Monday, June 26, 2006

Why Your Trading Isn't Working Out

A good physician knows that, before cure comes a diagnosis. You cannot treat a problem before you identify what that problem is.

All too often, traders assume that their performance problems are due to a single cause: trading the wrong chart pattern or indicator, having the wrong mindset, etc. As a result, they seek out one trading guru or coach after another, only to see their P/L head steadily south.

The reality is that there are quite a few reasons why trading might be unprofitable. Figuring out which might apply to you is the first step is getting the right help.

Here's a fourfold scheme that I have found helpful in conceptualizing trading problems:

1) Problems of training and experience - Many traders put their money at risk well before they have developed their own trading styles based on the identification of an objective edge in the marketplace. They are not emotionally prepared to handle risk and reward, and they are not sufficiently steeped in markets to separate randomness from meaningful market patterns. They are like beginning golfers who decide to enter a competitive tournament. Their frustrations are the result of lack of preparation and experience. The answer to these problems is to develop a training program that helps you develop confidence and competence in identifying meaningful market patterns and acting upon those. Online trading rooms, where you can observe experienced traders apply their skills, are helpful for this purpose.

2) Problems of changing markets - When traders have had consistent success, but suddenly lose money with consistency, a reasonable hypothesis is that markets have changed and what once was an edge no longer is profitable. This happened to many momentum traders after the late 1990s bull market, and it also has been the case for many scalpers after volatility came out of the stock indices. Here the challenge is to remake one's trading, either by retaining the core strategy and seeking other markets with opportunity or by finding new strategies for one's market. The answer to these problems is to reduce your trading size and re-enter a learning curve to become acquainted with new markets and methods. Figuring out how you learned the markets initially will help you identify steps you need to take to relearn new patterns.

3) Situational emotional problems - These are emotional stresses that are recent in origin and that interfere with decision making and performance. Some of these stresses might pertain to trading, such as frustration after a slump or loss. Some might stem from one's personal life, as in a relationship breakup or increased financial pressures due to a new home or child. Very often these problems create performance anxieties by putting the making of money ahead of the placing of good trades. The answer to these problems is to seek out short-term counseling to help you gain perspective on the problems and cope with them effectively.

4) Ongoing emotional problems - These are emotional patterns that predate trading and that show up in areas of life apart from trading. They include depression, anxiety, anger, attention deficits, and substance abuse. Such problems skew how people experience themselves and the world and lead to biases in processing information. As a result, it is difficult to trade (and manage risk) with consistency. The answer to these problems is to seek out competent professional help from a licensed psychologist or psychiatrist, including (possibly) counseling and medication assistance.

The important point is that not all trading problems are psychological in nature. Sometimes we need to work on the markets, sometimes we need to work on ourselves, and sometimes we need to do both. But first of all, we need to identify what our problems are. If you seek help for your trading concerns, make sure you do so from an individual who is experienced in both trading and psychology. If people only possess hammers, they'll treat you like a nail. You want mentors who possess multiple tools and who can design the kind of help that will be right for you.

For the trader, as the physician, diagnosing problems is the first step toward cure.

3 comments:

D TradeIdeas said...

Nice insight Brett, as usual. Number 2 is particularly relevant to some new features we are adding in the coming months to Trade-Ideas. Features to help traders with re-learning the curve. We call it the Odds Maker now but I would appreciate any suggestion you have on a different name or any feedback you have based on the article.

Best regards,

David

Brett Steenbarger, Ph.D. said...

Thanks, David; this sounds very promising. By identifying the strategies that have been working in the recent market and following how they perform in real time, you would have a better opportunity to recognize when those market cycles are shifting.

"Odds Maker" isn't too bad a name. I'd go with "Edge Finder"... :-)

Brett

Hlaoroo said...

"If you seek help for your trading concerns, make sure you do so from an individual who is experienced in both trading and psychology. If people only possess hammers, they'll treat you like a nail."

It seems like it would be difficult to find a therapist who's knowledgeable about the challenges of trading for a living? What about a "sports psychologist"?