The Daily Trading Coach

by Brett N Steenbarger

  Your assignment is to identify the ways of thinking that put you into your best trades and that enable you to manage risk most effectively. Once you identify how you think at your best, you have a model that you can replicate day after day in your trading, turning virtues into positive habits. You don’t have to be mired in cognitive distortions to benefit from a cognitive journal. Use the journal as a discovery tool for your best practices. It’s an exercise even the most experienced, successful traders can benefit from.

  COACHING CUE

  A trader I worked with used the phrase make them pay (and other, choice colorful phrases) when he saw that the longs or shorts were overextended in a market. He would not exit until he saw evidence of high-volume puking from the traders running from cover. The idea of make them pay engaged his competitive instinct and kept him in winning trades. Frequently, he would add to his position on retracements, eager to make them pay even more. You may find that you use similar phrases during your best trades. Cement those phrases into cognitive patterns that you can rehearse. The phrases keep you grounded in best practices.

  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 coaching processes at the home page on the blog for Chapter 6: http://becomeyourowntradingcoach.blogspot.com/2008/08/daily-trading-coach-chapter-six-links.html

  More material on cognitive approaches to change can be found in my chapter on “Cognitive Techniques for Enhancing Performance” in Enhancing Trader Performance. See also the chapter on “Cognitive Therapy: Introduction to Theory and Practice” by Judith S. Beck and Peter J. Bieling in The Art and Science of Brief Psychotherapies (American Psychiatric Press, 2004). Of additional interest might be the article “Remapping the Mind” from the articles section of my personal site: www.brettsteenbarger.com/articles.htm

  I like books that interview successful traders and portfolio managers; these books provide positive models for how to view markets and trading decisions. Among the most popular are the Market Wizards books by Jack Schwager; Inside the House of Money by Steven Drobny (Wiley, 2006), and Hedge Hunters by Katherine Burton (Bloomberg, 2007). Other models can be found in the writings of the contributors to Chapter 9: http://becomeyourowntradingcoach.blogspot.com/2008/08/contributors-to-daily-trading-coach.html. See also the Daily Speculations site (www.dailyspeculations.com) for interesting ways to think about markets and trading.

  CHAPTER 7

  Learning New

  Action Patterns

  Behavioral Approaches to

  Self-Coaching

  Without self-knowledge, without understanding the working and functions of his machine, man cannot be free, he cannot govern himself and he will always remain a slave.

  —G.I. Gurdjieff

  Behavioral methods in psychology are the outgrowth of early research into animal learning, emphasizing the roles of conditioning and reinforcement in the unlearning and learning of action tendencies. Modern cognitive-behavioral approaches to change treat thinking as a kind of behavior, making use of such methods as imagery and self-statements to modify our reactions to situations. Like the cognitive restructuring framework from Chapter 6, behavioral methods make extensive use of homework assignments in fostering change. The focus is on here-and-now skills-building, not explorations of past conflicts and their repetition in present-day relationships. Behavioral methods have been especially powerful in addressing anxiety problems, as well as issues of anger and frustration. In this chapter, we’ll explore behavioral techniques that you can master as part of your own self-coaching. You’ll find these techniques particularly relevant to help you deal with performance pressures and impulsive behavior.

  Because the essence of the behavioral approach is skills-building, you will benefit from these methods to the degree that you are a diligent student. Frequent practice of the techniques and application of skills to new situations is crucial in making the behavioral efforts stick. Pay particular attention to the exposure methods discussed later in the chapter and also summarized in Enhancing Trader Performance. Pound for pound, so to speak, I find these the most useful methods in the coaching arsenal. Let’s take a look at how you can master these methods for yourself . . .

  LESSON 61: UNDERSTAND YOUR CONTINGENCIES

  The essence of behavioral psychology is that we share many of the learning mechanisms found in the animal world. My cats Gina and Ginger, for instance, have learned that, when I get up at 5 A.M., I will give them some moist food for their breakfast. As soon as they hear me walking about, they come from wherever they’ve been sleeping and hustle into the kitchen, looking up at me with expectation. Because of repetition, they have learned to associate my walking around after a period of quiet with being fed. This is the essence of stimulus-response learning: animals learn to associate response patterns to stimulus situations. The contingencies between situation and response are reinforced over time, strengthening the learned pattern.

  Much of our behavior consists of simple responses to particular situations.

  In traditional behaviorism, it is not necessary to explain these learned connections with reference to the mental states of the learners. The cats don’t explicitly reason that it must be morning and I am rising for the day, so they should go to the kitchen. Nor does reason enter their decision to come to the portion of the house where we keep the moist food rather than the dry. Rather, the stimulus of hearing me awaken triggers their anticipation, much as hearing a particular old song may trigger associated memories. In the cognitive restructuring approach to coaching, we look to remap the mind and shift the explicit thinking of traders. In the behavioral mode, the goal is to unlearn associative connections that bring negative outcomes and acquire new connections that will be more adaptive.

