Trading Psychology Advice - 2: Pursue Your Development The Right Way

The greats in any field hear a different music than their peers.  That can make them seem a bit crazy.  One of my favorite examples occurs when a great musical group completely reinterprets a great song.  Consider the folk classic by Joan Baez and then the metal version by Judas Priest.  By the time we get to 3:50, we have a completely new song, a completely new experience.  Or take the dance classic Billie Jean by Michael Jackson and then listen to the same soulful song by Chris Cornell.      

Expert performers hear a different music, dance a different dance.

I recall a meeting years ago with a market great, Victor Niederhoffer, who experimented with turning market time series into musical sounds.  Done the right way, you could follow the market "music" and become exquisitely sensitive to shifts in pace, tone, etc.  Good traders look at charts and market data uniquely.  Great traders look at unique things. 

An important step in my trading development occurred when I encountered the work of John Ehlers and began to view market time series as multidimensional, incorporating elements of trend and cycles.  Understanding those dimensions made it far more clear when markets can be expected to continue their recent direction and when they can be expected to reverse.  Volume dictates the pace of movement; trends and cycles define the path.  It's a kind of music a trader can "dance" to, but the odds are good that the dance will seem insane to those looking at one-dimensional chart patterns or fundamental relationships.

An important thesis of the Trader Performance book is that our performance proceeds in two phases:  the development of competence and the development of expertise.  The process of building competence involves what we saw in the last post:  mirroring the actions of capable mentors.  Expertise development is quite different.  That begins when we synthesize the inputs and influences of multiple mentors and experiment with the insights that result from this synthesis.  Many problems in trading psychology and performance occur when we do not follow this developmental sequence.  We try to figure out markets on our own without proper mentoring.  We settle for copying others without finding our own integration of their ideas and influences.  

Pursue your development the right way:  first find and copy the masters and then hold onto pieces of what they teach you that truly resonate.  Those are the practices that mesh with your strengths and that ultimately hold the greatest potential for your performance.  Others won't hear your music and may view you as a bit insane when you dance to your own tune.  That's OK.  No one ever achieved great things by staying safely within the realm of consensus.

Further Reading:

Radical Renewal - an online book on the spirituality of trading

Stages in a Trader's Development

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Trading Psychology Advice - 1: Get the Right Kind of Help

 

Many times traders fail to reach their potential because they seek the wrong kinds of help.  Early in a trading career, what is needed is mentoring, not primarily psychological coaching.  Consider a young person who is early in their development as a baseball player.  The most helpful help will come from mentors who are familiar with the game and can teach proper ways to stand in the batter's box, pitches to swing at and let go, ways of adjusting the swing to the placement of the defensive players, ways of recognizing different kinds of pitches, etc. etc.  In copying the guidance of a mentor, the novice performer learns the fundamentals of performance.  Only later in their development do they modify those basic actions based upon experience.  It makes little sense to focus on self-help, psychological advice if performance problems are due to a lack of mastery of basics.

Conversely, the experienced player doesn't necessarily need to be shown basics.  The problem is implementing those basics with consistency.  This requires coaching from one familiar with the performance domain.  For instance, an experienced trader might have difficulty adapting to a new set of volatile market conditions and become frustrated when losses are larger than expected.  Coaching in such a situation might include techniques for mastering frustration as well as solution-focused efforts to reduce trading size, structure trades for better risk/reward, improve diversification, etc.

Here's a good way to think of ways to get the right kind of help:

If you lack experience, you need a mentor to show you what to do and how to do it.

If you have trouble drawing upon the experience you have, you need a coach to help you identify what you already do well and how to expand that.

Many developing traders have never seen a bear market, have never traded consistently volatile markets, and have never traded proper trends.  They need to go back to basics and obtain mentoring from those who have been there and done that.  

Experienced traders facing a new environment need to maintain a constructive mindset, focus on what they do best, and figure out how to adapt their strengths to current market conditions.  The right coaching helps the experienced professional become their best version of themselves.  

