Sunday, April 06, 2008

What Are You Doing Between Trades?

I want to thank readers for excellent comments and perspectives on my recent post that addressed the question of why trading is so difficult. In particular, I thought that Charles and Ziad identified a most important issue: the trader's engagement with markets *between* trades.

To take a step back, if I were asked the question, "What makes trading so difficult?", my response would echo Victor Niederhoffer: "Trading is difficult because of the ever-changing nature of market patterns".

In statistical terms, this is called nonstationarity; in my previous writings I described it as playing blackjack when the number of decks in the "shoe" periodically changes. You the card counter are keeping track of the number of picture cards dealt, not knowing that the supply of picture cards has just increased multi-fold.

Similarly, from one time period to the next, market patterns can change: we can see altered patterns of trending and altered patterns of volatility. This occurs within the day--the market's behavior is different in morning than midday--and across days, weeks, months, and years. (We currently are experiencing far more volatility than a couple of years ago).

A nice example of Niederhoffer's "ever-changing cycles" is the recent shift in one-sided days that I wrote about. When we get such shifts, traders who internalized the previous patterns (and, in this case, fade opening strength or weakness) become caught in the new patterns and lose money. This is a major cause of frustration in trading, and it is a major reason that successful traders can rather quickly become unsuccessful ones.

It is because of these changing cycles that traders need to stay actively engaged with markets *between* trades. At any time, trends can reverse, breakouts can occur, markets can become quiet, etc. Only by following the market's emerging patterns can traders hope to adapt to them and eventually profit. Charles provided an excellent example in his comment to the post: because he is actively figuring out what the market is doing, he avoids what I called the "fireman" syndrome among traders, in which periods of boredom oscillate with periods of intense emotion and action.

Ziad makes the valuable point that one does not need to approach the markets quantitatively to stay actively engaged. In my own trading, for example, I stay engaged by watching unfolding sentiment (NYSE TICK, Market Delta), seeing how price and volume behave at the edges of market ranges, and by seeing how markets correlated to my own are behaving. The time between trades is never boring, because my interest is captured by reading the emerging market patterns.

Herein lies the problem beneath the fireman syndrome: If the trader is more interested in trading than in understanding markets, the period between trades will not be productive. That period will either be boring (which will incite overtrading), or it will be dominated by negative thinking about recent performance (which will color future decision making).

This is why structuring one's time between trades with processes to examine markets--and to examine oneself, when needed--is very helpful for trading. The mind, like nature, abhors a vacuum. If we aren't prepared with constructive activities between trades, the mind will latch onto non-constructive ones.

I strongly suspect that a reliable way to identify a good trader is to observe what he or she is doing *between* trades.
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2 comments:

SSK said...

Hello Brett, Thanks for the articles as always! I have noticed in my trading, (even though there are other factors involved also), but back to the point of the article, I find that after a series of winning trades or losing ones, if I sense that I am being overly analytical or vacillating in making decisions, I have become flexible enough to walk away and engage in playing my percussion instruments completely adlib, but to the same set of songs that I listen to frequently when trading and playing. I think there is some relationship between the two, as after the physical exersise that occurs through hard playing for about 30 minutes, I notice that my mind works better,i feel better, I am more focused, and that is reflected in my trading. I noticed on days that I dont play, and just analyze market action, whether I win or lose, I am not able to be as nimble in trading as compared to trading after such an exercise with play the instruments.It is interesting because the setup I play with has about 12 bongos and congos, musical blocks, cymbals, rattles, etc, so when I am playing adlib, it is implicit in the sense that I am relying on a variety of musical sounds that I know are in a specific locations, but to put together an appealing compostion there is no time to analyze the patterns required to achieve that sound. I just let the mind work the hands, and it works quite well. Sure as with anything, the sounds become more delightful with practice, but the point here is, there is limited left brain activity I believe. Having said that, I do spend a lot of time reviewing my day trading snippets after the markets close,(here is one of four that I produced on friday), http://www.youtube.com/watch?v=XCtk8lcHJU4 and I spend a lot of time in self talk during their production which is beneficial.(thanks for that suggestion)! My preformance has gotten better since the implementation of these things. I have also implemented the grading scale that you spoke about a while back regarding setting goals and grading, and that works wonderfully. I have been working on entrys, and my avg for the month of march was a D+. That was based on a scale of A-F, with A=5points and F=1point. I grade every trade and I base the grade not on the profit or loss necessarly, but on where the entry is in relationship to the internal market rotations and I use profit potential from the entry as the touchstone. I think this week I am going to combine two elements in my daily goal, that of entry's and exit's at the same time. That will give me an immediate glimpse into the maximization of the trades potential. My exits are my weak point, even though my overall grade for entrys was a D+ in march, that month was my best month yet. It will be interesting to see side by side the entry/exit grade scale for trading next week. I started grading in mid march. Here is the link that I archive that information. http://www.swingtradingfutures.org-a.googlepages.com/daytradingsnippets Thanks for that suggestion along with all the others. Keep up the good work, Best, Steve ~SSK~

Krasimir said...

"Herein lies the problem beneath the fireman syndrome: If the trader is more interested in trading than in understanding markets, the period between trades will not be productive. That period will either be boring (which will incite overtrading), or it will be dominated by negative thinking about recent performance (which will color future decision making).

This is why structuring one's time between trades with processes to examine markets--and to examine oneself, when needed--is very helpful for trading. The mind, like nature, abhors a vacuum. If we aren't prepared with constructive activities between trades, the mind will latch onto non-constructive ones."

Brett, I agree with you providing market conditons suggest that possible opportunities would appear, and the trader then is actively engaged in figuring out how market unfolds. However, if market condtions are not favorable (ex. tight intraday range)then a (day) trader might fall victim in above patterns - overtrading or negative thinking - and the solution could be to find engagement off the trading screen.