Tuesday, May 5, 2015

The Three Vices of Trading

Perfectionism is often the chief culprit when the pain of losing exceeds the
pleasure of winning. Desperately trying to feel good about themselves, perfectionists set
unrealistically high ideals. They think they will finally be OK if they just accomplish X.
(For X, you could substitute many things, including looks, wealth, popularity, or
achievement). Because X is an unattainable goal, perfectionists ironically use their ideals
as a basis for self-criticism when their performance doesn’t match up. After all, is
achieving X will make me OK, then I must not be OK if I fail to achieve X. The
emotional theme of the perfectionist is “not good enough”. Perfectionists are driven to
do more and more because they never feel competent, worthy, and loved as they are.
Thus, even when there’s a profit on a trade, perfectionists will look for the portion of the
move that they did not participate in. If they caught most the move, they will reprove
themselves for not trading a larger position. And when trades don’t go well,
perfectionists review all the reasons that shouldn’t have made the trade, should have
known better, etc. By focusing on the portion of their performance that doesn’t match
their ideals, perfectionists transform successes into defeats, losses into failures. They
rationalize their perfectionism as a drive for achievement, but all they are accomplishing
is an undercutting of their confidence.
Perfectionism shows up as negative self-talk and self-blaming. Emotionally, we
recognize perfectionism from frustrated, angry feelings when trades don’t work out as
planned. “Beating myself up” is how many perfectionists describe their self-talk. The
way to beat perfectionism is to make a concerted effort to talk to yourself the way you
would talk to a good friend in a situation where things went wrong. Most people know
how to treat others with respect, love, and dignity. They just haven’t learned to do the
same for themselves. If you would be more nurturing, understanding, and supportive of a
friend than you are of yourself in the identical situation, then you know that you’re not
being your own best friend. If a trade doesn’t work out, the constructive trader focuses
on, “What can I learn from this?”—not “What’s wrong with me?”. In Woodie’s
language, the best antidote to perfectionism is the ability to reassure yourself, “There will
be better trades down the road.” The key is to not miss those better trades while you’re
beating yourself up!
Vice Number Two: EGO
Everyone likes to win in the markets. It’s only natural to feel good when you’ve
done your homework and end the day with a profit to reward your efforts. Ego
involvement in trading, however, goes further than this. When the ego is involved, we
write the market a blank check for our self-esteem. If trading is green, we feel good
about ourselves; if we go into the red, we feel diminished. That places tremendous
pressure on our trading over time. Not only do we have the burden and challenge of
reading complex market patterns; now we also have a psychological gun pointed to our
head ready to go off any time our pattern recognition fails us.
Most traders are aware of the dangers of trading with too much leverage. A trader
accustomed to trading 2 lots, where each tick in the ES is worth $25, would feel
overwhelmed jumping to 100 lots, where each tick now moves the account $1250. With
the stakes raised to such a degree, the same trade would now no longer feel the same. It
would be hard to let a position go against you by a point ($5000, instead of $100), and it
would be difficult to let a profit run. When traders invest their feelings about themselves
in their trading, they are operating with maximum emotional leverage. In the currency of
self-esteem, they trade 100 lots. So much of their emotional account rides on each trade,
that it inevitably affects decisions about cutting losses, letting profits run, and entering
and exiting in a timely fashion. The successful trader wants their trades to work out; the
ego-involved trader needs them to be profitable.
We know that ego threatens our trading when we find ourselves needing to trade
just to win back some recently lost dollars; when we feel a desire to advertise our
positions; and when we find ourselves riding an emotional roller coaster as profits wax
and wane. Just as we can recognize traders’ perfectionism from anger/frustration, we
recognize ego-involved traders from euphoria/depression. If trading has us truly
depressed, we know that it’s not just our trading account that’s hurting. The antidote to
ego-involved trading is to place our self-esteem eggs in many baskets: recreational
interests; other work involvements; relationships; and our spiritual lives. Many times we
pour our self-esteem into trading because those other facets of our lives are not properly
developed. A balanced life makes for balanced trading. In the spirit of Woodie’s CCI
Club, we can take some of the ego out of trading by learning from others, by becoming a
candle that lights other candles, and by using a portion of market profits to help others
make a wish that will come true. If your good feelings in life come from good
relationships and worthy achievements, you won’t need the markets for your happiness.
Market success can be the frosting on the cake of your successful life, rarely can it
substitute to the cake itself.
It is common for traders to complain of a lack of confidence in their trading, but
very often it is overconfidence that does them in. Overconfidence results from a lack of
appreciation of the complexity of markets and an underestimation of the challenges of
trading them successfully. In a sense, overconfident traders lack respect for the markets.
They think that reading about a few setups or buying the newest software will prepare
them to make money. Overconfident traders don’t want to work their way up the trading
ladder: they resist the idea that screen time is the best teacher. They also chafe at the
idea of growing their account. Rather than start with one contract and wait until they’re
profitable before trading larger size, they want big positions—and profits—right away.
Because they’re so eager to make money—and so sure they can make it—overconfident
traders generally trade impulsively. They won’t wait for the setup to form; they’ll jump
the gun—and get whipsawed in the process. Instead of being patient and waiting for
short-term patterns to align with longer-term patterns, they will take every trade,
enriching their brokers in the process.
The hallmark of overconfident traders is that they think they are going to make
something happen in the market, instead of patiently waiting to take what the market
gives them. Spelling out profit goals for each day or week of trading is one manifestation
of overconfidence. Humble traders know that markets expand and contract their
volatility—sometimes the trade just isn’t there. The overconfident trader, however, feels
that he/she is bigger than the market. Indeed, overconfident traders will often take great
pains to try to catch the tops of bull swings or the bottoms of corrections. As a result,
they often fight the market trend—and can get run over in the process. If the emotional
signs of perfectionism are anger/frustration and the emotional signs of ego involvement
are elation/depression, then the emotional signs of overconfidence are
impatience/impulsivity. Overconfident traders overtrade. They fear missing
opportunities more than they fear losing money. The antidote to overconfidence is rulebased
trading and the intensive rehearsal of trading rules. By making entries, exits, stops
and position sizing rule-governed and vigorously rehearsing trading rules during
simulated trading (as well as in real time with small positions), traders can greatly reduce
their impulsive trading. Very often this means training oneself to focus on (and rehearse)
what-if scenarios of being wrong in the market, as well as forcing oneself to spell out the
rationale, targets, and stops for all trades. By making trading a more self-conscious
process, traders interpose thought between impulse and action, gaining greater control of
their trading. When the trading room admonishes, “No boasting, just posting”, it is
encouraging restraint on overconfidence.

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