Turning trading around begins with seeking the right kind of help.  This is an important reason why success rates of traders at top trading firms are so much higher than among traders who try to develop entirely on their own.  When we are part of a team or trading community, we can learn from each other and achieve both mentoring and coaching.  Think of performance domains:  in sports, in the arts, in the military.  There is always mentoring and coaching to further the process of development.  It is very difficult, if not impossible, to find world-class athletes or musicians who are entirely self-taught.  That should tell traders something.

Further Reading:

How Individual Traders Can Benefit From Teamwork

The Power of Mentoring in Trading Success

Selecting a Trading Coach

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What Trading Cannot Do For Us

 

To paraphrase Ms. Rand, the quest for self-esteem is the surest sign of its absence.  A common underlying theme of blog readers who reach out to me is their desperate need for trading success.  They don't just want to be consistently profitable; they want to be among the elite of the elite.  They proclaim their passion for trading and their complete absorption in finding opportunities to profit.

One question I typically ask is, "What in your life is more important than trading P/L?"  The speed and depth of the answer speaks volumes.  A life wholly dedicated to market P/L is an impoverished existence, a desire to achieve a self-esteem that is otherwise absent.  A common reason for overtrading is the absence of anything else meaningful to be doing.

The overfocus on P/L is an attempt to evade the reality of that absence.  Little wonder we then overreact to losses and extended drawdowns.  That is when we most need a full life to fall back upon.

Trading can make us financially successful, and trading can provide meaningful intellectual challenge and satisfaction.  What trading cannot do for us is substitute for our needs for a full and fulfilling life.  In the Radical Renewal blog book, I emphasize that good trading comes from the soul, not the ego.  Good trading emerges from a mindset of plenty; it cannot bear the burden of our self-esteem.  Mastering volatile markets is easier with a stable life; drawdowns are easier to accept when we profit from many life activities and interests.

Further Reading:

Radical Renewal:  Tools for Leading a Meaningful Life

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How Can We Stay Chill In A Volatile Market Environment?

 

When I began my career working as a performance coach for traders, the first poster I placed in my office was a signed photograph from a military sniper.  It showed the sniper lying in the weeds, well camouflaged, and looking dead ahead with rifle poised.  The absolute stillness and focus of the well-hidden figure was striking.  What makes the best snipers special is that, when battle conditions heat up, they have trained themselves to slow down.  It's when multiple high-value targets come into view that they breathe slowest and become most still.  Opportunity brings focus, not excitement.  

The most common psychological issue I'm hearing from traders today is how to stay calm and focused during volatile market conditions.  It's natural that directional traders view lots of movement as lots of opportunity.  The excitement that brings when markets start to move your way, the frustration that brings when markets reverse on you--all have the potential to disrupt our planning, our concentration, and ultimately our best trading.

It's under these conditions that I find training with biofeedback to be most helpful.  Below are some links that can get you started looking into the topic.  It's also a topic I discuss in The Daily Trading Coach, particularly in the sections on Cultivating the Quiet Mind and behavioral Exposure methods.  In exposure work, we first learn to slow our heart rate and lower our body's level of arousal through the help of such methods as heart rate variability feedback and brain wave feedback.  Once we learn what we need to do to keep us chill, we then actively visualize trigger situations that tend to stress us out.  For example, we might visualize a market going against us and having to stop out with losses.  We vividly imagine the disappointment and frustration of the situation--while keeping ourselves in a state of low arousal and high concentration and monitoring our feedback.  We do this again and again and again in our practice, until stressful situations no longer take us out of our zone.

This requires regular practice, but is amazingly successful in rewiring our emotional responses to situations.  Our job is to climb the mountain of success, not carry mountains of fears and worries on our shoulders.  It is indeed possible to rewire ourselves and reprogram our responses to challenging situations.  When we are encountering volatile and choppy market conditions, this enables us to become like the sniper:  more and more focused as opportunity presents itself.