  In behavioral psychology, unlearning is the flip side of learning: if we don’t reinforce a particular contingency over time, the associative links are weakened, and the response patterns eventually die out. If I were to ring a bell each evening and feed the cats but then not feed them in the morning, eventually they would stop coming to the kitchen in the morning. Instead, they would learn to come running at the sound of the bell. You build a behavior pattern by reinforcing it; you divest yourself of the pattern by removing reinforcement.

  Many negative behavior patterns in trading, from this perspective, occur because they are either positively reinforced or negatively reinforced. This distinction is important and not well appreciated. Positive reinforcement is like the feeding of the cats: people come to associate something favorable with a particular stimulus situation. Thus, for example, I may associate my early-morning market preparation with a particular emotional state of readiness and mastery. That linkage has me looking forward to the preparation time and sticking with my routines. The contingencies between being prepared and feeling good (or being prepared and making good trades) are reinforced over time until they become ingrained habits.

  Negative reinforcement is a bit subtler, and it lies at the heart of why traders seem to cling to patterns that bring them losses. In negative reinforcement, it is the removal of a negative set of consequences, not the appearance of something positive, that strengthens the bond between stimulus situation and response. Let’s say I am in a trade that is going against me and I bail out of the trade at the worst possible time, when everyone else is selling. Intellectually I may know that, on average, this is an inopportune time to join the crowd, but the trade is so painful at that point that the exit feels, for the moment, like a relief. Drug addicts commonly begin their habits first by seeking a high (positive reinforcement), then by seeking to avoid withdrawal (negative reinforcement). The avoidance of pain is a powerful human reinforcement, and it shapes learned action patterns just as effectively as the introduction of pleasure.

  Many destructive trading behaviors are the result of pain-avoidance.

  One of the most devastating examples of learned behavior patterns in tra
ding is the association of thrills and excitement with the assumption of risk. When traders take too much risk, they experience profits and losses that are very large relative to their portfolio size. Some traders may find these swings stimulating, to the point where they become their own reinforcements. These traders find themselves trading, not for profits, but for thrills. Inevitably, the law of averages catches up to such traders. When these traders go through a series of losing trades, days, or weeks, their high leverage works against them and they blow up. This is not because thrill-seeking traders are inherently self-destructive. Rather, it is because they have learned, through repeated emotional experience, the linkage between risk-taking and excitement.

  Research suggests that contingencies between situations and responses are more quickly and deeply learned if they are accompanied by strong emotion. This process is how people can become addicted to powerful drugs after only a few uses. It is also how we can become fearful and paralyzed by a single traumatic incident. An animal that would take weeks to learn a new trick can learn to avoid tainted food after getting sick on it just once. Emotion accelerates behavioral learning. This is the source of many trading problems, and it also opens the door to powerful behavioral coaching methods.

  As your own trading coach, it is important that you understand your own contingencies: the linkages between your expectations and your behaviors. Instead of thinking of your trading problems as irrational, think of them as learned patterns that are supported by something positive that you gain or something negative that you avoid. Something is reinforcing your worst trading behaviors: once you understand that contingency, you are well-positioned to remove the reinforcement and introduce new reinforcers of desired trading patterns.

  Behavioral coaching is about reinforcing the right behaviors and removing reinforcement from the wrong ones.

  To get started, think back to your most recent episode of truly bad trading. I can recall, for instance, a recent incident in which I so convinced myself of a turnaround in a falling market that I held a position well beyond the original stop-loss point. What is the reinforcement in that situation? In my case, I had been on a nice winning streak and I didn’t want that to end. I associated getting out of the trade with breaking my streak; as long as I was in the trade, I could retain hope that my streak would be intact.

  That reasoning makes no sense of course and, if pursued to its logical conclusion, I could have given back every ounce of profit I made during the streak just by holding the one bad trade. But the emotional connection was strong: I was attached to the winning—so much so that its pull was greater than the pull of simply trading well.

  So take a look at your most recent episode of horrific trading. What gain were you associating with the bad trading? What negatives were you looking to avoid? What was the contingency at work? As previous lessons have emphasized, the first step in the change process is to become our own observers and recognize the patterns that hold us back. Your behaviors, as irrational and destructive as they seem, are there for a reason. A careful behavioral analysis will reveal the reasons—and will position you well for changing those.

