The Daily Trading Coach

by Brett N Steenbarger

  Access to intuition requires a still mind; highly intuitive people are not bored by stillness and, indeed, thrive on it.

  When our attention is divided and we are distracted, we lose our feel. This is because the implicit pattern recognition manifests itself as a felt sense, a subtle kind of awareness. If I am not attending to those subtle cues of mind and body, I will miss signals altogether. In such a state, we cannot pick up on nuances of conversations or small, but significant shifts in traffic patterns. We lose valuable information, and we lose much of our ability to react quickly based upon internalized patterns.

  Worse still, in a chronically distracted state, we never sustain the attention in the first place to internalize complex market patterns.

  This is why serenity—the quiet mind—is so important. With a quiet mind, we can attend to the subtle cues of pattern recognition. Undistracted, our antennae are extended, able to pick up signals of situations that feel right and those that don’t. The experienced trader has seen so many markets and perceived so many relationships among market variables that she learns to trust these gut signals. It is neither mystical nor irrational. Just as a horse whisperer can become one with the horse, understanding the most subtle communications, an experienced trader can hear the whispers of markets.

  But if the mind is noisy, the whispers are drowned out.

  Those who fear boredom never achieve the still mind.

  The two essential steps in achieving a quiet mind are a still body and focused thought. This is where biofeedback can be extremely helpful for the trader: it provides a structured method for learning to quiet the mind. The biofeedback that I use currently is the emWave unit from Heart Math (www.heartmath.com). It provides measures of both heart rate and heart rate variability (HRV). The user’s finger goes into a small sensor, which is connected to a computer with the biofeedback software. The HRV readings are displayed in a chart; as readings rise, the chart readings become like sine waves. Lower readings create jagged, nonrhythmical patterns. The goal is to keep the patterns as sine wave-like as possible. There is also a feature that displays the proportion of high, medium, and low HRV readings over time, accompanied by audio beeps. You can thus close your eyes (for instance, while engaging in guided imagery) and still track your HRV. Even children can use the unit by clicking on video game features that play the game by keeping HRV readings high.

  After a while using the biofeedback, you learn that keeping yourself still, focusing your attention, and keeping your breathing deep and rhythmical is the best way of generating high HRV scores. (Users can set the software for various levels of difficulty to build skills.) The emWave is thus a training tool—teaching users to control mind and body—and a way of tracking focused attention over time. There are other, similar units available (for example, Journey to the Wild Divine); ease of use and the appeal of the graphical interface will dictate most traders’ preferences. If I had to invest in a single psychological tool to aid trading, this kind of biofeedback unit would be my choice. It is highly portable and can even be used in real time during trading, with the feedback screen minimized but sound enabled.

  Biofeedback is a tool for training yourself to control the arousal level of mind and body.

  When you are your own trading coach, it’s important to keep your mind in shape much as an athlete stays in proper conditioning. I find that 5 to 10 minutes each morning prior to the start of trading is useful in bringing a quiet mind to trading. During that time, you stay completely still in a comfortable seated position and breathe deeply, slowly, and very rhythmically. Your eyes can be closed throughout and you can focus your attention on your breathing, on soothing imagery, or on quiet music through headphones. The key is staying in that Yoda state described in The Psychology of Trading: very relaxed, yet very alert and focused. As you practice this each day, you build skills, so that you can eventually quiet your mind on demand, with only a few deep, rhythmical breaths. This is enormously helpful during hectic times during the trading day, keeping you out of situations in which you become impulsive and reactive in the face of moving markets.

  Just as you prepare for the day’s trading by studying recent market action, reviewing charts, and identifying areas of opportunity, it makes sense to engage in mental preparation to build the mind-set needed to capitalize on your ideas. Your assignment is to devote a portion of each morning to mental preparation and the generation of a quiet mind. If you have difficulty sustaining the effort or reaching that Yoda state, consider incorporating biofeedback into your morning routine, much as athletes work out daily on treadmills and weight machines. Mastering your mind state is a key component of mastering performance: if you can sustain serenity during the most boring market occasions, you’ll be well prepared to catch moves when trading picks up.

  COACHING CUE

  If placing trades is your major source of stimulation in financial markets, you’re bound to overtrade. By cultivating collaborative relationships with peer traders and developing routines for generating trade ideas and themes, you need not face boredom during slow markets. Other markets, other time frames: for the dedicated trader, there is always something of interest.

  LESSON 27: BUILD EMOTIONAL RESILIENCE

  Three traders place the exact same trades; all of them lose money. The first trader becomes discouraged, curses the market, and gives up for the day. The second trader reacts with frustration, vows to get his money back, trades more aggressively, and loses a bundle on the day. The third trader pulls back, reassesses her strategy, waits for a clear area of opportunity, and places a good trade that brings her even on the day.

  What is the difference among these traders? The research literature in psychology refers to it as resilience: the ability to maintain high levels of functioning even in the face of significant stresses. A resilient person, for example, can lose his job, but still function well at home and implement an effective strategy for finding new work. The individual who lacks resilience is thrown for a loop by the lost job. This interferes with other areas of life and makes it difficult to find new opportunity.