Further Reading:

Using Biofeedback to Manage Stress

Mastering Trading Psychology With Biofeedback - Short Video   

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Creativity in Finding Market Opportunity

 

As I've emphasized in the Trading Psychology 2.0 book, creativity is essential to success in trading financial markets.  Finding opportunity that others don't perceive is the heart of what great traders do.  That requires looking at new things and viewing old things in new ways.  The very successful participants in markets enjoy creative discovery, and that keeps them excited about markets regardless of recent profitability.

Consider a standard technical indicator such as Bollinger Bands.  We could view the market--or a stock--to be a buy when it closes above its upper band and a sell when it closes below its lower band.  The idea is that if the market is more or less than two standard deviations from its recent average price, that is indicative of a trend.

But suppose we view the bands differently.  Suppose we look at every stock in the NYSE universe and identify how many close each day above and below their upper and lower bands.  Now we've turned the strength/weakness measure into a breadth measure.  

I've collected those data for about three years and have noticed a pattern that no one talks about.  It's when we have very few stocks trading above their bands that next 5-20 day returns are most favorable.  And when we have very few stocks trading below their bands, the next 3-5 day returns are most favorable.  Interestingly, the correlation between the daily number of stocks trading above and below their bands is a very modest -.20.  In other words, breadth strength and breadth weakness are independent variables.

Now the door is open to similar analyses using common technical indicators.  By viewing presence/absence of strength/weakness uniquely, we can find unique relationships.  The absence of strength or weakness may be as important to markets as their presence.

This is what trading psychology is meant to be.  Not a stale rehashing of the need to be disciplined, but the positive development of our greatest cognitive and behavioral capacities.  Creativity is all about asking new and better questions.

Further Reading:

The Role of Creative Insight in Trading

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Very Oversold Stock Market: Is It Time To Buy?

 

The U.S. stock market is dramatically oversold, with very negative breadth.  One way of capturing that is to look at the percentage of stocks in the SPX that are trading above their 3, 5, 10, 20, and 50-day moving averages.  That percentage, in each case, is below 10.  More than 90% of all stocks are in bear modes.

This is an unusual condition.  I went back to 2006 (almost 4000 trading days) and could only find 26 examples of such uniform bearishness.  The occasions tended to cluster:  eight of them occurred in the latter part of 2008; five of them in the February-March period of 2020; four of them in May and June of 2010.  

Did broadly oversold lead to trading opportunity?

Twenty days later, the market was up 17 times, down 9 for an average gain of +2.42%.  That compares with an average 20-day gain of +.67% for all other occasions.  The average gain for the oversold markets was even greater when looking 50 days out:  +8.20% versus +1.98%, with 21 occasions up, 5 down.

That did not mean that we rose in a straight line.  Twenty of the 26 occasions posted a lower close within a ten-day period; 15 of those 20 occasions dropped more than 2%.  The occasions in September and October, 2008 and the 2020 occasions were especially problematic, dropping another double-digit amount before stabilizing.

We've all heard about the person who couldn't swim and who jumped into the water because it averaged only 4 feet in depth.  Averages, in themselves, don't tell us about the variability around those averages.  What we've seen after broadly oversold markets is average gains on an intermediate-term basis, but significant variability in the short-term and further weakness on some occasions further out.

Positive average returns don't mitigate the need for sound risk management.  If central banks need to see significantly weaker economies to crush inflation, then stock markets can be expected to anticipate that weakness.  The average individual investor is long stocks and long bonds.  Both positions are getting crushed and could see real disaster if central banks need to continue to administer harsh medicine.

Further Readings:

Using Breadth and Strength to Track Market Cycles

Understanding Market Cycles

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Four Reasons You May Not Be Succeeding In Your Trading

 

It is not at all uncommon for traders to feel as though they are falling short of their expectations.  Trading is all about risk and reward, and all of us have finite hit and Sharpe ratios.  That all but guarantees that there will be periods of drawdown and suboptimal performance.  When we chronically underperform our expectations, that itself can lead to a frustrated mindset that ensures future trading challenges.  Here are four reasons you might be underperforming your expectations over significant periods of time and what you can do about them:

1)    Your expectations are unrealistic - It is not at all uncommon that developing traders attempt to take shortcuts in their learning process and take too much risk, too soon.  Often, this is because they *need* to make money and can't allow themselves to travel the learning curve of developing experience and expertise.  Think of any performance field, from athletics to music to acting.  No one achieves consistent expertise and success in a matter of months.  In the field of medicine, a student goes through four years of study to become a doctor--and then goes through multiple years of graduate study to master a specialty.  Our expectations should be about learning and development; we need to grade ourselves on our progress, not on whether we can hit our end point quickly.

