The Daily Trading Coach

by Brett N Steenbarger

  COACHING CUE

  Track your daily physical well-being—your state of alertness, your energy level, your overall feeling of health—against your daily trading results. Many times fatigue, physical tension, and ill health contribute to lapses in concentration and a relapse into old, unhelpful behavior patterns. It is difficult to make and sustain mental efforts when you lack proper sleep or feel run down from a lack of exercise. Very often, our moods are influenced by our physical states, even by factors as subtle as what and how much we eat. When you keep a record of your daily performance as a function of your physical condition, you can see these relationships for yourself and begin preventive maintenance by keeping body—and thus mind—in peak operating condition.

  LESSON 63: HARNESS THE POWER OF SOCIAL LEARNING

  One of the greatest mistakes traders can make in coaching themselves is to work on their craft in isolation. It is easy to become isolated as a trader, particularly given that all it takes is a computer and Internet connection in one’s home to access the most liquid markets. During my work with trading firms, however, I have consistently seen how access to other professionals aids the learning process. From peer professionals you obtain role modeling, encouragement, and valuable feedback on ideas. A social network of traders also offers powerful behavioral advantages that can aid your self-coaching. Thanks to Web 2.0 and the many online resources available, such social networking can occur virtually, not just within a trading firm.

  Psychologist Albert Bandura was one of the first behaviorists to observe how reinforcement in a social context can aid the acquisition of new behaviors. When we observe others rewarded for positive behaviors, the vicarious experience becomes part of our learning. Similarly, when we see others making mistakes and paying the price for these, we learn to avoid a similar fate. In this way, your learning becomes a model for others and theirs provides models for you. Experience is multiplied many times over, accelerating the learning process.

  Social learning multiplies experience and shortens learning curves.

  Since I first began full-time work as a coach for trading firms in 2004, my own trading has changed radically. I have learned to factor intermarket relationships into my trading, and I have learned to think in terms of risk-adjusted returns, with each trade carefully calibrated for both risk and reward. I am keenly aware of the effect of position sizing on my returns, and I carefully track my trading results to identify periods of shifting performance that might be attributable to market changes. These changes all resulted from observing successful professionals across a variety of trading settings, from proprietary trading shops to investment banks. Since instituting these changes, I’ve enjoyed greater profitability with smaller drawdowns. Seeing how the best traders managed their capital provided me with powerful lessons that I could apply to my own trading.

  Perhaps my most effective learning, however, came from observing failed traders. I have seen many traders lose their jobs (and careers) as the result of faulty risk management and an inability to adapt to market shifts. Those failure experiences were painful for the traders, but also for me, as I developed close relationships with many of them. Their pain and the crushing of their dreams was powerful learning for me. I vowed to never make those mistakes myself.

  We learn most from emotional experience, including the experiences of others.

  When you share ideas in a social network, including self-coaching efforts, you obtain many learning experiences that become your own. Vicarious learning is still learning, whether it’s learning concrete trading skills or learning ways of handling performance pressures. One of the real values of published interviews with successful traders, such as found in the Market Wizards series, is that you can learn from the experience of others. When you actually observe this experience in real time, however, the contingencies are much more immediate and powerful. How a trader in the hole pulls himself out, or how a trader adapts to a changing market, or how a trader successfully prepares for a market day—all provide models for your own behavior. You learn, not just from their actions, but also from observing the results of their actions.

  Once you enter a social network of capable and motivated peers, the praise and encouragement of the group become powerful reinforcers. Most of us want to be respected by our fellow professionals, and the support of valued peers can be a meaningful reward. This reinforcer occurs among children, who find that they are praised by teachers, parents, and peers for good behavior and not praised when they behave badly. Over time, this differential reinforcement creates associative links for the child, so that he will do the right things even if no immediate praise is available. Similarly, young, developing traders will absorb the praise of mentors like a sponge; this helps them associate the right trading behaviors with favorable outcomes. When you share successes with fellow professionals, you turn social interaction into social learning.

  Find experienced traders who will not be shy in telling you when you are making mistakes. In their lessons, you will learn to teach yourself.

  For this lesson, I encourage you to locate online networks of traders (or assemble one of your own) in which there is openness about trading successes and failures. Online forums are a possible venue; you can also connect with readers of trading-oriented blogs who participate in discussions. Or perhaps you will choose to write your own blog, openly sharing your trading experiences and attracting like-minded peers. When you network with traders who have similar levels of motivation, commitment, and ability (as well as compatible trading styles and markets), you can establish a framework in which learning follows from shared ideas and experiences. We’ve seen in Chapter 5 how relationships can be powerful agents of change. In the behavioral sense, you want to be part of the learning curves of other traders, so that you can absorb their lessons. A great start is to establish such a mutual learning framework with just one other compatible trader. Their emotional learning experiences become yours; yours become theirs. Their victories spur your ability to do the right things; your accomplishments show them the path to success. This effectively doubles your behavioral learning, supercharging your self-coaching efforts.