  A key reason why many people lack resilience is that they take negative events personally. Some portion of their self-worth is connected to their individual life outcomes. When events go well, they feel good. When they encounter roadblocks, they become discouraged, doubtful, and frustrated. Instead of dealing directly and constructively with the blocks, they react to the emotions triggered by their personalizing of events. An inspiring example of resilience is author Viktor Frankl’s survival in a Nazi concentration camp. He set about writing a book (first on scraps of paper, then in his mind) during his internment, giving him a purpose: a reason to keep going. Others who experienced the same horrific conditions lacked such purpose and ultimately perished. The larger part of persistence is nurturing a reason to persist, a greater purpose and vision.

  The survivors are those who have a vision and purpose greater than themselves.

  I recently researched a new pattern that I wanted to trade and saw an opportunity in early-morning trading. I vacillated between placing a small-sized trade and one more normal in size. I thought about the trade going against me and realized that I didn’t really want to lose money on a relatively untested idea. With the smaller trade, I didn’t care about the implications of the profitability of the trade for my portfolio. A larger trade could dent my week’s performance, and that would have been frustrating to me. So I placed the small trade, observed the pattern in real time, made a small profit, and started the process of integrating the pattern in my usual trading.

  In selecting trade size, I was letting my psychological resilience dictate my risk taking. When I traded to my resilience level, I kept myself in a favorable state regardless of the trade’s outcome. “How will I feel if I’m stopped out?” dictated my trading size. To be sure, this can be taken to an unhealthy, risk-averse extreme. We can take so little risk on trades that we severely diminish potential returns. The key is to know yourself and es
pecially the limits of your resilience. Occasionally I’ll fantasize about placing an über trade on a promising idea and taking a mammoth profit. I realize, however, that such a trade can overwhelm my resilience. As soon as the position went against me—even in a normal, expectable adverse excursion—I would be stressing about the dollars lost. Undoubtedly this would prevent me from managing the trade effectively.

  Successful traders learn to build their resilience over time and adapt to stresses that at one time might have been overwhelming. That small trade I recently placed would have qualified as a large trade back in the late 1970s when I placed my first trades. Now it is emotionally inconsequential. Experience builds adaptation: we can generally handle familiar situations with a high degree of resilience.

  When we master one level of challenge, we build resilience for the next level.

  The most effective way of to build emotional resilience is to undergo repeated, normal drawdowns and see—in your own experience—that you can overcome those. Our losses provide us with the deep emotional conviction that we can weather losses and ultimately prosper. Someone who has undergone many life setbacks and bounced back acquires the confidence that he can land on his feet in almost any situation. The trader who experiences repeated drawdown, only to later hit fresh equity highs, knows that she has nothing to fear during normal performance pullbacks.

  When you are your own trading coach, your challenge is not only to sustain a high level of resilience, but also to build that resilience over time.

  A worthwhile exercise is to expand on the routine from my recent trade and vividly visualize the worst-case scenarios for trades that you place. In other words, once you set your stop level, visualize how you would feel and how you would respond in that worst-case scenario. Most importantly, figure out what your next course of action might be, including your possible next trade. In other words, mentally rehearse the resilient behavior that you want to cultivate. You can think of this as play-acting the role of a highly resilient person. As you rehearse resilience and act on the rehearsal, that role becomes more a part of you. To paraphrase Nietzsche, you’re finding your greatness by play-acting your ideal.

  In trading, we develop ourselves. Every gain is an opportunity to overcome greed and overconfidence. Every loss is an opportunity to build resilience.

  Beware: resiliency does not mean that you jump into subsequent trades after you sustain losing ones. Rather, the resilient trader is one who can sustain well-being even after normal, expectable losing trades. When you lack resilience, you become backward-looking and respond to the last trade rather than the next market development. The resilient trader remains proactive, even in the face of loss. A resilient trader might thus stop trading or resume trading following a loss; it’s the following of basic, time-tested plans and strategies—and not impulsively running toward or away from risk—that defines authentic resilience.

  COACHING CUE

  If I ask a trader how well he is doing and I receive a dollar figure as a reply, I usually know there’s a problem afoot. Experienced traders think of their returns in percentage terms, not absolute dollars. Thus, for example, they might think of cutting their risk if they’re down 5 percent on the year or limit their risk on a trade to 25 basis points (0.25 percent of their portfolio value). If you calibrate yourself in dollar terms, you will find it difficult to increase your trading size or to get larger as you grow your portfolio. Standardize your view in percentage terms and you make yourself more resilient; a $20,000 loss on a $2,000,000 portfolio won’t feel significantly different from a $500 loss on a $50,000 portfolio. Similarly, when you cut your trading size, you’ll standardize your risk management if you’re calibrated by percentages, rather than let losses run because they seem small in absolute dollar terms.

