Tuesday, April 18, 2006

Ten Lessons I Have Learned From Traders

Ten Lessons I Have Learned From Traders

Brett N. Steenbarger, Ph.D.

Note: This article is taken from the reading for my free Web lecture on 4/20 for Woodie's CCI Club. The lecture is scheduled for 4 PM CT.

1) Trading affects psychology as much as psychology affects trading – This was really the motivating factor behind my writing the new book. Many traders experience stress and frustration because they are trading poorly and lack a true edge in the marketplace. Working on your emotions will be of limited help if you are putting your money at risk and don’t truly have an edge.

2) Emotional disruption is present even among the most successful traders – A trading method that produces 60% winners will experience four consecutive losses 2-3% of the time and as much time in flat performance as in an uptrending P/L curve. Strings of events (including losers) occur more often by chance than traders are prepared for.

3) Winning disrupts the trader’s emotions as much as losing – We are disrupted when we experience events outside our expectation. The method that is 60% accurate will experience four consecutive winners about 13% of the time. Traders are just as susceptible to overconfidence during profitable runs as underconfidence during strings of losers.

4) Size kills – The surest path toward emotional damage is to trade size that is too large for one’s portfolio. We experience P/L in relation to our portfolio value. When we trade too large, we create exaggerated swings of winning and losing, which in turn create exaggerated emotional swings.

5) Training is the path to expertise – Think of every performance field out there—sports, music, chess, acting—and you will find that practice builds skills. Trading, in some ways, is harder than other performance fields because there are no college teams or minor leagues for development. From day one, we’re up against the pros. Without training and practice, we will lack the skills to survive such competition.

6) Successful traders possess rich mental maps - All successful trading boils down to pattern recognition and the development of mental maps that help us translate our perceptions of patterns into concrete trading behaviors. Without such mental maps, traders become lost in complexity.

7) Markets change – Patterns of volatility and trending are always shifting, and they change across multiple time frames. Because of this, no single trading method will be successful across the board for a given market. The successful trader not only masters markets, but masters the changes in those markets.

8) Even the best traders have periods of drawdown – As markets change, the best traders go through a process of relearning. The ones who succeed are the ones who save their money during the good times so that they can financially survive the lean periods.

9) The market you’re in counts as much toward performance as your trading method – Some markets are more volatile and trendy than others; some have more distinct patterns than others. Finding the right fit between trader, trading method, and market is key.

10) Execution and trade management count – A surprising degree of long-term trading success comes from getting good prices on entry and exit. The single best predictor of trading failure is when the average P/L of losing trades exceeds the average P/L of winners.


John Wheatcroft said...

Doc, I'm copying these and will refer to them often. They make a tremendous amount of common and not-so-common sense. Thanks.

Still learning, still learning.

Brett Steenbarger, Ph.D. said...

Thanks; I appreciate that. I've been trading since the late 1970s and I'm also still learning, still learning.


TraderEyal said...

Yes, excellent article. Thanks!

Brett Steenbarger, Ph.D. said...

Thank you, TraderEyal. I've enjoyed your blog, as well. Readers might be interested in TraderEyal's recent interview on the StockTickr site. I'll link that on my personal site tomorrow.


Trader Lar said...

Now I know why I never made any money day trading for a year.

Brett Steenbarger, Ph.D. said...

Yes, daytrading is difficult because the hidden costs of trading add up, especially for the retail trader who is paying $5-$10 per transaction. That doesn't sound like much, but at two trades a day and 250 trading sessions a year, it's between $5 and $10 thousand--or 5-10% of a $100,000 portfolio. Then add the friction of buying offers and selling bids, losing a tick with each transaction as a result of not operating on the inside market, and it's easy to see how a trader could wipe out in seven months. Which, I am told, *is* the average time it takes daytraders to wipe out their accounts (which are usually woefully smaller than $100 K to start). Very difficult business.


eyttan said...

well... daytrading the emini futures is different, commissions are low (less then $5 round trip). and also by daytrading it is not open a position at the morning and closing at the end of the day... you are missing the point here...
i trade the emini nasdaq 100 for four years.. average of 4 trades a day, very profitable. it's not easy but definitely not a losing endeavor.

Brett Steenbarger, Ph.D. said...

Hello Eyttan,

Thanks for your note and perspective. I did not mean to imply that trading success is impossible. That's clearly not so, as I've worked with intraday traders who have earned more than a million dollars a year for multiple years. Many of these traders trade 50-100 times a day and overcome the hurdles associated with slippage and commissions--quite a feat, which inspired me to write my new book.

That having been said, these successful traders are the distinct exception in the trading world. I have been informed by reliable contacts in the brokerage world that the average daytrader runs through his/her entire trading stake in 6-7 months. The proportion of daytraders (or any traders for that matter) who can sustain a reasonable living from their craft is, in my experience, no different than the proportion of golfers who can make their living at the sport (or actors making their living on the stage).

My goal, especially with my new book, is to try to improve those odds of success for traders at least a bit. It is always a joy to encounter skilled traders who have sustained success, and I heartily congratulate you for yours.


MarketProfessor said...

Dr Brett,

I consider myself as a student of you even though not interacted personally. I've discovered your website though Victor Niederhoffer's book and website. Since then I've benefited tremendously in my outlook and intutive understanding of the markets. Many of the discussions made by you have improved my resilience in the markets and me a confident trader.

I entirely agree and experienced first hand the effect of brokerage in day trading. The friction is so high you get tremendously disappointed.I would like to know any specific strategies to minimise frictional costs of trading.As I am living in India I am requesting my brither in US to bring your two books. Your website along with dailyspeculations is a constant companion for almost four years guiding in market up and downs.


G Dhananjhay