This accounts for what people have learned about change processes in therapy. People often come to therapy with maps that have been distorted by painful life experiences. They identify with these maps and try their best to assimilate new experiences into them. On many occasions, I have had clients respond to something positive I said by dismissing it, indicating that it is my job to be supportive of people. It is easier for them to disqualify feedback that does not mesh with their negative schemas than to acknowledge that their views of themselves and others are faulty.
One of the most powerful experiences people can create for another person is to extend themselves beyond the bounds of what is normally expected. For example, every student with whom I meet in counseling is given my home phone number and the opportunity to interact with me by phone, e-mail, or direct visit in between regularly scheduled meetings. At times, this has required meeting with someone late at night or on a weekend. I vividly recall one crisis call I received from a distraught student while I was on vacation with my family in Bermuda. I am not compensated for these extra contacts, and nowhere in my job description does it say that I should extend myself in such a manner. One student, amazed that I would meet with him at midnight before a major exam to head off a mounting anxiety problem, asked why I did this. My response was simple: Because you're worth it.
Many people have no schema—no mental filing cabinet—to hold such a concept. Without the ability to reconcile my actions with their schemas, they are prodded to accommodate to reality by altering those schemas. Discrepancy—novel experience—creates change because it forces people to redraw their mental maps.
This cognitive remapping can be observed among those developing their trading skills. At some point, after seeing their systems work on paper and then in actual trading, the schema of "I can't do this" is replaced by a growing sense of mastery and understanding. At one time, when you first slid behind the wheel of a car, you no doubt felt shaky about your driving skills. With repeated, successful experience, however, you reorganized your maps. Emotionally this manifests itself as a quiet confidence. You don't think about whether you'll drive successfully or not. You take it for granted; you know that you can do it.
For years, I had thought of myself as a nervous and not especially skilled public speaker. Then I found out that my graduate school scholarship required me to teach a large class three times a week. The first couple of weeks were agony; but after that, the teaching became routine. I gradually developed the ability to read my audience and acquired a sense for how to present the material in an engaging way. By the end of the course, I could walk in front of an auditorium of students and routinely deliver a fine lecture. Even more important, I started to think of myself as a good public speaker! Quite literally, the new experience shifted my internal model of myself, creating a new identity.
Recall the conclusion of Michael Gazzaniga and colleagues in their research with split-brain patients. When they asked patients to explain the actions of their left hands (which were processed by the relatively nonverbal right brain hemisphere), the patients readily invented rationales for their behavior. This led the researchers to conclude that a major function of the left: hemisphere—John Cutting's Mind #1—is that of interpreter, making sense of experience. It is not a large leap to recognize that this interpreter is an important originator of mental maps, transforming raw experience into an internalized sense of self. People do so, Gazzaniga holds, through the creation of narratives. They create stories that explain their experience, much as scientists use theories to explain their observations.
The cognitive psychologist George Kelly made clever use of this narrative interpreter by encouraging his clients to construct ideal selves in their counseling. During sessions, clients would elaborate their idea of the person they would like to be, right down to the mode of dress, the manner of speech, and the body postures. The ideal selves were even named. They were very much like an author's creation, fleshed out in lifelike detail. Once clients constructed this ideal self, they were instructed to enter into unfamiliar social situations and to act the role of their ideal person. For example, a shy person might go to a mall and enact the role of the assertive, outgoing shopper. What Kelly found was that his clients invariably encountered positive feedback for their new role enactments, much as I received praise for my lecturing during my graduate years. Over time, the clients internalized this feedback, revising their self-concept in the direction of their ideal.
It is not too difficult to speculate what Kelly was accomplishing with his cognitive restructuring. In enacting a new role, clients needed to enter new states of consciousness. They had to adopt novel emotional patterns, physical states, and ways of thinking. They truly were, in Nietzsche's phrase, play-actors of their ideals. Through repetition and feedback, they literally programmed a new state on the mindscape, expanding their identity and behavioral repertoire.
This brings me back to an important point. Your interpreter is always turned on while you are trading. You will inevitably internalize your trading experience. And you will most deeply internalize those experiences that occur during times when you inhabit nonordinary spots on the radio dials of consciousness. If you feel unusually calm and confident, this will stand out to the interpreter. If you are particularly fearful and self-doubting, the interpreter will take note. Your identity as a trader is a distillation of those experiences that most stand out in your awareness. The interpreter does not need to make sense of routine facets of reality; only nonroutine experiences will trigger your remapping efforts.