  COACHING CUE

  An increasing number of professional trading firms—particularly proprietary trading shops—are creating online access to their traders, trading, and resources. Several of these firms are mentioned in Chapter 9. Read the blogs from these firms and participate in their learning activities as an excellent way to connect with other traders and model their best practices.

  LESSON 64: SHAPE YOUR TRADING BEHAVIORS

  Two children, two different homes: both improve their test grades in math; both fail in English. In the first home, the parents praise the improvement in math and encourage similar progress in English. In the second home, the parents call attention to the English grade and demand to know why the child couldn’t pick up that grade as well. Which child will be most likely to show further school progress?

  Behavioral psychologists who utilize behavior modification as a means for altering action patterns would support the first set of parents. Positive reinforcement, as a whole, works better than punishment. If we reinforce the right behaviors, the child will learn to do the right thing. If we punish the wrong behaviors, the child will learn to fear us. Nothing positive is necessarily learned.

  Punishment fails because it does not model and reinforce the right behaviors.

  Many traders seek to motivate themselves more through punishment than praise. These traders focus more on their losing trades than on their winners. They spend more time on weak areas of trading than building and extending their strengths. Such traders learn to associate unpleasant things with trading. These traders anticipate criticism and punishment and find it difficult to stay wholeheartedly engaged with the learning process.

  We can see such dynamics at work in the journals many traders keep. One page after another details what the trader did wrong and what he needs to do to improve. Self-evaluations emphasize the bad tr
ading, everything that could have been better. It’s little wonder that these traders find it difficult to sustain the process of maintaining a journal. After all, who wants to face negativity and psychological punishment every working day?

  Many traders fail to sustain work on their trading because they find little positive reinforcement in their work.

  Trainers use frequent rewards to teach animals tricks. The trainers don’t expect the dog to, say, jump through the hoops all at once. Rather, they will first give a reward each time the dog approaches the hoop. Then the trainer will wait for the dog to go through the hoop before they dole out the reward. Then they’ll lift the hoop just a couple of inches and reward the dog when it jumps through the hoop. Then they’ll add a second hoop and a third . . . they’ll raise the hoops a little at a time . . . all the while requiring new behaviors that are closer to the desired endpoint before giving the reward.

  This process is known as shaping. Trainers shape animal behaviors by rewarding successive approximations to desired ends. In a classroom, a teacher might first reward a disruptive student for five minutes of quiet attention. Later, it will take 10 minutes for the student to earn the reward; eventually the reward will require an entire class period of good behavior. Frequent-flyer programs at airlines aren’t so different. At first, you earn bonuses for simply joining the programs. Only after you ride the airline regularly, however, do you earn later rewards. If you want the greatest perks, you have to shape your riding habits to fit the program.

  Shaping is a testament to the power of positive reinforcement. Imagine punishing the dog for not going through the hoops. The chances are good that the dog would simply cower in the presence of the trainer; it certainly wouldn’t figure out the right behaviors from the punishment of the wrong.

  When you are your own trading coach, you are the trainer as well as trainee. You are teaching yourself to jump through the hoops of good trading. For this reason, you need an approach to coaching that is grounded in positive reinforcement. Your coaching must stay relentlessly positive, building desired trading behaviors—not punishing the wrong ones.

  You can keep a positive tone to the learning process by shaping your trading behaviors: rewarding small, incremental progress toward the desired ends.

  The first place to implement the shaping approach is in a journal. As an experiment and a worthwhile exercise, try keeping a positive trading journal for a few weeks. Divide your trading into several categories, such as:• Research and preparation.

  • Quality of trade ideas (ideas that carry conviction).

  • Number of diversified (uncorrelated) trade ideas.

  • Quality of entries (favorable risk/reward for trades; low amount of heat taken per trade).

  • Sizing/management of trades (scaling in/out by planned criteria).

  • Execution of exits (following profit targets/stop losses).

  Each journal entry then focuses on what you did right in each of those categories each week. You write down, in specific detail, your best performance in each of these areas and then you review your entries before trading the next week, with the aim of continuing the positives.

  As the previous lesson noted, this use of positive reinforcement and shaping is even more powerful if you conduct your assessment in a social framework, where you exchange your weekly positive report cards with one or more valued peers. This framework allows you to support the progress of others, even as they reward yours.

