious, there are confirmation biases and attempts to impose "conviction" on markets.  Clarity allows ideas to come to us.  No ego-based needs to project our views onto markets can yield clarity or understanding.  It wouldn't work for me as a psychologist and, for the same reason, it fails in trading.

Further Resources:

How We Can Improve Our Access To Intuition

Awareness and Acceptance in Trading

Three Minute Trading Coach Video:  Creating Purpose In Our Trading

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Two Great Questions To Ask During A Trade

 

What we think about before we put on a trade helps determine our mindset during the life of the trade.  When I am trading well, my thinking before the trade focuses on two topics:

1)  What will tell me the trade is wrong?  - Knowing *exactly* what will tell me I'm wrong and where I would exit is essential to sound risk management of the position.  I am constantly updating my views on what would tell me I'm wrong.  For example, on Friday I put on a trade where I bought the ES futures early in the morning and the position quickly went in my favor.  I immediately told myself that, if I'm right, we should not see a reversal to the prior low.  We did indeed reverse and I got out with a small loss.  That experience helped me see that the market could not sustain buying and was one of the data points that got me into a nicely profitable short position a little later.  Because I am mentally rehearsing being wrong, I am accepting the possibility of loss and taking the psychological threat out of that possibility.  My best trading is not with confidence and optimism.  My best trading is with open-mindedness to the possibility of being wrong. 

2)  What will tell me the trade is working out? - If I'm trading well, I am open to the intuition that this trade is working.  Perhaps I see volume coming into my direction; perhaps I'm seeing a move triggered by a catalyst; perhaps I'm seeing a breakout of a key level.  At some point, I get the sense, "This is working".  My best trading occurs when I'm prepared for that possibility and can add to the trade, particularly when I've identified the trade as a medium-term opportunity.  In Friday's trade, we broke to new lows in the NYSE TICK, which told me fresh institutional selling  was coming into the market.  Using the next bounce in TICK to add to the position helped me make the most of the opportunity.

The combination of knowing where you're wrong and identifying when you're right allows you to keep losses small and maximize gains.  Notice that both questions keep a trader market-focused and not focused on previous wins, losses, P/L, fear of missing, etc.  The right trading psychology is not positive or negative; it's focused.

Further Reading:

A New Way to View Trading Challenges

How We Can Become More Intuitive in Our Trading

Two Hallmarks of Quality Trading

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A Different Way Of Viewing Your Trading Problems

 

Think about the important relationships in your life.

What are the greatest challenges and problems you experience in your relationships?  What are your greatest weaknesses in your relationships?

Those are what you will repeat in your relationships with markets, and those are what will undermine your success.

What are your greatest relationship strengths and your most fulfilling relationship experiences?

Those are what will show up in your relationships with markets, and those are what will underpin your success.

Great things come from loving relationships; problems in relationships occur when we place our own egos and needs ahead of our love for our partners.  

Ayn Rand pointed out that, before we can say "I love you", we have to be able to have an "I".  No relationship can provide self-esteem where it is lacking in ourselves.

How would you trade if you had loving relationships with markets?  

How would you trade if you expected relationships to provide you with your self-esteem?

How well would your relationships work out if you approached them the way you approach markets?

Knowledge is necessary for trading success, but it's wisdom that unlocks that knowledge.  Love is the key that unlocks.

Further Reading:

Radical Renewal

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How We Can Improve Our Access To Intuition

 

The heart of discretionary trading is pattern recognition.  Some traders track patterns in fundamental data; some follow price and volume behavior; some attempt to quantify patterns in sentiment and breadth data; some focus on patterns that follow events, such as earnings releases.  When we have experienced many examples of patterns, we internalize them and develop a "feel" for their occurrence.  It is that feel that we call intuition.

In the Radical Renewal blog book, I raise the issue of how our egos impact our trading.  What is ego?  It is our self-talk.  Whenever we focus on hopes, fears, frustrations, and needs, we end up talking to our selves about ourselves.  Such self-talk can be useful in planning and thinking through issues.  We need our egos to navigate the world and accomplish things.