This line of reasoning leads to an important psychological conclusion. If you are to become successful in trading, you must learn to make losing routine. No doubt this sounds more than a little odd and counterintuitive. But think about it: If you treat each trade as a hypothesis regarding market direction ("Under conditions X, Y, and Z, I predict the market will do A in B time frame"), then every trade should be stopped out when the hypothesis is disconfirmed. Moreover, to avoid the risk of ruin—the loss of trading capital that results from the string of disconfirmed hypotheses that can be expected over time with any trading system operating under less than perfect certainty—you will want to put to work only a portion of your capital on each trade. This combination of stops and money management makes losing an ordinary event. A limited loss on a high-percentage trade is not a failure or a bad trade. If your trades are 50 percent winners and you can keep the average losses half the size of the gains, you will make a fine living.
Again and again, I have noticed this mind-set among successful traders: They treat losing trades as a cost of doing business. Like a baseball player who realizes that making outs on 60 percent of his at-bats will get him to the Hall of Fame, successful traders realize they will strike out on a fair number of trades. Their skill is in recognizing the sour trades as early as possible and cutting them short. Psychologically, they never internalize losing experiences, even though they may have many of them. Their interpreters simply don't act on routine events. Conversely, imagine the trader who wins on 9 out of 10 trades but gives everything back in traumatic, uncontrolled losses on the other occasion. It is not difficult to imagine the sense of self that will be internalized from such a roller-coaster pattern.
Kelly's role therapy would make an ideal counseling method for traders. Rather than focusing on eradicating personal conflicts, the trader would define an ideal self: the trader she always wanted to be. This definition would be rich and detailed, right down to the data collected by the ideal trader, the ways in which the data would be utilized, the entries and exits to be implemented, the money management employed, the mind-set adopted, and soon. This fictitious ideal trader would have her own name and an ideally laid out trade station. Her pretrading routines would be defined, as well as her end-of-day activities.
Then, with as much conscious effort as possible, the trader would implement this ideal without exception. Every signal would be taken, every stop honored, and every routine followed. I
f the trader indeed utilizes valid, tested methods, this enactment over time would produce the same results as my lecturing in graduate school. The trader would internalize successful experience and revise her image in the direction of her ideal.
You have to enact success before you internalize success. No one talks himself into a revised mental map. Powerful, nonordinary experience, not well-intentioned "positive thinking," is the fountainhead of personal change.
MODELING YOURSELF AS A TRADER
The foregoing discussion clarifies why models of the ideal trader must come from one's own trading experience, and not from fantasy. When I audited my trading results, I found that my most successful trades were short term, where I had clear hypotheses to test, definite action points for entry and exit, and a limited time horizon so that I could devote full concentration to the trade. When I held positions longer, I inevitably suffered larger drawdowns when my hypotheses did not pan out, creating far more emotional circumstances for managing the trades. This, in turn, generated scenarios in which I held bad positions too long, doubled up on losing trades, and otherwise shot myself in both feet. Under such emotional conditions, I could not internalize a positive model of myself as a trader.
If someone were to ask me to fantasize the ideal trader, I might think of some big-time operative who moves millions of dollars with each trade, like a Warren Buffett or a Peter Lynch. I learned, however, that this was not the ideal that best fit with my cognitive and emotional makeup. I am much more effective focusing on one market at a time, with sharply defined parameters for my hypotheses and risk management. I am also far more effective approaching each day as a fresh event, trading larger positions on anticipated intraday moves and strategically managing overnight exposure. What this means is that I will rarely hit home runs. In baseball terms, I am less likely to be a Roger Maris, a Hank Aaron, a Mark McGuire, or a Barry Bonds than a Tony Gwinn, a Rickey Henderson, or a Lou Brock. My goal is to strike out rarely and to get on base (and maybe steal one) as frequently as possible. That is less glamorous than the long ball, and it poses a significant challenge. In defining my ideals I need to first accept who I am and what I do best. I perform reasonably well as a brief therapist and a short-term trader. Speed is part of my game. Put me in a long-term treatment facility or make me a manager in a value-oriented mutual fund, and I will fall well short of my potential.
The best models always come from within.
PLAYING MARKET PINBALL
A seminal experience in trading psychology came to me during my college days when I passed my time by playing pinball machines. Overall, I was a very average pinball player. I would keep some balls in play for a long time and lose others within seconds. My flipper control improved with experience, but it never became so precise that I could hit targets at will. And I never mastered the body control that true pinball wizards use to nudge the ball into the right spots.
I was persistent, however; and generally, after a time, I could identify an anomaly in the machine I was playing: a particular maneuver that could rack up points. I would then exploit this anomaly time and time again and attain respectable scores. For example, one machine that I played had ramps on either side of the machine and a number of targets in the center. The tempting strategy was to catch the ball on the flippers and then aim for the center targets when they were lit. Although this led to occasional high scores when my aim was good, it also led to an unfortunate number of lost balls that drained down the center, between the flippers.
