• Waiting for pullbacks in a trend before entering a position.
• Establishing my target price at the outset of the trade, so that I can enter the trade with a profit potential that exceeds the loss I’m willing to take.
• Sizing my trade so that I’m risking a fixed, small percentage of my portfolio value on the idea.
• Adding to longer-term trades on pullbacks after they have gone my way and remain profitable.
• Exiting trades on my planned stop-loss points or at my designated profit target.
Trading rules will differ for each trader depending on their markets and trading style. The important thing is to know what you do when you are most successful, so that you can cement these positive patterns, even as you expose yourself to challenging trading conditions.
LESSON 70: A BEHAVIORAL FRAMEWORK FOR DEALING WITH WORRY
We hear a great deal about fear and greed, and all of us have experienced bouts of overconfidence and frustration. On a day-in and day-out basis, however, few problems are as thorny for traders as worry.
Worry occurs when we anticipate an adverse outcome and its consequences. We can worry about missing an opportunity or about being wrong in a trade. We can worry about the future of our trading career or, sometimes, worries from personal life outside of trading can affect decision-making. It is common, for instance, for young traders to experience more stress after they have married, had children, or purchased a new home. With the added financial responsibilities come worries.
Worry is problematic for traders for several reasons:• It undercuts confidence. It is difficult to maintain optimism and focus on progress while anticipating negative outcomes.
• It interferes with concentration. Thought and emotion directed toward worries are taken away from tracking market patterns.
• It leads to impulsive decisions. For most people, worry is so noxious that they will take action to reduce their concerns. Such action is not necessarily in the best interest of one’s trading account.
• It is not productive. Rarely does worry lead to concrete, constructive problem solving. Worrying about negative outcomes does not generally help people achieve positive ones.
It is difficult to make sense of worry from a behavioral vantage point. No one truly enjoys worry, so it is unclear why the behavior persists. This is especially puzzling for chronic worriers. They do not enjoy focusing on negative things and typically are not happy people. So what keeps them worrying?
Visualizing worst-case scenarios and how you would handle them is constructive; worry reinforces a sense of hopelessness and helplessness in the face of those scenarios.
To make sense of worry, let’s review the difference between thinking about a negative event and actually experiencing that event. I can think about losing money in my trading and the thought does not bring particular anxiety or concern. If, however, I vividly imagine a particular trade that I am planning and visualize myself taking a loss on a large position, I can generate palpable experiences of nervousness. Abstract thought rarely generates strong emotion. Imagery, on the other hand, acts as a surrogate for reality. Think about sexuality and nothing happens; imagine an erotically charged scene and the body responds.
From a behavioral vantage point, worry is a form of thinking and, as such, it can function as a negative reinforcer. Let’s say that I anticipate a stressful meeting with the risk manager at my trading firm. My underlying fear is that he will reduce my capital and express a loss of confidence in me. Rather than experience the hurt and resentment that such a meeting would engender, I worry about making the meeting on time, what I’ll say in the meeting, what I might miss in the markets while the meeting is going on, etc. None of these worries has the power to evoke strong emotion. Rather, the worries serve as distractions from the difficult feelings I would experience if I actually visualized outcomes of the meeting. If I avoid experiencing these feelings, worry serves as a negative reinforcer. Strange as it might seem, worry is not so noxious when the alternative is facing scary outcomes.
Worry can possess reinforcement value in other ways, as well. If I were feeling out of control in my trading, that feeling would be unpleasant to dwell upon. If I worry about details in the work I’m going to have done on my house, I shift my focus to something more controllable. While it may seem that I worry about negative outcomes—and, in the example, I am—the psychological reality is that I substitute a lesser concern for a greater one when I worry. What we worry about is usually not what is scariest to us. Indeed, it is a diversion from the scariest scenario—and therein lies its reinforcement value.
Worries about small things usually mask larger concerns.
Exposure work can be a great antidote to worry. When we expose ourselves to our greatest concerns—our worst-case scenarios—we can plan for these possibilities and mentally rehearse positive coping. If, for instance, I’m threatened by an upcoming meeting with the risk manager at my firm, I’ll look at the worst case outcome—a large cut in my capital—and figure out a trading plan that will focus on my most successful trading and bring me back to my prior portfolio size. Once I anticipate the worst and figure out how I’d deal with it, I take the catastrophe out of the situation. That eliminates the need for worry-based diversions. Worry thinking can’t be a negative reinforcer if it is more noxious than the alternative of facing possible outcomes constructively.
