When you are your own trading coach, your job is to keep yourself within your niche, swinging at pitches that fall within your sweet spots and laying off those that yield marginal results. This means knowing when to not place trades, not to participate in markets. Equally important, it means knowing when your advantage is present and making the most of opportunities. A common pattern among active traders is that they will trade too much outside their frameworks, lose money, and then lack the boldness to press their advantage when they find genuine sweet spots. It’s easy to see careers lost by blowing up; less visible are the failures that result from the inability to capitalize on real opportunity.
I recently talked with a day trader who was convinced that he would make significant money if he just held positions for several days at a time. Though it looked easy to find spots on charts where such holding periods would have worked, in real time that trade was much more difficult. It was not in the trader’s wheelhouse; it was outside his niche. Calibrated to measure opportunity and risk on a day time frame, he found himself shaken out by countertrend moves when he tried holding positions longer. Worse still, he mixed his time frames and tried to convert some losing day trades into longer-term holds. Outside his niche, he began trading like a rookie—with rookie results.
What is your wheelhouse? What do you do best in markets? If you could trade just one strategy, one instrument, one time frame, what would these be? Do you really know the answers to these questions: have you truly taken an inventory of your past trades to see which work and which have been low and outside?
There is nothing wrong with expanding your niche in a careful and thoughtful way, much as a company might test market new products in new categories. But just as management books tell us that great companies stick to their knitting and exploit core competencies, we need to capitalize on our strengths in our trading businesses. As we will see in Chapter 8, you are not just your own trading coach: you are the manager of your trading business. That means reviewing performance, allocating resources wisely, and adapting to shifting market conditions.
The greatest problem with overtrading is that it takes us outside our niches—and therefore out of our performance zones.
Here’s a simple exercise that can move you forward as the manager of your trading business. At the time you take each trade, simply label it as A, B, or C. A trades are clearly within your sweet spot; they’re your bread-and-butter, best trades. B trades are your good trades: not necessarily gimmes or home runs, but consistent winners. C trades are more marginal and speculative: they’re the ones that feel right, but are clearly outside your wheelhouse.
Over time, you can track the profitability of the A, B, and C trades and verify that you really know your niche. You can also track the relative sizing of your positions, to ensure that you’re pursuing the greatest reward when you take trades in your sweet spots and assuming the least risk when you’re going after that low, outside pitch.
The more clearly you identify your niche, the less likely you are to get away from it. That clarity can only benefit your profitability and emotional experience over time.
COACHING CUE
If you categorize your trades/time frames/setups/markets as A, B, or C as outlined above, you have the start for good risk management when you go into slumps. When markets do not behave as you expect and you lose your edge, cut your trading back to A trades only. Many times, slumps start with overconfidence and getting outside our niches. If it’s the A trades that aren’t performing, that’s when you know you have to cut your risk (size) and reassess markets and trends.
LESSON 20: VOLATILITY OF MARKETS AND VOLATILITY OF MOOD
I recently posted something important to the TraderFeed blog. I took two months in the S&P emini futures (ES) market—January and May, 2008—and compared the median volatility of half-hour periods within the months. During that period, overall market volatility, as gauged by the VIX, had declined significantly. The question is whether this day-to-day volatility also translated to lower volatility for very short time frame traders.
The results were eye-opening: In January, when the VIX was high, the median 30-minute high-low price range was 0.60 percent. In May, with a lower VIX, the range dwindled to 0.28 percent. In other words, markets were moving half as far for the active day trader in May than January.
Let’s think about how that affects traders emotionally. The trader whose perceptions are anchored in January and who anticipates much greater movement in May will place profit targets relatively far away. In the lower volatility environment, the market will not reach those targets in the time frame that is traded. Instead, trades that initially move in the trader’s favor will reverse and fall well short of expectations. Repeat that experience day after day, week after week, and you can see how frustration would build. Out of that frustration, traders may double up on positions, even as opportunity is drying up. I’ve seen traders lose significant sums solely because of this dynamic.
Alternatively, the trader who is calibrated to lower volatility environments will place stops relatively close to entries to manage risk. As markets gain volatility, they will blow through those stops—even as the trade eventually turns out to be right. Once again, the likely emotional result is frustration and potential disruption of trading discipline.
Both of these are excellent and all-too-common examples of how poor trading can be the cause of trading distress. It may look as though frustration is causing the loss of discipline—and to a degree that is true—but an equally important part of the picture is that the failure to adjust to market volatility creates the initial frustration. Any invariant set of rules for stops, targets, and position sizing—in other words, rules that don’t take market volatility into account and adjust accordingly—will produce wildly different results as market volatility shifts. For that reason, the market’s changes in volatility can create emotional volatility. We become reactive to markets, because we don’t adjust to what those markets are doing.