2)  The markets have changed - I recently spoke with a trader who had been making money earlier this year and then stopped making money.  The frustration of the recent performance led to further trading problems.  When we examined his trading, it was clear that he had a bullish bias and made his money by fading extreme price moves.  In the higher volatility environment, price moves went from extreme to more extreme and, of course, the bullish bias stopped working once we transitioned to a macro environment of quantitative tightening, rising interest rates, and high inflation.  Our trader was underperforming because he, in relative terms, was a one-trick pony.  He needed to return to researching opportunities and add to his trading arsenal.  Failure is often a failure to adapt.

3)  You are not playing to your strengths - I often find that traders attempt to make money in ways that do not tap into what they are truly good at.  Active traders who recognize shifts in patterns in markets will develop longer-term "conviction" and lose their flexibility.  Big picture traders who excel at researching opportunities in markets will get caught up in the wiggles of short-term price movement and get "chopped up".  This is why it is so important to study your trading successes:  trades and periods of trading when you have been at your best.  We learn a lot by identifying our most fulfilling period of trading: these are usually the ones that reflect our distinctive strengths.  The goal is to become the best version of yourself, not to become someone else.

4)  Trading is not your path - This is the one possibility that you almost never hear from trading gurus and would-be mentors and coaches.  They seek your business, so it's toxic to suggest that maybe trading is not your best path to success and fulfillment.  The ability to make a significant living from a performance field--athletics, music, writing--is the rare exception, not the base case.  I have shared many times my attempt to become a full-time trader.  I made money--and I was miserable.  My deepest rewards come from connecting with and helping people:  that is why I became a psychologist.  Sitting in front of screens for hours at a time did not tap into the best of me, and that was a guarantee that I would never achieve my greatest success as a trader.

Failure is information.  When we fall short, there is usually an important lesson to be learned.  Understanding why we're falling short of expectations is the first step in setting ourselves on our best path.

Further Reading:

Overcoming Our Fear of Failure

Three Warning Signs of Trading Failure

Keeping Your Spirits Up When You Are Drawing Down

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Trading Lesson From a Social Psychology Experiment

 

I recently came across a classic social psychology experiment.  The subjects were seminary students and they were told to prepare a talk on the Good Samaritan.  Both groups were told that they would be delivering their talk to a group of mentors.  The first group was told that they running late to the talk and to get to the classroom as soon as possible.  The second group was told that they were on time and did not need to rush to deliver their talk.

Unknown to the subjects, along the way to the classroom was an actor lying on the ground, moaning, and in obvious discomfort.  The group of seminary students not in a rush to their talk was significantly more likely to stop to help the actor than the group in a rush.  Indeed, among the rushed group, there were students who literally stepped over the person in distress in order to get to the classroom!  

There is an important parallel to the trading world.  If a seminary student who has just been focusing on a parable about helping will not help a person in obvious distress because of their own immediate needs, how much more so will we fail to do what we are meant to do because of our own internal pressures!  The person lying on the ground in distress is our profit and loss statement.  No matter how much we rehearse our "process" and what we are meant to do, our best intentions can become hijacked by the needs of the moment.

The point is that it is not enough to merely look at what is out there:  we need to see.  If we truly see a person in need, we will stop and help, even if this makes us a bit late.  If we truly see the risk and reward in front of us, we can stop and do the right thing.  Overtrading is a failure of vision.  We are looking at the market, but not seeing opportunity and threat.  

