The Daily Trading Coach

by Brett N Steenbarger

  LESSON 36: DISRUPT OLD PROBLEM PATTERNS

  As you continue your journaling over a period of weeks or longer, you will become attuned to your problem patterns. Usually, a trader does not have 10 different problems. Rather, he may have one or two problems that manifest themselves in 10 different ways. For instance, a trader may grapple with missing good trades, occasionally ignoring stop-loss levels, sizing positions too conservatively, and cutting winning trades too quickly. These examples may seem like different problems, each requiring a different coaching plan and process. As the trader examines his or her journals, however, they’re likely to find that a single problem pattern—anxiety related to negative self-talk—is responsible for all of these. It’s not that the trader has many problems (though it may certainly feel that way); it’s that there is a single, core problem that affects many aspects of the trading process.

  As you can see from the above example, self-coaching requires that you not only detect patterns but patterns among the patterns. It’s these patterns of patterns that usually form the core focus of coaching efforts. This means that if you can accurately identify the core pattern, many different trading difficulties can fall into place in a reasonable period of time. Once the trader in our example learns to master anxiety and not channel it through self-defeating self-talk, he will miss far fewer opportunities, become more consistent in sticking to stop-loss levels, take appropriate risk, and let trades progress toward their designated targets.

  Asking yourself, “What is the common denominator behind my different trading mistakes?” begins the process of finding patterns of patterns.

  Often the core pattern will involve a feeling state that recurs for the trader and that disrupts good decision-making. For example, the trader may lapse into periods of anxiety, frustration, or self-defeat. How this feeling state impacts trading may vary from day to day, which is what produces the multiple manifestations that lead traders to think that they have dozens of problems. By tracing each trading problem back to a particular cognitive (thinking) or emotional (feeling) state, we can then identify the events that typically trigger that state and design effective coaching interventions to tackle those situations and triggers. Often, a trader will know what he is doing wrong, but won’t know the right thing to do. This issue occurs when traders have not been sufficiently solution-focused. They know, for instance, that they should not double down on losing trades to make money back, but they don’t know how to reenter a trade and exploit good research after having been stopped out of an initial position. This situation requires two important coaching steps: 1) interrupt the problem pattern so that it does not disrupt trading; and 2) develop rules and procedures for a possible solution pattern (which will form the theme of the next lesson).

  Because traders don’t always have solutions readily at hand and need to stop bleeding losses, interrupting problem patterns is often a first coaching objective. “Above all else, do no harm”—the Socratic oath in medicine—is relevant here. The ability to stop doing wrong things won’t, by itself, generate good things, but it can keep you solvent long enough to find solutions!

  Change starts when you stop yourself from doing what doesn’t work.

  A major point from The Psychology of Trading is that the key to disrupting problem patterns is to alter the state that you’re in when those problems first appear. This means that it’s important to become vigilant to the emergence of patterns, recognizing the characteristic ways that they appear. For example, some of my worst trading occurs when I focus on my P/L as the trade is unfolding. This focus may lead me to tolerate larger than normal losses in a small position, because it’s not hurting me, or it may lead me to take profits too quickly on a large position to book a sure gain. I’ve learned that if I start counting profits during the trade, I need to refocus my attention. I accomplish this by turning briefly from the screen, fixing my gaze on something nearby, and taking a few deep breaths. Once I’m in a new state—more calm and focused—I find it easier to be detached from the P/L and let the trade unfold in its planned manner.

  Another quick way of shifting state is simply to walk away from the screen temporarily and engage in a quick activity unrelated to trading. Some activities might be a few stretches or exercises; talking with a fellow trader; or getting something to eat or drink. Often, doing something different enables you to approach situations differently: the new activity helps you shift your frame of thinking and feeling. I find this activity particularly useful after taking losses: a quick walk outdoors, getting away from markets, allows me to return to the screen with a fresh perspective.

  When you change your physical state, you alter how you experience the world and process information.

  Still another mode of state shifting is to write in a journal or talk aloud during a particular situation. The latter is especially useful if you’re trading alone and won’t be a distraction to others if you process information aloud. If you write or talk about what is happening and give voice to what you think and feel at the time you’re thinking and feeling it, you shift from being a person immersed in experience to being a person observing his own experience. If you’re an active trader, in and out of markets quickly, you may not have time to write out journal entries and observe yourself in that manner. Talking aloud, however, can be accomplished while still watching the screen; in fact, that’s how many traders in Chicago work with me during the trading day: they talk aloud about what is happening while they are engaged in trading.

  To use my example from above, if I talk aloud my thoughts about my P/L while I’m in a trade, that alerts me to the fact that I’m no longer focused on the trade itself. If I hear myself talk about something other than the management of the present trade, it kicks me into a different mode and pushes me to make an effort to get back to the market itself. This shift becomes easier and easier as traders learn to make self-observation a habit.