Poor trading practice—poor execution, risk management, and trade management—is responsible for much emotional distress. Trading affects our psychology as much as psychology affects our trading.
Personality research suggests that each of us, based on our traits, possess different levels of financial risk tolerance. Our risk appetites are expressed in how we size positions, but also in the markets we trade. When markets move from high to low volatility, they can frustrate the aggressive trader. When they shift from low to high volatility, they become threatening for risk-averse traders. The volatility of markets contributes to volatility of mood because the potential risks and rewards of any given trade change meaningfully. In the example from my blog post, that shift occurred within the span of just a few months.
Note that traders can experience the same problem when they shift from trading one market to another—such as moving from trading the S&P 500 market to the oil market—or when they shift from trading one stock to another. Day traders of individual equities will often track stocks on a watch list and move quickly from sector to sector, trading shares with different volatility patterns. Unless they adjust their stops, targets, and position sizes accordingly, they can easily frustrate themselves as trades get stopped out too quickly, fail to hit targets, or produce outsized gains or losses.
Many traders crow about taking a huge profit on a particular trade. All too often, that profit is the result of sizing a volatile position too aggressively. While it’s nice that the trade resulted in a profit, the reality is that the trade probably represents poorly managed risk. Trading 1,000 shares of a small cap tech firm can be quite different from trading 1,000 shares of a Dow stock, even though their prices might be identical. The higher beta associated with the tech trade will ensure that its profits and losses dwarf those of the large cap trade. That makes for volatile trading results and potential emotional volatility.
Risk and reward are proportional: pursuing large gains inevitably brings large drawdowns. The key to succ
ess is trading within your risk tolerance so that swings don’t change how you view markets and make decisions.
Do you know the volatility of the market you’re trading right now? Have you adjusted your trading to take smaller profits and losses in low volatility ones and larger profits and losses when volatility expands? If you’re trading different markets or instruments, do you adjust your expectations for the volatility of these? You wouldn’t drive the same on a busy freeway as on one that is wide open; similarly, you don’t want to be trading fast markets identically to slow ones.
One strategy that has worked well for me in this regard is to examine the past 20 days of trading and calculate the median high-low price range over different holding periods: 30 minutes, 60 minutes, etc. I also take note of the variability around that median: the range of slowest and busiest markets. With this information, I can accomplish several things:• As the day unfolds, I can gauge whether today’s ranges are varying from the 20-day average. That gives me a sense for the emerging volatility of the day that I’m trading. This helps me adjust expectations as I’m trading. For instance, the S&P e-mini market recently made a 12-point move during the morning. My research told me that this was at the very upper end of recent expectations, a conclusion that kept me from chasing the move and helped me take profits on a short position.
• When I see that volatility over the past 20 days has been quite modest, I can focus on good execution, place stops closer to entry points, and keep profit targets tight. That has me taking profits more aggressively and opportunistically in low volatility environments, reducing my frustration when moves reverse.
• When I see that volatility over the past 20 days is expanding, I can widen my stops, raise my profit targets, adjust my size, and let trades breathe a little more. Not infrequently, the higher volatility environment will be one in which I can set multiple price targets, taking partial profits when the first objective is hit and letting the rest of the position ride for the wider, second target.
Note that what’s happening in the above situations is that I am taking control over my trading based on market volatility. Instead of letting market movement (or lack of movement) control me, I am actively adjusting my trading to the day’s environment. That taking of control is a powerful antidote to trading distress, turning volatility shifts into potential opportunity.
The Excel skills outlined in Chapter 10 will be helpful in your tracking average volume and volatility over past market periods.
As your own trading coach, you want to monitor your mood over time. When you see your mood turn dark and frustrated, you want to examine whether there have been changes in the markets that might account for your emotional shifts. Many times, these will be changes in the volatility of the markets and instruments you’re trading. Establish rules to adapt to different volatility environments as a best practice that aids both trading and mood.
COACHING CUE
If you know the average trading volume for your stock or futures contract at each point of the trading day, you can quickly gauge if days are unfolding as slow, low-volatility days or as busy, higher-volatility days. If you know how current volumes compare to their average levels you can identify when markets are truly breaking out of a range, with large participants jumping aboard the repricing of value. If you can identify markets slowing down as that process unfolds, you can be prepared and pull your trading back accordingly.
RESOURCES
The Become Your Own Trading Coach blog is the primary supplemental resource for this book. You can find links and additional posts on the topic of stress and distress at the home page on the blog for Chapter 2: http://becomeyourowntradingcoach.blogspot.com/2008/08/daily-trading-coach-chapter-two-links.html
Make sure that you structure your learning process as a trader in a way that will build success and confidence. This process will help greatly with the management of stress and distress. That topic—and especially the topic of how to find your trading niche—is covered in depth in the Enhancing Trader Performance book, including a section on psychological trauma. A detailed discussion of how emotional states affect trading can be found in The Psychology of Trading. Links to both books can be found on the Trading Coach blog (www.becomeyourowntradingcoach.blogspot.com).
