The Daily Trading Coach

by Brett N Steenbarger

  When we change the lenses through which we view events, we change our responses to those events.

  What are your most exaggerated emotional responses to markets? Do you feel angry when ideas don’t work out; devastated after losses; stricken by fear during volatile periods? Or perhaps you swing from overconfident, cocky feelings to feelings of despair and worthlessness? Your strongest feelings are reflections of your most entrenched thought patterns, and those feelings reflect your core schemas:• Schemas of justice—“I put in my work; I should make money.”

  • Schemas of catastrophe—“It would be terrible if my trade didn’t work out.”

  • Schemas of safety—“I can’t act; the market is too dangerous.”

  • Schemas of self-worth—“I’m a total failure; I can’t make money.”

  • Schemas of rejection—“I’ll look like such a fool if I can’t succeed at this.”

  It’s easy to see how these schemas naturally lead to exaggerated emotions of anger, frustration, fear, and depression. As your own trading coach, you want to use your most extreme feelings to figure out your most distorted ways of viewing yourself and your trading. If you’re managing risk properly, there should be nothing overly threatening about any single trade or any single day’s trading. If you find yourself responding to markets with a high degree of threat, then you know that the problem is not the markets themselves or even your trading, but the interpretations you’ve placed on your trading results.

  Please read those last two sentences again, slowly. If you are trading well—with plans built on demonstrated edges, with proper risk control—trading will have its stresses, but should not be filled with distress. Markets cannot make us feel anxious, depressed, or angry; the threat lies in how we view our market outcomes.

  One exercise I like to conduct when I find myself responding to trading with strong emotion is to simply ask, Am I reacting to the situation as it really is, or am I reacting to what I’m telling myself about the situation? That question forces me to confront my thinking and ask whether the magnitude of my emotional reaction is truly warranted. If it is not the objective situation that creates your feelings, then your emotion has to be internally generated, a function of how you are processing events. If the emotion is out of proportion to the situation, your thinking about the situation must be distorted.

  The greater the distortion in our thinking, the greater the distortion in our emotions.

  Make yourself write down what you would have to say to another person—another trader—to make them react the way you’ve just reacted. What could you say to them that would lead them to respond so extremely? The odds are good that what you would tell another person to generate the emotion is what you are telling yourself:• “You’re no good!”

  • “It’s all your fault!”

  • “You’re going to lose your money!”

  • “You can’t win!”

  If you write down these messages every time you catch yourself in the throes of an extreme emotional response, you’ll come close to duplicating the output from your cognitive schemas. It’s much easier to redraw mental maps when they’re lying open in front of you.

  COACHING CUE

  A common thought pattern that distorts traders’ reactions to markets is what we might call a “justice schema”: the idea that markets should be fair, should offer opportunity, or should behave as they’ve behaved in the past. Once we lock ourselves into notions of how markets should behave, we open ourselves to frustration and disappointment when they take their own course. Many times, I’ve seen traders grow restive, fuming at markets that just aren’t moving. Traders become impatient and jump all over any move to new highs or lows, hoping that this will be the breakout move—only to find the market return to its slow range. By challenging yourself when you catch yourself thinking or talking about how the market should behave (but isn’t behaving), you can use the frustration to channel your energies elsewhere: toward longer time frames in the same market, toward fresh research, or toward other instruments or markets. When we react to our own sense of justice and injustice, we no longer objectively process actual market activity.

  LESSON 53: LEARN FROM YOUR WORST TRADES

  Alcoholics Anonymous teaches people to become aware of their stinkin’ thinkin’. But we don’t have to be alcoholics to process the world in distorted ways. We develop repetitive patterns of behavior, and we follow daily routines. Most of us are creatures of habit: we tend to go through consistent morning routines, eat at the same times of day, and go to sleep around the same hour. We take the same routes to and from work, and we listen to the same music, watch the same television shows. There’s not much in our lives that isn’t patterned.

  So it is with our thinking. We learn ways of processing information, and these become part of our routines. We blame ourselves to help avoid conflict with others; we anticipate negative outcomes to help us not become surprised when things go wrong. In individual situations, such modes of thinking may suit us well. As engrained habit patterns, however, they impose distortions upon the world. After all, not everything really is our fault. Not every event does go poorly.

  Our negative thought patterns are learned habits; the key to cognitive work is unlearning them and replacing them with more constructive ways of processing events.

  Once these modes of thinking become automatic, their accompanying feelings follow along. When we blame ourselves, we feel discouraged, diminished, and depressed. When we anticipate the worst, we feel anxious and uncertain. To the extent that we bring these schemas to trading, we no longer respond to markets objectively. We are like robots, responding with automatic thoughts and unwanted feelings.