A great way to coach yourself past worry is to make note whenever you catch yourself worrying and ask, “What am I really fearful of? What’s the real issue here?” What you generally find is that there’s an unresolved situation looming in the background. Until the situation is faced squarely, it intrudes in your work and affects your mood. Suppose you find yourself worrying about whether a specific trade will work out. When you stop and reflect, you realize that you’ve sized the trade and placed your stop-loss point in such a way as to make such worry unnecessary. So what is the real concern? Perhaps the fear is of one’s future as a trader. Perhaps it’s a conflict at home. Whatever the real problem is, you want to visualize the situation vividly and walk yourself through your most constructive response. Then visualize the situation and solution again—and again. With repetition, the worst-case scenario will become routine. It will no longer evoke strong emotion. And that will leave you with little reason for worry.
COACHING CUE
Worry can be a great signal that we are harboring larger concerns about our basic trade ideas. When I find myself glued to the screen, following the market tick by tick during a longer-term trade, I know that something is wrong. Beneath the worries about the market’s moment-to-moment action, I have deeper concerns—perhaps that my basic idea is wrong all along. This can be a useful signal: when we’re comfortable with trades, we don’t need to worry over every tick in the market. And when we are worrying about those ticks, it’s a good sign that we’re not comfortable with our position—and that can lead to constructive reevaluation and planning.
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 7: http://becomeyourowntradingcoach.blogspot.com/2008/08/daily-trading-coach-chapter-seven-links.html
Chapter 9 of Enhancing Trader Performance details several strategies for changing behaviors that interfere with trading decisions, including a step-by-step description of exposure-based methods. See also Chapter 8 of that book for cognitive and cognitive-behavioral techniques.
A detailed account of behavioral approaches to change can be found in the chapter “Brief Behavior Therapy” by Hembree, Roth, Bux, and Foa in The Art and Science of Brief Psychotherapies, edited by Dewan, Steenbarger, and Greenberg (American Psychiatric Publishing, 2004).
Articles relevant to behavioral views of trading can be found among my collected articles, including the articles on “Behavioral Patterns That Sabotage Traders” and “Techniques for Ove
rcoming Performance Anxiety in Trading”: www.brettsteenbarger.com/articles.htm
Articles on emotional intelligence, staying in the zone, and balancing trading with the rest of life can be found in Psychology of Trading, edited by Laura Sether (W&A Publishing, 2007).
CHAPTER 8
Coaching Your
Trading Business
He is not great who is not greatly good.
—William Shakespeare
In the previous chapters, we have explored ways of coaching yourself by becoming your own trading psychologist. Now we will turn to another facet of self-coaching: guiding your trading business. You, as a trader, are a business person no less than someone who offers goods and services to the public. You have overhead to cover, and you have returns you need to make to stay in business. Like any business owner, you risk your time, effort, and capital to earn returns higher than you could obtain from other activities. But are you getting the best return for your efforts? Are you taking the right amount of risk at the right times? Are you devoting the majority of your efforts to the activities that will provide the best returns? When you are your own business coach, you focus both on doing the right things and upon doing things right. There’s much you can do as your own psychologist. Now let’s see how you can thrive as your own business consultant . . .
LESSON 71: THE IMPORTANCE OF STARTUP CAPITAL
If you consistently break even in your trading, you will eventually lose all your capital. This is because there are costs embedded within trading, such as commissions and fees for data services, software, and computer support. It is no different in any business: an entrepreneur has to at least make enough to cover the overhead to stay afloat.
Many businesses fail because they lack adequate startup capital and cannot keep their overhead under tight control. They don’t realize how long it will take to build a large and loyal customer base. As a result, they burn through their cash before they can sustain breakeven operations. To preserve capital, they cut back on essentials such as marketing and advertising. This creates a death spiral of fewer customers, lower income, and further belt-tightening.
Adequate startup capital enables the entrepreneur to make a beginner’s mistakes and address the holes in his business plan before going out of business. Business plans are like battle plans in times of war: they are indispensable, but also subject to frequent change. Without sufficient resources, businesses cannot weather those changes.
Much of the stress that new traders experience is the result of an inadequate capital base: they are trying to do too much with too little.
So it is with traders. When they begin their business with modest capital, they cannot survive their learning curves when markets change and inevitable slumps take hold. Like failing businesses, they then begin to cut back on essential overhead, such as needed data and redundant systems. With little more to trade with than the same charts that everyone else looks at, the undercapitalized trader in overhead reduction mode virtually ensures that she will never maintain a distinctive edge.
So how much startup capital is sufficient for a trader? If you are just learning about markets, very little capital is needed to advance your learning curve. I began trading in late 1977 with a $2,500 stock market account at a regional brokerage in Kansas City. That enabled me to trade 100-share lots of individual stocks and test out my ideas without undue risk. Now, with the advent of simulation platforms, as discussed in the Enhancing Trader Performance book, it is possible to realistically test strategies and gain a feel for markets without placing money at risk.