Bringing unmet personal needs to trading is a great way to become like the seminary students who--on the way to a talk about helping!--rush by a person and fail to help.  It's another way of saying that great trading comes from the strengths of the soul and not the needs of the ego.

Further Reading:

Radical Renewal

The Main Ideas From Radical Renewal

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We Become What We Do

 

If a movie was being made of your life, what would be the story line?  Would it be interesting?  Would you want to watch that movie?

We do not change by setting goals.  Goals can direct the changes we wish to make, but we actually change by doing things differently.  What we do, day after day, is what we internalize.  We become what we do.  Day by day.

When we live a life of routine, our life becomes routine.  That's not a movie we're likely to watch.

When we tackle challenges each day, each day becomes a vehicle for growth.  We achieve successes, we encounter setbacks, we constantly live some part of the person we wish to become.  That provides a plot to our lives.  That can make for a worthwhile movie.

G.I. Gurdjieff understood that our greatest enemy in life is sleep.  When we live by habit and routine, we go through life asleep.  We cannot achieve our ideals if we live on autopilot.  That is why growth can only occur through daily, directed efforts.  

Imagine your life as a movie.  With each of your day's activities, you write the plot.  We become what we do.  What is your story line going to be?

Further Reading:

Overcoming Trading Challenges

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Four Pieces of Trading Wisdom to Turn Your Trading Psychology Around

 

Our perspective--on life and on trading--shapes our experience.  We can make trading a stressful roller coaster or we can make trading a rewarding development of our character virtues.  Here are four pieces of trading wisdom that have offered me the perspective to approach markets in a healthy, constructive, challenging, and fulfilling way:

1) Your uniqueness shapes your success - We are wired to find the exercise of our strengths to be energizing and rewarding.  The best thing we can do in our trading is try lots of things and discover what we do well and what speaks to us.  Your greatness can be found in the patterns of your success.  Yes, it's helpful to correct our weaknesses, but no one ever reached their potential by becoming less bad at something.

2)  If you want a fulfilling and successful career, lead a fulfilling and successful life - No one can live an impoverished life and expect success in their work.  The lives we lead are mirrors, and we internalize the images that we experience.  When we live good, generous, and caring lives, we experience ourselves as good, generous, and caring--and that naturally leads to our being good, generous, and caring toward ourselves.  We're most likely to find success if we lead lives that make us feel worthy of success.

3)  We become who and what we love - When we truly love another, we give them our best selves.  That leads us to constantly exercise the qualities that define us at our best.  When we focus on ourselves and our profits become our greatest love, we train ourselves to live self-absorbed lives.  Love for another person pushes us to step outside of ourselves and internalize the best of the one we care about.  It is difficult to overreact to markets if we have people in our lives so much more important that the ups and downs of profitability.

4)  Most trading psychology problems boil down to spiritual shortcomings - This is the thesis of the blog book Radical Renewal.  It is the intrusion of the ego into trading processes that leads to poor decisions and unwanted emotions.  The great religious and spiritual traditions of the world are a virtual crowdsourcing of wisdom for leading rich, productive, fulfilling lives.  A neglected spirit cannot yield a positive psychology.

Sadly, many traders look to tweaks in their "process" to find success and fulfillment in their work.  Of course, it's always important to learn from experience and improve what we do.  But no amount of tweaks will add up to living the right kind of life.  At some times, in some situations, you have been truly happy and fulfilled:  you have been your best self.  That--not any self-help platitudes--is your best starting point for turning your trading psychology around.

Further Reading:

Finding Our Fulfillment

To Increase Your Discipline, Focus on Your Fulfillment

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Improving Your Trading Psychology By Improving Your Trading

 

What if you had the patience to wait for clarity in the market's behavior?  

What if you only traded when a backtested pattern in the market was playing itself out in real time?

What if you rigorously reviewed each day's market behavior to become sensitive to the trends and cycles present here and now?

What if you didn't *need* to trade and only acted when there was clarity:  when larger and shorter time frames line up?