  COACHING CUE

  Identify the emotions that are most painful for you and then track their occurrence during your trading. For some traders, this will be the pain of losing. Other traders respond negatively to boredom or to the helplessness of uncertainty. Many times your worst trading decisions will be the result of trying to rid yourself of those emotions. This negative reinforcement leads to hasty, unplanned trading behaviors that seem to make no sense in retrospect. If you can identify the negative reinforcement at work, you can more consciously and constructively deal with the difficult feelings.

  LESSON 62: IDENTIFY SUBTLE CONTINGENCIES

  The linkages between situations and our behavioral responses to those linkages are sometimes quite clear. When traders experience fear in a volatile market and prematurely exit a position, we can readily appreciate that they are managing their emotions, not their capital. The relief at being out of a fast market outweighs objective considerations of risk and reward.

  Other times, the contingencies that govern our behavior are far more subtle and difficult to identify. For that reason, such patterns can be extremely challenging to change. If we don’t know what we’re responding to, it’s difficult to shape a different response pattern.

  Subtle shifts of mood are one example of stimulus situations that could affect decision-making without our awareness. For instance, some individuals are emotionally reactive to the amount of sunlight they receive and can experience winter blues or even seasonal affective problems during periods of low sunlight. This disruption can affect a trader’s concentration and motivation, interfering with his research and preparation. Similarly, family conflicts can affect mood, which in turn affects trading. One trader I worked with found himself less patient with his ideas, entering and exiting before his signals unfolded. When we looked into the problem, it was clearly episodic—not something that occurred every day. During periods of conflict at home, he was more irritated, and that manifested itself as impatience in his trading.

  The problem patterns in our trading are often triggered by subtle shifts in mood and energy level.

  Many physical cues can also affect mood and cognitive functioning. These cues include fatigue, hunger, muscle tension, and fitness. I know that I process market data much more effectively and efficiently when I am alert. Anything that affects my energy level adversely will also impair my ability to synthesize large amounts of market information. This is not only because I am less cognitively efficient, but because lack of alertness also affects my mood. In a more fatigued state, I tend to feel less emotionally energetic and optimistic. I won’t look for that creative market idea; I’ll become more discouraged and risk-averse after losses. If I’m not clued into my physical state and its relationship to my mood, I’ll simply think that these periods of lesser performance are random. In fact, most mind and body shifts are as stimulus-response bound as any animal behavior in a learning experiment.

  As I emphasized in The Psychology of Trading, a great deal of our learning is state-based: what we know in one state of mind and body can be quite different from what we process in another state. When I am listening to favorite music, my mind is expansive, I can see broad market relationships, and formulate big picture ideas to guide the week’s trade. In a state when I’m pressured for time or distracted by an irritating situation, I suffer from tunnel vision, losing the large perspective. On those occasions, I’m much more likely to make impulsive trades, responding to recent price action rather than broad market dynamics. Often those trades lack good risk/reward qualities; they are much more likely to be losers than winners.

  I refer to these subtle environmental cues as triggers, because they can set off behaviors that are unplanned and unwanted. When I’m irritated, for instance, I’ve learned to rid myself of the feeling by simply pushing aside whatever is bothering me. This reaction is a classic example of negative reinforcement. If the thought of doing errands irritates me because I have other things I want to be doing, I quickly push the errands away and focus on what I want to do. The errands don’t get done, of course, and loom as a chronic irritant. My pattern of procrastination is clearly negative reinforcement-based, but it is not helpful: it leaves me with a lingering negative mood and a backlog of unfinished business. Worse still, continually reinforced, the negative mood can become a pattern in my trading. It’s not too great a leap from procrastinating over errands to procrastinating about acting on a losing position.

  Many of the behavioral patterns that interfere with our day-to-day lives also find expression in our trading.

  Sometimes, when coaching yourself, you won’t know what is triggering your most troubling trading behaviors. They seem to come out of nowhere. That’s when it’s most important to use a trading journal to catalog all the possible factors—physical, situational, emotional, relationship-based, trading-based—that might be as
sociated with your problematic trading. When you engage in this cataloging, you want as open a mind as possible; often, the patterns will be different from ones that you’ve been considering. One trader I worked with experienced trading problems for no apparent reason; only after considerable review did we figure out that these problems occurred when he experienced problems with the firm’s management. The frustration led him to seek gratification from his trading, impelling him to overtrade. He didn’t make a conscious connection between the two; rather, he was trading to manage an emotional state in a simple stimulus /response manner.

  The cataloging you undertake in your journal may need to cover a considerable period of time before you notice patterns. What you’re likely to find, however, is that how you trade is affected by your physical and emotional state—which is affected by situational factors at home and work. Understanding these contingencies enables you to build some firewalls into your trading practice, as we will see in the next several lessons. Without such understanding, however, you’re likely to blindly repeat history, losing a measure of self-determination. It’s when we create our own contingencies that we truly possess free will and the ability to pursue our chosen goals.