  When you talk aloud your thoughts and feelings, you no longer identify with them; you listen to them as an observer.

  A good self-coaching question to ask yourself is: How different would your P/L be if you could eliminate the 5 percent of your largest losing trades? Often, this percent by itself would make a huge difference to a trader’s profitability. By interrupting the patterns that accompany those large losers that result from bad trading (not just being wrong on an idea), you can “above all else, do no harm.” It’s usually a particular emotional state or pathway of thinking that triggers the bad trading. If you recognize the state and thoughts as they’re occurring, you can stop yourself and, at the very least, avoid disaster.

  This recognition would make a wonderful goal to work on in your trading. Choose just one negative pattern that has accounted for many of your largest losing trades and then identify the common triggers for that pattern. Then select one method for interrupting the pattern when you notice one of the triggers occurring—even if that method is doing nothing more than placing no more trades until you regain emotional equilibrium. A good coach knows when to take his player out of the game for rest and a lesson. When you are your own trading coach, sometimes you need to do something similar. Remember: the goal is not to trade; the goal is to make money. Sometimes the best way to make money over the long haul is to ensure that you keep your money when all the wrong patterns are firing.

  COACHING CUE

  If I say something in a frustrated tone or make a frustrated gesture while I’m trying to get into a trade, while I’m managing a trade that’s already on, or while I’m trying to exit, that is my signal that I need to interrupt an emerging pattern. I typically will slow my breathing considerably and focus on my breathing as I’m continuing with my business. As soon as is practical thereafter, I take a short break from the screen and don’t enter any new positions until I have figured out why I’m frustrated, what that tells me (about me and/or the market), and how I want to factor that into my trading. If you use frustration as a cue to interrupt patterns you are prevented from acting mindlessly
on the frustration, but also you are set up to become mindful of the reasons for the frustration.

  LESSON 37: BUILD YOUR CONSISTENCY BY BECOMING RULE-GOVERNED

  One of the major goals of coaching yourself is to turn positive trading behaviors into habit patterns. This is crucially important. You don’t want to have to think and make yourself do the right things each time opportunity occurs. Rather, you want to do the right things automatically. Effort and energy you spend thinking about what to do—and trying to make yourself do it—is taken away from markets themselves. When you can do the right things automatically, your concentration can be wholly focused on what you are doing. That is essential if you’re going to be sensitive to subtle market shifts in supply and demand.

  Rules are the bridge between new behavior patterns and acquired habits. Children are not born with a developed sense of ethics and responsibility. They are taught rules by parents and teachers that are eventually internalized. Some of that internalization occurs by observing role models over time; much of it results from turning the desired behaviors into explicit rules that can be rehearsed. Such mental rehearsal allows people to keep old behavior patterns in check and make conscious efforts to engage in new ones.

  We see such dynamics at work when traders are learning to control losses. Instead of exiting trades when the pain of loss is too great—a pattern that comes all too naturally—a trader will create a rule-based stoploss level. The rule may be accompanied by other thoughts that emphasize the importance of the rule, the losses that will follow from not following the rule, and the benefits of adhering to the rule. In such an instance, traders choose to refuse to do what they feel like doing at the moment. Rather, they seek to be rule-governed. That is what keeps us driving on the proper side of the road, even when we’re in a rush. Rules are checks on our impulses; they keep us doing the right things even when we’re not inclined to act in our own best interests or the interests of others.

  We follow social rules without even thinking about the rules of proper social behavior because we’ve repeated the right behaviors so often and have internalized the rules so thoroughly over time. That’s the goal with trading rules.

  Trading is especially challenging, because the normal human response is rarely the one that makes money. One exercise from the TraderFeed blog examined periods of time that were up on a one-month, one-week, and one-day basis and compared those with periods that were down over those three time frames. In the first situation, almost anyone would identify the trend as rising; in the second situation, it’s a clear downtrend. Had you bought the market after the up periods, however, you would have severely underperformed the market averages. Had you sold after the down periods, you would have lost considerable money. The obvious strategy fails precisely because it is so obvious. By the time a trend is readily apparent; all the momentum and trend followers are aboard. They’re the ones scrambling to get out when the tide turns, leaving traders who acted on the obvious with losses.

  When we create rules, we put a brake on those normal human tendencies. A rule might be as simple as “only buy if the market is down over X period.” Surprisingly, in the broad stock market, such a simple rule works pretty well on average. Another rule might be, “Never enter a trade unless you first measure risk (stop-loss level) and reward (profit target) and have a reward-to-risk ratio of 2:1 or better.” Such a rule would restrain a trader who is tempted to jump aboard late in a market move.

  What traders call setup criteria often are simply rules for getting them into trades. When the criteria are not established as firm rules—and mentally rehearsed as such—there is a tendency to violate the setups. This violation often occurs because of the fear of missing a profit opportunity or because of risk aversion after a prior loss or series of losses. When the setups are structured as rules, trading may not be mechanical, but it can be much more consistent. Most frequently, the inconsistent trader is the one with the loosest rules.