  As Gurdjieff noted, it is important to become emotionally aware of this reality: At some point you’re deeply absorbed in trading, observing market patterns, and acting upon those. Then a shift occurs, and you are no longer in control of your thinking. It has become hijacked. An activated schema now sets off an avalanche of thoughts and feelings that may very well have nothing to do with the situation at hand. Suppose someone hijacked your computer as you were trading and suddenly switched the screen from your markets to some other, random ones? Suppose your mouse was taken out of your control and clicked on trades that you didn’t want?

  I guarantee, if that happened to you, you’d become very upset. You would not tolerate someone controlling your computer or your mouse. You would do everything in your power to regain control of your equipment. That has to become your attitude toward the hijacking of your mind. It’s not enough to simply observe automatic thoughts taking control; you need to feel the horror of literally losing control of your mind and behavior. Much of the motivation to change faulty schemas will come from the awareness of the pain they inflict in all aspects of your life.

  Automatic thoughts don’t just enter our mind; they take over. We change when we sustain the motivation to stay in control of our minds.

  We’ve seen that reviewing your self-talk via audio or video recording and tracking your most extreme emotions during trading can alert you to your stinkin’ thinkin’. Another powerful tool to help identify problematic schemas and thought patterns is to review your absolute worst trading decisions. Your worst trading decisions may or may not be your largest losing trades; they could be occasions in which you simply missed a golden opportunity. You’ll know your worst trading decisions by your reaction to them, “How could I have done that?” That reaction is a fantastic tell, indicating that you truly were not in your proper mindset when you made the poor decision. At some level, when you’re mystified how you could have been so mistaken or boneheaded, you are recognizing that your mind had been hijacked.

  Once you identify these worst trades—and this will require a review of your journal, as well as a look back on your recent trading experience—you then want to re-create the thoughts and feelings that led to the faulty decision-making. Normally we like to put such episodes behind us, with a simple reassurance that next tim
e we’ll trade with better discipline and preparation. But in this exercise, you want to perform a psychological autopsy and exhume your faulty decision-making process in all its gory detail. What were you thinking at the time? What were you feeling? What were you trying to avoid or accomplish with your trading decision?

  The common thoughts and feelings during these poor trading episodes will be your clue as to the schemas that were being activated at the time. Perhaps it was a safety schema: you were telling yourself that you could not afford to lose paper profits or to take a particular risk. Alternatively, it could have been a self-worth schema, as you told yourself how great it would be if this trade hit a home run. Your feelings during these trades—the fear, the overconfidence—will provide valuable clues as to the automatic thoughts that were generated.

  Our worst trades come from reacting to our automatic thoughts instead of markets themselves.

  In my own trading, a common schema that is activated is a variation of the safety theme: avoid danger. To be sure, this can be a useful mode at certain market junctures, helping a trader size positions appropriately and limit losses on trades. Where the schema introduces distorted perception, however, is in defining danger as any drop from an equity peak, not as an outright loss of capital. This makes it particularly difficult to stay in winning trades, because relatively small retracements will stimulate desires for profit taking. A more realistic perspective would define danger not only in terms of lost paper profits, but also in terms of lost opportunity. Some of my worst trades have been ones in which I acted on a short-term perspective and subsequently missed the longer-term market move. The need to avoid danger exposed me to the equal danger of cutting profits short.

  Notice that these worst trading episodes cut across patterns of thinking, feeling, and behaving. Once we start from the (faulty) premise, “You must avoid risk,” and once we define risk as any market movement against our positions, we shape our feelings and actions accordingly. Reviewing your worst trades may be painful, but it is also liberating. It tells you where your mind has gone astray, and that can lead you to corrective action.

  COACHING CUE

  Many of our worst trades come from the demands we place on ourselves. Keep tabs of the times you tell yourself that you need to, must, and have to participate in market moves or make money. When these demands become rigid absolutes, we end up chasing market moves, refusing to take small losses, and otherwise violating principles of good trading. When we are more focused on those internal demands than on our trading rules, that’s when we’re most likely to lose money. You’ll be able to identify those demands by the internal feeling of pressure that they generate. There’s a different feeling when you trade from opportunity versus trade from pressure. Track your worst trades and the feelings associated with them to alert you to the ways in which your automatic thoughts can sabotage your best trading.

  LESSON 54: USE A JOURNAL TO RESTRUCTURE OUR THINKING

  Review your past emotional episodes and trading mistakes as a helpful way to identify your mental maps and the ways in which they can distort your perception. The goal of cognitive work, however, is to be able to catch your automatic thoughts—those bouts of stinkin’ thinkin’—as they are occurring so that they cannot hijack your mind and your trading.

  In Enhancing Trader Performance, I outlined how a cognitive journal can be used to help traders restructure their thought processes. The journal format I suggested took the form of a single page for each trading day or week (depending on the frequency of your trading), with each page taking the form of a table. The left-hand column of the table describes the events that occurred at the time you experienced a trading problem. This column would include what was happening in the market, what you were planning, and how you entered—or didn’t enter—the market.