If you’re looking for a book specific to stress and trading, you might look into Mastering Trading Stress by Ari Kiev, MD (www.arikiev.com), which is written by an experienced trading coach.
How do emotions affect financial decisions? Two good books are Richard L. Peterson’s Inside the Investor’s Brain, published by Wiley (2007) and Your Money and Your Brain, written by Jason Zwieg (Simon & Schuster, 2007).
Information on the research of James Pennebaker regarding writing as a way of coping with stress and distress can be found on his page: http://pennebaker.socialpsychology.org/
CHAPTER 3
Psychological
Well-Being
Enhancing Trading Experience
Happiness is the meaning and the purpose of life, the whole aim and end of human existence.
—Aristotle
Recent research into what has been called positive psychology has yielded insights into the importance of well-being: positive emotional experience. It is not enough to cope with stress and minimize distress. If we’re going to maximize performance, it means that we need to make the most of our concentration, motivation, and energy. How many times have I seen traders miss trades or fail to prepare adequately for the day, simply because they were worn down, not operating at their peak? An Olympic athlete would never think of coming to his event in less than the best shape. Too often, however, traders will risk their capital after being sleep-deprived, burned out, or distracted. How you manage your trading will depend, in part, on how you manage the rest of your life.
But what is well-being and how can we maximize it? A wealth of research, much of it conducted in the past decade and unknown to traders and even trading coaches, helps us answer these questions. Let’s take a look at how you can coach yourself toward more positive experience—and performance.
LESSON 21: THE IMPORTANCE OF FEELING GOOD
One of the most overrated variables in trading psychology is passion for trading or passion for the markets. Self-reported passion means a great deal of things to different people; my experience is that it is only weakly correlated with how hard traders actually work at their craft. Traders who are desperate for profits, traders who approach markets addictively like gamblers, traders who live and breathe markets 24/7: all may claim a special passion for what they do. These passions may or may not support good trading and a positive learning curve. Desire and motivation are necessary, but not sufficient, for trading success.
Rather than focus on passion, traders would do well to reflect upon the overall emotional tone of their market experience. In researching and trading markets, as well as working on trading skills, do you experience meaningful happiness, contentment, and motivation? Are you truly enjoying what you’re doing?
This positive side of emotional experience is what psychologists refer to as psychological well-being. A person with high well-being experiences the following on a frequent basis:• A positive mood (happiness).
• Favorable expectations (optimism).
• A positive physical state (energy).
• A positive appraisal of self and life (fulfillment).
• Favorable relations with others (affection).
None of us feel all of these things all of the time; indeed, many of these five factors may wax and wane depending upon life circumstances. Still, psychological research suggests that some of us experience significantly more well-being than others. A portion of this variation can be attributed to inborn personality traits that are present across a range of life circumstances. Other variations can be attributed to our environment, especially the degree to which our settings satisfy or frustrate our needs and affirm or contradict our values.
Much of psychological well-being is a function
of the fit between a person and her social and work environments.
When people are chronically unable to experience positive emotions, we might suspect the presence of an emotional disorder, such as the form of depression known as dysthymia. Other emotional problems, including anxiety disorders, can be sufficiently pervasive as to prevent people from experiencing joy and life satisfaction. In such circumstances, it is important for people to seek the assistance of an experienced, licensed mental health professional. Many times, very hands-on approaches to therapy—sometimes in concert with medication—can make a huge difference when chronic problems interfere with positive life experience. You don’t need to be actively depressed—crying, unable to get out of bed, suicidal—to benefit from psychological help when positive emotions are chronically absent.
The Resources for Chapter 1 include a source for brief therapy referrals through the Beck Institute for Cognitive Therapy and Research.
The majority of people, however, experience varying balances of positive and negative emotions as a function of life circumstances. When their lives affirm their values and needs, they enjoy the emotions listed above. When life fails to meet their needs, they respond with unhappiness, frustration, and diminished energy. In this sense, positive emotions serve as life barometers, informing us of the degree to which we’re doing the right things for us.
You can see, then, why positive emotions are so important to trading. If you’re trading well, learning and developing, and succeeding in your efforts, your positive emotions should outweigh the negative ones over time. The dominant emotional experience of your work should be the kind of pride, satisfaction, and sense of accomplishment that gives you energy and optimism. If you’re not trading well, if you’re not growing and developing as a trader, and if your efforts are not yielding success, your experience of trading is apt to be more negative. You’ll spend less time feeling satisfaction, energy, and optimism than frustration, overload, and discouragement.
The Daily Trading Coach Page 10