It just so happened one day that I was playing the machine and the ball came down the right ramp to my left flipper. My hand had strayed from the button and instead of catching the ball on the flipper or hitting the ball, I failed to engage the flipper at all. The ball then bounced from the left flipper to the right one. That seemed strange to me; I would have assumed that if you didn't use the flipper at all the ball would simply drain down the center. After numerous trials, however, I discovered, on this particular machine, that allowing the ball to hit the left flipper from its descent down the ramp invariably allowed the player to catch the ball on the right flipper. Once caught, the ball could be sent up the left ramp (scoring points) and would either then come down the left or right ramp. Either way, it could be caught again on the right flipper and sent back up the ramp. With a little practice, I could repeat this pattern dozens of times for each ball, accumulating points with each repetition. The amount of points gained was less than if I went for the center targets, but I very rarely lost the ball. As a result, I literally could play this machine all day on a single token.
To be sure, this did not make for particularly exciting pinball. It eliminated most of the sources of uncertainty by exploiting a high percentage pattern with great frequency. But the elimination of uncertainty and excitement was also a major reason for the success of the strategy. The game became almost entirely mechanical and routine, removing emotional interference from the play. Although I was never a great pinball player, I revised my mental map sufficiently to internalize the fact that I could be successful on that particular machine. Eventually, I discovered enough anomalies on various machines that I revised my maps one more time. Given enough time and experience, I became confident that I could locate anomalies in most machines.
It is interesting that those anomalies could only be discovered by pursuing odd and seemingly irrational strategies. Playing the pinball or video game the way the designers meant for the game to be played invariably created losses. For instance, years later, I was able to win in one video basketball game by taking only one kind of shot (a jumper from the corner). The game allotted this shot a sufficiently high percentage of made baskets that victory was assured. Varying one's shots or taking what looked like higher percentage shots was a sure way of losing the game.
To win in the markets, you only need to discover one such anomaly and play it consistently. Like a card counter in blackjack, you will still encounter uncertainty and losses. More important, however, you will have tilted the odds in your favor. With sufficient repetition, the results will show on the bottom line. And the interpreter will grab hold of those results and revise your identity as a trader accordingly. There are many different markets—commodities, equities—just as there are many pinball and video machines. The key is to crack the code, to find the anomalies.
And, as with pinball, these anomalies will be found when you investigate the counterintuitive strategies—buying when the market seems weakest, and vice versa. It is at the emotional extremes that markets are imperfectly efficient; you cannot win by playing the markets the way designers meant for them to be played.
I recently took pencil to paper and examined what happens in the New York Stock Exchange Composite Index ($NYA) following those occasions when 5 percent or more of the traded issues made new 52-week lows on a particular day. My investigation spanned the period from 1978 to 2001 and identified returns 150 trading days (approximately 7 months) into the future.
There were 442 days in which 5 percent or more of the issues traded that day had made new annual lows. These tended to occur late in bear markets, when pessimism was running high and selling was most indiscriminate. It is interesting that the market was higher 150 days later approximately 88 percent of the time and by nearly 13 percent. For the sample overall (in keeping with the bullish tendencies of the 1978–2001 period), 150-day periods tended to rise on 73 percent of the occasions, but only by 6.5 percent. Those who bought at times when there was significant selling achieved returns twice as great as the norm. They had figured out the pinball machine.
CONTRARY TRADING: FADING THE MAPS OF TRADERS
Such counterintuitive trades work for cognitive reasons as well. Your interpreter is always attempting to make sense of the markets, even as it continually reshapes your sense of self. Much of the literature of technical analysis, valid and not so valid, is a set of heuristics, or rules, that help your interpreter cope with the ongoing stream of market data.
Because a picture is worth
a thousand words and market charts encode a large amount of information in a single graphic, chart reading and the graphic display of indicators are a staple of most traders' arsenals. It is rare indeed to find a software package for trading that does not feature these elements.
Now there is nothing inherently wrong with reading chart patterns or interpreting oscillator displays. It's just that these reflect the way the pinball machine designers want you to play the game. It is unlikely that you will find the counterintuitive anomalies by trading moving average penetrations, RSI extremes, or other tactics built into every major charting program.
A more promising strategy may even be to trade against these shibboleths, taking the same seemingly irrational route that I followed when I chose to not engage my flipper. Trading against popular chart patterns is a particularly promising approach. Everyone is familiar with situations where people can perceive meaningful chart patterns in random number series. In any series of sufficient length, people are apt to see formations that look like double tops or bottoms, flags and pennants, and so forth.
If you think of chart patterns as market communications, you can see that an understanding of those communications needs to take context—those metacommunications—into account. Unfortunately, much chart reading does not do that.
The text of a communication is what is being said. The context of a communication is the set of circumstances surrounding the communication. You interpret most of what you hear situationally; that is, you draw on the context of communications to derive their meaning. A simple "How are you?" means something different when uttered by a doctor during an office visit than it does when spoken by the doctor at a cocktail party.
The Psychology of Trading Page 31