The problem occurs when our self-talk becomes so loud that it drowns out our intuition, our feel for patterns.  There is no way we can be sensitive to patterns in what a market is doing if we're raging to ourselves about the need to make money, the fear of losing, or the fear of missing out.  If intuition is the whisper of the soul, self-talk is the shout of the ego.  Often, we lose our feel for what we're doing as we become most self-focused.  This happens in all areas of life, not just trading.  

Many self-help and coaching techniques simply substitute one kind of self-talk for another.  Filling our minds with positive talk might feel better than burying ourselves in worries, but both lead to clutter that drowns out the whisper of intuition.  What we need is a quiet and open mind so that we can amplify the whisper into a clear and consistent voice.  This is why many traders find meditation helpful:  in controlling and quieting the body, we can focus the mind and let patterns speak to us. 

One exercise that I have found remarkably effective in quieting the mind and improving access to intuitive knowing is simply to take a brisk walk very early in the morning.  The streets where I live are completely quiet and the air is often cool and refreshing.  During the walk, I focus my attention on all that I see and look for the beauty in my surroundings:  an attractive house, colorful flowers, a cute squirrel, the morning sky.  My mindset is one of appreciation and gratitude, focusing on all that I am privileged to be surrounded by.  I don't think about my work and the day ahead; I don't think about what happened the day before.  The mindset is entirely focused on the present.

Think about how many trading problems occur because we are not simply present in the present.  We are caught up in what just happened and we become focused on what might happen.  We talk, talk, talk to ourselves and never reach the quiet state where we can simply listen.  We become masters of intuition when we can operate continuously with a focused, open mind.  This is a strength that can be exercised and developed:  the simplest walk can help us turn the soul's whisper into a reliable voice. 

Further Reading:

Radical Renewal - Spirituality and Trading

Intuition, Luck, and Anxiety in Trading

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Two Hallmarks Of Quality Trading

 

I recently wrote an important article on the topic of how the ways in which we trade impact our psychology.  We commonly assume that working on our heads will improve our trading.  Less often do we recognize that the best way to maintain a positive trading psychology is to trade well.

What does it mean to trade well?  Here are two key hallmarks of quality trading:

1)  Quality trading is planned, not reactive - Planned trading means that we begin with an idea that we have researched and then identify good risk/reward points for participating in the idea and proper sizing for the trades, so that we can easily survive being wrong.  Planning means that we clearly identify what needs to happen for us to exit and/or modify our positions.  When we overtrade or take positions out of a fear of missing moves, those trades are reactive.  In reactive trading, we make decisions for psycho-logical reasons, not logical ones.

2)  Quality trading is open-minded, not biased - Sometimes we see traders who trade with a fixed idea and/or a persistent directional bias.  They look for evidence to support their views and discount evidence that might lead them to question their positions (confirmation bias).  Open-minded trading  means that we can express ideas in multiple ways and that we can trade multiple, independent ideas.  We are not wedded to one side of the market or one trade idea.

A very simple way to evaluate our trading is to rate each trade on the two criteria above and sum up those ratings.  If we're developing as traders, we will become more planned and more open-minded in what we do.  We will develop processes that keep us planned and open-minded.  The goal is to trade well, not to simply make money.  If we trade well, we inevitably maintain a focused mindset and place ourselves in the best possible position to succeed.

Further Reading:

How We Trade Impacts Our Psychology

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Awareness and Acceptance in Trading

 

I had two interesting experiences recently.  The first occurred on Friday morning.  The stock market was short-term oversold and displaying early signs of strength before the NY open.  Prior to the decline, we had been seeing unusually low volume and volatility.  I had a string of losing trades during that period.  Each time I recognized the poor environment for what it was and limited my losses.  That awareness, I've found, has been essential in managing risk and maintaining a sound trading psychology.  It was not a great environment for my trading, and that accepting that allowed me to take the losses with equanimity.  Once the market showed strength on Friday, my research suggested the possibility of a short-covering rally.  I bought several positions early on and then other research kicked in shortly after the open suggesting that we could see a trend day.  Now the awareness was of a positive opportunity set.  I added to the positions and the resulting gains more than erased the prior losses.  It was awareness and acceptance of the environment--and the rapid updating of these--that allowed for good decision making.