  One of the better pieces of self-coaching from early in my trading career occurred when I set a goal of reaching a certain size in my trading account. I normally don’t emphasize P/L goals, but in this case I wanted a tangible focus on steady profitability. Once I reached the goal, my commitment was to withdraw a portion of money from the trading account and use it for something enjoyable for the family. This emphasis rewarded my longer-term progress, but also brought my family into the positive reinforcement. When I finish this book, one of my personal goals will be to lose some weight—long hours in airplanes and hotels between working with traders have taken their toll. I’ve promised myself a new wardrobe from a Chicago tailor if I reach my weight goals. Each week I’ll be weighing myself and tracking my progress. With every opportunity to snack, I’ll be thinking about that new wardrobe and how I would feel if I didn’t make weight that week. There’s little doubt in my mind that I’ll reach my goal.

  Tangible rewards for your success are among the strongest positive reinforcers.

  The key to making a positive journal work is shaping. At first, you jot down entries for even very small things that you did right. Later, you only make notations of larger examples of virtuous trading. If you conduct the shaping process properly, you’ll always have good things to write about—even on losing days. This process ensures that you’re always learning, always building on strengths, always keeping your motivation up. The difficult part about self-coaching isn’t just making progress, it’s sustaining the progress. Progress is much easier to accomplish when your focus is building yourself up, not tearing yourself down.

  COACHING CUE

  What is meaningful for you as a tangible reward for your self-coaching progress? A vacation with loved ones? A new car? One trader I work with donates a portion of his profits to a charity he deeply believes in; helping them out inspires his own efforts. It helps to reinforce the small steps of progress via shaping, but it also helps to have a larger goal that you’re working toward; a goal that is meaningful for you. Remind yourself periodically of the goal; track your progress toward the goal. The psychologist Abraham Maslow recognized clearly: we perform at our best when we are impelled toward positive goals, not driven by deficits and unmet needs.

  LESSON 65: THE CONDITIONING OF MARKETS

  A large part of money management follows from a deep appreciation of fat tails. Market returns are not normally distributed; they show a higher proportion of extreme occurrences than you would expect from a simple flipping of coins. This is true across all time frames. The odds of a multiple standard deviation move against you (or for you) are sufficiently high that, if you’re in the market frequently over a long period of time, you will surely encounter those periods in which markets stay irrational longer than you can stay solvent.

  The distribution of market returns is also leptokurtic: it is far more peaked around the median than a normal distribution. This implies that market moves revert to a mean more often than we would normally expect by chance. Just as a market seems to be moving in one direction—trending—it reverses course and finishes little changed.

  It is difficult to imagine a situation better designed to create frustration . Markets produce large moves more often than would be expected if returns were distributed normally, which leads traders to seek large, trending moves. But markets also revert to mean returns more often than we would expect in normal distributions, creating many false trends. If you trade a countertrend strategy, you run the risk of being blown out by a multiple standard deviation move. If you try to jump aboard trends, you’ll find yourself chopped to pieces during false breakouts.

  The very structure of market returns ensures a high degree of psychological challenge for traders.

  The tendency of markets to make extreme moves amid frequent mean reversion creates interesting and important psychological challenges that affect self-coaching. To fully appreciate this, we need to understand the dynamics of behavioral conditioning.

  Let’s say that, each time I ring a bell, I hit you over the head. Soon, you’ll learn to duck as soon as you hear the bell. That is a conditioned response . Days later, you might be in a different location and will still duck if the bell sounds. It’s automatic; not a behavior guided by explicit reasoning. You’ve learned to associate bell and pain, just as Pavlov’s dogs associated a ringing bell with the appearance of meat. Bell rings, dogs salivate. Bell rings, you protect yourself.

  Now let’s take our experiment a step further. I ring a similar but different bell and once again hit yo
u over the head. Before long, you learn to duck whenever you hear any bell. This is called generalization. Your conditioned responses (the ducking) have now extended to a class of stimuli similar to the original one.

  Much of what we call traumatic stress is the result of such conditioning. In the Psychology of Trading book, I mentioned my car accident in which I was thrown from a vehicle while riding as a passenger. Just as a result of that single, powerful event, I developed an anxiety response any-time I subsequently sat in the passenger seat of a car—even when the vehicle wasn’t moving! I had learned an associative connection between being a passenger and extreme danger; the conditioning stuck with me even though I intellectually knew it made no sense.

  Many of our extreme reactions to market events are the result of prior conditioning.

  Powerful positive emotional events can yield the same kind of conditioning. The high obtained from certain drugs can be so strong that some people will develop addictive patterns after a single use. Underlying the addiction is the learned connection between the high and the use of the substance. That, too, overrides reason and reorganizes behavior.