You see a market likely to go higher after a thrust in breadth.  You notice a trend higher on a particular time frame.  You see a pullback from that trend that can't meaningfully trace the prior rise; you enter for a retest of the prior high and possible trend continuation.  You follow a formula for taking partial profits at the prior high; letting a portion of the trade run to a short-term overbought extreme.

When you wait for clarity, trading comes to you.

Working on your mindset to improve your trading is not the key to trading psychology.

Working on your trading to improve your mindset is the promising performance path.

If you wait for clarity, you'll trade with focus.  

If you *need* to trade and *need* to make money, you'll never wait for clarity.

Further Reading:

Trading With Clarity

Confusion and Clarity in Trading

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The Key to Understanding and Overcoming Trading Tilt

 

I recently spoke on a YouTube video for SMB Capital regarding the dynamics of trading on tilt.  The example I gave in order to place the topic in perspective was that of a surgeon.  A surgeon performing a delicate procedure might feel frustration if things aren't going smoothly, but the surgeon never allows the frustration to take over.  (Can you imagine a surgeon on tilt, slashing away with no discipline whatsoever?!)  Why is it that the surgeon can maintain perspective and professionalism, but many traders cannot?

Tilt is a function of frustration; when we become frustrated, we're more likely to act impulsively.  This is why some of the most effective techniques for managing our tilt states involve physical control of the body.  If the body is calm, the mind finds it easier to maintain perspective and control.  As this video suggests, our frustrations typically stem from the need to be right.  In that sense, tilt is the natural consequence of our egos getting in the way of our best performance.  (See Radical Renewal for a detailed treatment of that topic; most trading psychology challenges are actually spiritual challenges in which we act from ego, not from soul).  

The key to understanding tilt is that the needs we bring to our performance ultimately dictate how we will respond to success, failure, and challenge.

What needs does a surgeon bring to treating a patient?  The number one need is captured in the physician's oath to "Above all else, do no harm".  The safety of the patient is always primary.  That is a soul-need.  It says, "I am a servant entrusted with this person's body".  It's not about me, it's not about how quickly I can do the surgery or how much I'll make from the procedure.  It's about the sacred responsibility of caring for another person. 

The successful trader brings to markets the need to trade well.  "Above all else, do no harm" means that our capital is valuable and that we need to manage risk and be able to accept expectable setbacks.  The trade is not about me; it's about identifying opportunity and acting decisively and responsibly to capture that opportunity.  If I bring ego needs to trading, every loss and every missed trade can become an ego threat.  If I bring my soul's need for growth and development to trading, I can take pride in my work and stay calm and focused, even when things aren't going according to expectation.

We can trade well and learn during a drawdown.  No one trades well with a wounded ego.

Further Reading:

Techniques for Overcoming Frustration

Facing Our Trading Fears

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Creativity in Analyzing Market Information

 

In a recent video shared by SMB Capital, I discuss why creativity is necessary for trading success.  Quite simply, in order to achieve unique returns, we have to be able to perceive and act upon unique opportunity.  What we see in markets is a function of where we look.  If we're drilling for oil and look in the same places as everyone else, we'll come up with a lot of dry holes.  Half the battle is knowing where to look for the opportunities that others are missing.  

An important topic in the Trading Psychology 2.0 book is how to develop our creativity by asking questions that others don't ask and studying information that others don't gather.  Here's a nice example of creative processing from my trading many years ago.  My point in that article was that "creativity is the new discipline".  It's not enough to find an edge and stick to it in a disciplined manner.  Now the discipline has to extend to finding fresh edges.

Here's an example of a creative edge emerging from unique data sets.  For a number of years, I have tracked, each day, the number of stocks across all indexes that make fresh one-month new highs and fresh one-month new lows.  Normally, we look at the data reported by the NYSE regarding 52-week new highs and lows.  I have found value in the shorter-term measures.  Over the past three years, all of the market's gains (SPY) over a next 10-day basis can be attributed to low levels in the monthly new highs.  In other words, it's the relative absence of new highs that predicts positive returns over the next 20 days.  Similarly, a relative absence of new monthly lows is significantly associated with positive returns over the next ten trading days.  What is meaningful, interestingly, is the absence of new highs and new lows.  I would have never anticipated this had I not collected and investigated the data set.