  Rules aid trading consistency.

  When you are your own trading coach, you not only formulate your rules, but also must do so in a way as to maximize the odds that you will actually follow them. The key to successful rule-creation is the recognition that rules are more than thoughts that go into your head. A good rule also comes with feelings attached: an awareness of both the consequences of violating the rule and the benefits of following it. What keeps a diabetic person faithful to a diet or an eager child patiently waiting her turn to answer a question in class? It’s not just the thought of the rule, but also the immediate sense of what would happen if the rule were violated. When people think, “I can get away with it,” the rule loses its force: it’s merely a set of empty words and good intentions.

  This, then, is the secret to formulating trading rules, whether they relate to entries, exit, position sizing, stop-losses, diversification, or idea generation: whenever you write down the rule or mentally rehearse it, make sure that you are emotionally connected to that rule. Make yourself relive situations in which you’ve violated the rule. Focus your attention on successful episodes of trading in which you followed the rule. Make the rule more than a guideline; it should represent a belief and conviction. The best rules feel like must, not just should.

  Your assignment is to take a thorough trading inventory of your trading rules. How many do you really have, and how explicit are they? Do you just remind yourself of them passively, or do you rehearse them with belief and conviction? If you’re like most traders, you’ll find that you have many loose guidelines, but few firm rules. That means that you haven’t really drilled down to identify the patterns behind your best and worst trading, which really form the backbone of all good rules.

  Rules should reflect best practices in trading.

  Remember: you can’t follow a discipline that you never formulated in the first place. The clearer the rules and the more you feel them, the stronger they will serve as brakes to your impulses and guides to your best behavior. Rules are not straightjackets; they free you up to be your best. Think of professions in which consistency is a virtue: airline pilots landing an aircraft, surgeons making incisions, racecar drivers maneuvering in a pack. The best performers are rule governed: they are keenly aware of the dangers of ignoring the rules of their profession. It is in the internalization of their rules that they achieve flawless execution. That is your goal in coaching yourself: to make rules so routine that they make extraordinary performance the norm.

  COACHING CUE

  Rule-following is a great basis for self-evaluation. Creating checklist report cards to track your rule governance helps ground you day to day in best practices. Among the rules you should consider formulating and tracking for self-assessment are:• Rules for position sizing.

  • Rules for limiting losses, per trade, per day, per week, etc.

  • Rules for adding to existing positions.

  • Rules for when you stop trading or limit your size/risk.

  • Rules for increasing your size/risk, per trade, per day, etc.

  • Rules for entering and exiting positions.

  • Rules for preparing for the trading day/week.

  • Rules for diversification among positions.

  Not all these rules will apply to all traders; the key is to focus on the rules that capture your best trading and turn those into report cards for daily/weekly self-assessment and goal setting.

  LESSON 38: RELAPSE AND REPETITION

  The greatest enemy of coaching is relapse. It is relatively easy to initiate change, but quite difficult to sustain it. Our old patterns are what come naturally: they’re what we’ve been doing day after day, year after year. Those patterns are overlearned; they have been repeated so often that they have become automatic. If change efforts are not sustained, the automatic patterns naturally fill the void.

  What this means in practice is that there is a certain series of stages to any change process:

  Phase One—We repeat old patterns automatically, experience consequences, and
try to avoid the consequences as much as possible.

  Phase Two—Consequences of old patterns accumulate and we develop an awareness of the need to change, though we may not know how to change and may have ambivalent feelings about change.

  Phase Three—We can no longer accept the negative consequences of our old ways and commit ourselves to making changes by trying to think and act differently.

  Phase Four—We slide back into old patterns periodically when our change efforts lose momentum, creating oscillating periods of change and relapse.

  Phase Five—We engage in new patterns sufficiently often that they become automatic, greatly reducing the relapse into old ways.

  So let’s take a practical example: In phase one, we are in an unfulfilling romantic relationship, but minimize the problems and try to go on from day to day. In phase two, we recognize that the problems are there, but wrestle with the question of whether we really want to rock the boat and raise concerns with our partner. Phase three brings clear awareness of the need for change and discussions at home to work out problems. Phase four sees periods of good times, interrupted by resumptions of the problematic interactions, perhaps aided by couples counseling. In phase five, we keep working on the counseling exercises, changing patterns of communication, until there are new and more constructive ways of engaging each other that have become routine.

  This step-wise scheme suggests that relapse is not merely a problem, it is a step on the road to change. Few people change patterns all at once and for all time. More often, there is a tug-of-war between the old, overlearned patterns and the new, constructive ones we’re working on. This tug-of-war occurs precisely because the new patterns have not yet been overlearned: it takes conscious effort to enact them. Early in the change process, we don’t think about change; in the middle phases, we have to think about change in a very conscious manner. Only late in the process do the new behaviors come more naturally and automatically.