The second conversation was with a trader who insisted that his goal for trading was to maintain a consistent high level of calm and confidence.  He wanted to be positive in his outlook (and aggressive in his risk-taking) no matter what was occurring in his trading and in markets.  I explained to him that feelings of doubt and uncertainty can represent information and are not necessarily things to brush aside.  My recent market experience was a case in point.  It was the loss of "conviction" that helped me limit losses and stand aside until opportunity presented itself.  Open-mindedness was the key from my perspective, not optimism.  The trader was surprised by what I had to say.  He had not considered that a state of doubt and uncertainty could be a wonderful guide for actions (and inaction!) in markets.

Awareness of the environment we're in and acceptance of the opportunity sets in front of us is essential to making sound trading decisions.  It's when our needs for profits and our desire for risk-taking drive our decision-making that we lose self-awareness, lose market awareness, and overtrade.  If markets were perfectly consistent, it would make sense for us to pursue a totally consistent mindset.  When opportunity sets vary over time, it makes sense for us to accept reality and adjust accordingly.  The weather might look overcast and windy, with a forecast for rain.  Staying "positive" and leaving the umbrella at home is no virtue.

Further Reading:

How to Change Negative Patterns in Our Lives

How Spiritual Growth Furthers Our Psychological Growth

Knowing Your Limits as a Trader

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The Importance of Rejuvenation

 

This is one of the great challenges of performance in trading:  We need routine ("process") to follow rules and best practices accumulated through experience.  We need variation in routine ("creativity") to discover new and better rules and practices.  

It is important to immerse ourselves in trading and maximize our focus to best apply what we've learned from research and experience.

It is important to step away from trading to refresh our views of markets and rejuvenate.

If you want to make changes in your trading--or in your life--those have to begin by breaking routine and changing something you do.  Daily.

When we rejuvenate, we can view what we are doing in a fresh light and figure out how to best break our routines.

Many traders fail for the same reason many marriages fail.  They get stale.  Love--for a person or for markets--never dies.  It has to be killed.  Routine kills.  

How are you rejuvenating?  How are you innovating?  How are you staying fresh in your approaches to markets?

TraderFeed and The Three Minute Trading Coach will be on a short hiatus during a period of rejuvenation.  During that time, I will be researching new edges in the market and new ways of trading those--and I look forward to sharing those.  I will also spend time with extended family in a reunion:  connection brings rejuvenation.  Stay tuned, and thanks as always for your interest and support--

Brett

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Playing The Right Game

 

A number of traders that contact me are working very hard at improving the "setups" that they trade each day.  Often, they're doing a good job of improving their game, but are they necessarily playing the right game?

Let's take a look at relevant statistics with the SPY ETF as a market proxy.  What we want to see is how much of the movement in the index occurs during NYSE trading hours and how much occurs when the NYSE is closed.  

Going back to the start of 2019, we have gained about 188 points in SPY.  Of those, nearly 109 occurred in overnight action, when the NYSE was closed.  During 2021 thus far, the number of points gained overnight was very similar to the number gained during the day sessions.  Bottom line, much of the directional opportunity in the market has been unavailable to daytraders.

This is an important reason why a number of the traders I work with at SMB have begun researching multi-day edges in the market.  They've opened longer-term accounts, and they've been learning options strategies that provide them with superior risk/reward in holding positions overnight.  By changing the game they're playing, they've expanded their opportunity set--and that is paying off.  

I'm finding the same thing in my own trading.  I have three separate accounts.  Two hold positions over longer horizons (days to weeks) and one trades mostly intraday.  When I backtest a pattern in the market that shows a historical edge over a one-week+ horizon (such as when occurred when the sharp drop on June 19th was followed by a sharp rise), I enter and hold positions in the two accounts and then trade intraday pullbacks in the short-term account.  The net result is that I can pursue opportunity even when the market moves against me short-term.  This creates a win-win mindset.

Similarly, among the SMB traders, I find a more positive mindset because they can participate in far more opportunity and not face the frustration of having their ideas play out in time zones when they're not active.

It's a great example of how improving your trading can improve your mindset and trading psychology.  If you're frustrated that you're not taking advantage of the opportunity that is present, perhaps it's not simply that you're playing the game poorly.  Perhaps you need to reassess the game you're playing.

Further Resources:

How Spiritual Growth Can Further Our Psychological Growth

Three Minute Trading Coach:  Building Our Emotional Awareness

Building Our Capacity for Reaching Our Goals

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