  The second column is an account of how you are talking to yourself about the problem. In the book, I took the traditional approach of using the second column to describe your beliefs about the events. What may be most helpful to your self-coaching, however, is to actually transcribe your thoughts about the events and capture what you’re thinking and feeling. This column should capture the ideas going through your head at the time as faithfully as possible, as in, “Why didn’t I take the trade when I had it? I should have been up money today and instead I’ve lost more than I should. I am so disgusted with myself. I don’t know if I even want to keep trading.”

  Many times, key phrases from your transcribed self-talk will alert you to the nature of the schemas being activated. For instance, in the example above, the word should is often a good sign that a perfectionist self-worth schema is playing itself out, leading to angry self-talk and a discouraged frame of mind. Once the musts and shoulds are triggered, they turn the trader’s attention away from markets and toward the issue of self-worth. Note that this is not happening in a constructive context; rather, the self-talk is critical and punitive. It is difficult to see how such thinking could move a trader forward.

  I like to think of these automatic thoughts from the second column as a kind of tape recorder in the brain that clicks on during particular situations (first column). Many times, the very same phrases and messages recur from situation to situation. This process becomes easy to observe when reviewing your cognitive journal: you see not only how negative the self-talk can be, but also how automatic and robotic it is.

  Pay particular attention to emotional words and phrases that recur in your self-talk: These words and phrases are shaped by our core schemas.

  The third column describes what happens as a result of the self-talk: the feelings you have and the actions you take. For instance, in the example above, those angry, perfectionist thoughts might lead you to quit for the day and sulk, missing opportunity and a chance to learn about current markets. Alternatively, the angry self-talk might lead to subsequent revenge trades that lose even more money. The third column chronicles all the consequences of the automatic thinking, both personal and monetary.

  Over time, a review of this third column will cement for you the absolute toll taken by the distortions in your thinking. When you are your own trading coach, it’s necessary to sustain your motivation for change. Seeing that your thinking is both tape recorder-like in its mechanicalness and sabotaging in its consequences will sear into your mind that change is not optional . Reading entries from day after day after day that highlight the same thoughts, the same behaviors, and the same losses and lost opportunities focuses not only the mind, but also the motivation for change.

  The most common mistake traders make in keeping such a journal is that they are not sufficiently specific in their entries and thus miss crucial details and understanding. Below is a sample of a journal that lacks detail and fails to help the trader understand the specific thought patterns and consequences that appear across various trading situations:

  Now let’s take a look at the same cognitive journal, but with detailed entries.

  Note how the added detail makes it clear what is going on in the trader’s mind. The elaboration of the trader’s self-talk also clarifies the links among the events, as one trading mistake led to another, with one schema (self-worth) first triggering overconfident thoughts and feelings, then frustrated ones, then ones of defeat and failure. We can also see how the trader’s home life is connected to the thoughts and feelings affecting trading decisions, as the trader is feeling a need to prove himself to his spouse as well as to himself.

  When you are your own trading coach, you want to look between the journal entries as well as within each of them. That will often illustrate the links among your thoughts, as events trigger distortions in processing, which bring further events, and still additional distortions. Your assignment is to capture the flow of your thoughts and the connections of these to your feelings and actions. Only once you clearly see how the mental dominoes fall can you interrupt the process by turning your mind in a different direction.

  COACHING CUE

  What are the schemas
and thoughts that accompany your best trades? Extending your journal to include how you think when you’re trading very well helps you take a solution-focused approach to cognitive work. The last lesson in this chapter may provide some ideas along this line. Also keep an eye out for the hope schema, in which trades that are losing money trigger automatic thoughts of hope for a return to breakeven. Those thoughts often lead to violation of stoploss rules and trigger subsequent schemas of regret and self-blame. There’s a role for intuition in trading, but beware situations in which you are into wishin’. Those are usually excellent points to get flat and regain perspective. When you are your own observer, your negative thoughts can themselves become reliable trading indicators.

  LESSON 55: DISRUPT NEGATIVE THOUGHT PATTERNS

  How do you break a habit pattern? When we have a smoking habit, or when we find ourselves eating out of habit, one of the first steps toward change is simply catching ourselves in the act of repeating our unwanted actions. By disrupting a habit pattern, we gradually make it less automatic, less capable of controlling us.

  So it is with our habitual thought patterns. When we interrupt and disrupt these patterns, they become less automatic. We gain a measure of control over them; they no longer take control from us.

  The most basic technique to disrupt negative thought patterns is thought-stopping. Thought-stopping is exactly what it suggests: a conscious effort to stop a train of thinking while it is occurring. When you have used cognitive journals and reviews of your trading to clearly identify your pattern of automatic thoughts, you become increasingly sensitive to their recurrence. This enables you to recognize their appearance in real time. By giving yourself the command to Stop!, you disrupt the automatic nature of the thinking. This gives you time to calm down, change the focus of your attention, and engage in other useful cognitive exercises.