(A good exercise is to develop an explanation for why this edge exists and how you might use the underlying logic to create edges at other time frames or in other markets.  That's how the creative process works).

Here's another unique finding over that same period.  Essentially all the market's (SPY) upside on a next 3-5 day basis has occurred when few stocks close above their upper Bollinger Bands.  Similarly, we see superior returns over a next five-day basis when few stocks close below their lower Bollinger Bands.  

In short, there is information in the absence of strength and weakness.

When you look at new and different data, you open the door to seeing new and different patterns in markets.  And that means your drilling is more likely to strike oil.

Further Reading:

How Rare It Actually Is For Daytraders to Consistently Make Money

What is the Purpose of Your Trading--And Why That's Important

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The Key to a Successful Trading Psychology

 

In recent posts, I have shared my framework for thinking about trading and trading psychology.  I've also explained a few core concepts central to this approach, including how active traders can diversify their risk-taking; how to deal with stress in trading; and why volume is key to understanding trading opportunity.  In this post, I will explain the single most important psychological factor in active trading and why it is crucial to performance:  open-mindedness.

Pattern recognition is the core cognitive skill involved in active trading.  One mistake many beginning traders make is that they equate patterns in markets with chart patterns.  For the rational, evidence-based trader, patterns are only meaningful if they have explanatory value.  

When trading short time frames, the patterns in markets that are meaningful are ones that track actual supply and demand among market participants.  From the sequencing of trades in a market, we can observe increasing or decreasing volume and whether the volume has a directional bias.  Across many trades, we can detect trends and cycles.  When there is relatively stable participation in markets, we can expect the patterns of trending and cycling that we've observed in the recent past to continue in the immediate future.  That sets up potential opportunity.

One of the challenges of financial markets is their complexity.  Patterns show up across differing time frames, with trends and cycles nested within one another.  Thus, at one time frame, we may observe a trend, but at a longer time frame we can see that this trend is simply a directional move within a larger cycle.  A true understanding of market patterns requires the ability to place price behavior in proper context.  Successful pattern recognition is not merely seeing a trend or cycle on one time frame; it is the understanding of price behavior across multiple time frames.

In practice, that means our tracking of markets needs to be dynamic, not static.  We need to be tracking what is happening across shorter, medium, and longer time frames in order to detect the opportunity in their alignment.  Meaningful market patterns do not "set up" at any single period, but rather derive their meaning in how they are nested within one another.  I recently noticed the ES market cycling on a higher time frame (using charts where each bar represents 20,000 contracts traded) and making a clear higher oversold low on a shorter time frame (each bar was 5000 contracts traded).  That led to a profitable trade buying the oversold low and holding until we tested the high of the longer-term range.

At other times, those kinds of patterns will set up in the nesting of much longer time frames and even shorter ones.  Only if I am dynamically scanning the market across multiple time horizons can I begin to detect how the longer-term and shorter-term movement are meaningfully related.  During that dynamic scanning, I am not looking for trades and I am not at all focused on what I think the market will do or should do.  Rather, I am watching across the time horizons with a completely open mind, much as I (as a psychologist) might start a first meeting with person by listening, listening, listening.  Eventually, if I observe and listen long enough, a pattern--something meaningful--will jump out at me.

This is why maintaining an open mind is the key to a successful trading psychology.  Great trade ideas can't come to us if we are not open to them.  Pattern recognition, whether in a therapy office or in trading, means that we see relationships unfold.  This is why intuition is central to successful active trading.  The goal is not to have an optimistic mindset or a mindset filled with "conviction".  The goal is to be have a quiet and open mind, dynamically observing the interplay of markets and time frames.

The truly great trades are the ones that come to us.

Further Reading:

A Radical Method for Quieting the Mind

How to Develop Creativity, Best Practices, and Best Processes

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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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