  LESSON 28: INTEGRITY AND DOING THE RIGHT THING

  Many of the lessons in this book begin with a discussion of a trading issue and then proceed to suggestions about what you can do about the issue. This lesson will actually start with the recommendation and then work backward from there. Your assignment is to read Ayn Rand’s novel The Fountainhead. If you’ve read it previously, the assignment is to reread and review it.

  For those not familiar with the book, The Fountainhead is the story of architect Howard Roark, who is an unorthodox creative genius. He faces stiff opposition to his ideas, including the ambivalence of the woman he loves. Throughout, he must decide whether to abandon or compromise his ideals, especially as he sees lesser talents succeed commercially by pandering to public fashion. In many ways, The Fountainhead is a study in integrity and the difficulty and importance of doing the right thing.

  There can be no self-esteem without a self: a well-defined sense of who one is and what one stands for. There are many false substitutes for self-esteem, including the approval of others and the size of one’s trading account. Ultimately, however, self-esteem is a function of knowing yourself and remaining true to your values: possessing a vision of what can be and remaining faithful to that vision.

  Many traders have no more vision than a desire to make money. There’s nothing wrong with making money, of course, and for those who do so through the independent efforts of mind, such earnings are a rightful source of pride. Traders who attempt to latch onto holy grails instead of independently relying on their planning and judgment, however, substitute the desire for a quick, easy score for the more difficult challenge of developing competency in reading and acting on market patterns. Someone who consummates a long-term courtship and someone who hooks up for a one-night stand engage in the same physical act, but the meaning is completely different. One is an expression of esteem; the other is often a flight from self.

  In so many fields, we never see the fruits of our labors; we’re part of a larger team and process. Trading is unique in that we alone are responsible for what we earn, and we see each day the outcomes of our efforts.

  When you read The Fountainhead, it’s instructive to reflect on how Howard Roark would approach the field of trading. Would he join a proprietary trading firm that frantically searches for stocks in play, robotically fading moves or chasing strength or weakness? The mere thought is ludicrous. Would he attend a few seminars or read a couple of books and trade the same untested chart patterns as other beginners? It’s unthinkable.

  No, Howard Roark the trader would be a keen student of markets, just as Roark the architect was a devoted student of building materials and methods. He wouldn’t trade a single method in all markets, just as he didn’t repeat the same design to fit all housing sites. Rather, he would carefully consider each unique situation and tailor the strategy to fit the present context. Roark the trader would work from carefully considered plans, just as he worked from blueprints that he had developed from scratch. In short, Roark would approach trading the same way he approached architecture: as an expression of his creative vision and the sheer joy of giving birth to something new and valuable.

  Most of all, Roark the trader, like the architect Roark, would stand for something. He would have a view of markets and how and why markets move, just as he had a view of design and building. It would be his view, not something borrowed slavishly from tradition or current fads. The odds are good that this view would be unconventional and meet with more than a little skepticism by the self-appointed gurus of trading. That wouldn’t matter. Roark the trader would remain faithful to his framework. When confronted with the choice of following the crowd versus act on his convictions, he wouldn’t hesitate to do the right thing.

  Every great trader I have known has an outlook and a set of methods that are distinctively his own.

  For that reason, economic success for trader Roark would be a tangible indicator of his efficacy and the rightness of his efforts. It is effect, not cause. He doesn’t trade to simply make money any more than he builds to sell homes and office buildings. Roark the architect built because that was what he was meant to do. Even when he didn’t have clients, he was designing buildings in his mind an
d in his sketches. Similarly, trader Roark would be tracking and investigating markets even if he wasn’t placing orders. His work is an extension of who he is; his profits are the result of years of effort and integrity.

  One’s work could entail raising a child, building a business, designing a high-rise structure, or developing a unique framework for analyzing and trading financial markets. Each, to be accomplished well, requires sustained, dedicated effort; a vision of what can be; and a willingness to pursue that vision even when it’s more comfortable to slide by. This is the true source of emotional resilience: a pride and esteem so deep that one is unwilling to compromise oneself in the face of setbacks and disappointments.

  What about your trading is uniquely yours? What have you developed that most distinctly distinguishes you as a trader? What is the vision behind your trading? That is your core, your essence as a trader. When you’re trading well, you’re remaining true to that essence, and that will serve you well during the most challenging times. If you can’t provide detailed answers to these questions, are you truly ready to be risking your capital? Will you really have the confidence to weather adversity, with only borrowed ideas and methods to draw upon? Read Chapter 9 of this book carefully; you’ll see that experienced traders build a career from their work from figuring markets out for themselves and then remaining true to their ideas and to the evidence of their senses.

  COACHING CUE

  This lesson shows why it is so important to follow one’s trading plans. The plans may not be perfect, and they may not work well at times. If, however, you are to build confidence in your judgment and train yourself to act with integrity, there’s no alternative to following the ideas you believe to be correct. You cannot build confidence by abandoning your convictions and contradicting your perceptions. The clearer you are about your market views, mapping out your actions under various scenarios and your rationales for trades, the easier it will be to act on your judgment and see, in your own experience, your own progress and growth.