Some commentators downplay the value of paper trading and simulation-based trading with live data because the psychological pressures of losing real money (and the overconfidence that comes with winning) are not present. This, however, is precisely why simulated trading is perfect for traders early in their development. Simulation enables the beginner to simply focus on the mechanics of trading and the recognition of trading patterns without having to worry about losing startup capital. After all, if traders can’t succeed in simulated trading, there’s no way they’ll succeed when those psychological pressures are added to the mix!
What makes sense, therefore, is to require yourself to earn consistent money in practice trading before you assume modest risk with 100 shares (or one lot of a futures contract). You thus need to sustain success with that small size before you trade larger. Just as a business should sustain success with one store before opening other outlets, a trader should have to earn his way toward trading size. If beginning traders stick to this one self-coaching rule, many could stay in the game long enough to become experienced traders.
A great business rule: Make yourself earn increases in trading size/risk by trading well and consistently with smaller size/risk.
When the aim is trading for a living, far more startup capital is required. At the money management firms I currently work with, for example, a portfolio manager is quite a star if she can sustain 30 percent returns year after year without taking undue risk. That portfolio manager will inevitably be given more capital to manage and, if success follows, may even strike out on her own with her own fund. In truth, a consistent 15 percent annual return, achieved with modest risk, will keep a portfolio manager well employed at most firms. True, any particular trader may achieve outsized returns in a given year, especially if taking large risk. The question, however, is: What kinds of average returns are sustainable over time?
A developing trader who expects to outperform seasoned money managers year after year substitutes fantasies for business plans. But if consistent 30 percent returns after expenses are stellar, how much trading capital would be required to sustain a living—and to keep the trading account growing at the same time? It’s not difficult to see that an account well into the six figures would be a minimum startup for a trader that wanted a good living from his work.
Not many traders early in their careers have access to that kind of liquid capital. As a result, they start with much less capital and try to trade it aggressively to generate returns large enough to support a household. For a while, that might work out. Eventually, however, such traders sustain grievous losses that cannot be surmounted. After all, once you lose 50 percent of your capital, you have to double your remaining money just to get back to where you were. An undercapitalized trader, like an undercapitalized business, can’t weather many adverse events—especially if taking large and frequent risks.
Long before you seek to trade for a living, you should work at trading competence: just breaking even after costs.
When you are your own trading coach, you’re also the manager and entrepreneur of your own trading business. That means that you have to start with a viable plan for success. Among other things, that plan should address:1. How you’ll learn markets and obtain trading competencies.
2. How you’ll capitalize your business so that you can make a good income from realistic, solid risk-adjusted returns.
If you cannot raise the capital needed to make a living from realistically good returns, then your challenge is to make yourself attractive to trading firms that can front you sufficient trading capital. Take the steps needed to become attractive to such a firm and make that part of your business plan; this will form the basis for the next lesson. For now, your assignment is simply to learn markets before you put significant capital at risk, establish success over a range of market conditions and cycles, and ensure adequate access to capital before you give up your day job. Stress test the startup plan for your trading business: calculate how you would get by if returns were modest for the first couple of years. Run your plan by seasoned traders who make their living from markets; find the weak spots and address them. As the old saying goes, failing to plan is tantamount to planning to fail.
COACHING CUE
One of the smartest business decisions I made in my trading was to begin with an account small enough that it would not impact my family’s lifestyle if I lost every penny. Early in my development, I had
no illusions of trading for a living; my goal was to simply get better. A major milestone in my development came when I could consistently keep losing trades smaller than winners. Early in my trading efforts, it was a few large losers that impaired my overall performance. Had I been trading with money needed for my family’s well-being, the stress of making rookie mistakes would have been overwhelming. Margie referred to my trading account as play money; she never counted on it or the income from it in our financial planning. Without the pressure of profitability demands early in my development, I was free to make mistakes and learn from them. A sure way to maximize stress and lower your odds of success is to put your capital at risk before you have cultivated your skills.
LESSON 72: PLAN YOUR TRADING BUSINESS
When you’re your own trading coach, you are also the manager of your trading business. What is your business plan for success? How are you going to achieve your goals as a trader?
The first step toward good planning is to know why you are trading. That sounds silly: doesn’t everyone trade to make money? Yes and no; I’m continually surprised at traders’ fuzziness about their goals. If you’re a beginner, your goal is simply to learn the ropes, internalize market patterns, and practice skills related to good execution and risk management. If so, as the previous lesson emphasized, you can accomplish those ends with little or no capital at risk. What you need is a learning plan and a platform from which you can observe markets and trade them in simulation mode. (The elements of learning plans are covered in Enhancing Trader Performance and will be addressed in later lessons in this chapter).
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