Many times, it is possible to identify and to angrily challenge the internal dialogues that accompany trading problems. Earlier I mentioned the example of a trader who becomes upset when he misses the price high on a short sale or the price low on a purchase. He waits and waits for his stocks to return to these levels so that he can stop berating himself for the missed opportunity. Instead, he finds himself missing entire trending moves—and beating himself up even worse!
By focusing his attention on his perfectionism and venting his frustration toward his perfectionistic "tapes," he can distance himself from this destructive pattern and enter positions once trending moves are under way. Each time he feels tempted to engage in picking tops or bottoms, he has to vividly imagine the consequences from his worst trades and direct his anger at his perfectionism. At times, this might mean shouting his angry reaction aloud, confronting the perfectionistic thoughts as an enemy. Associating his old pattern with pain instead of safety, he will be able to accept taking pieces of market moves, perhaps viewing the "missed" portion as an insurance policy that helped guarantee that the odds are tilted in his favor.
Like Dave, this trader learned that it is very difficult to identify with a pattern he hates. Anger is sometimes construed as a negative emotion. It is, in fact, a potent tool in the arsenal of those who would trade from the couch. If you can identify a repetitive pattern that interferes with the attainment of your goals and if you can make this pattern your enemy, expressing all your frustration and rage at it, you will have changed your relationship to yourself. Instead of identifying with the problem, you now become a fighter combating the problem, reinforcing your will—and your control. Note, however, it wasn't just anger that shifted Dave, but the experience of total rage. Once again, the extent of the leap created the rapidity of the change.
Chapter Fourteen
Trading from the Couch
The greatest changes you can make are already occurring.
In these pages, I've attempted to open the door on the therapy room. We have entered the heads of people like Ken, Sue, Phil, Mary, Jack, Dave, Walt, and Joan. We have also looked inside the counselor's head, exploring how human change processes require far more than simple talk. Perhaps we can now pull together some of the lessons from these case examples and summarize how they can enable you to become a more effective trader.
PROPOSITIONS FOR TRADING PSYCHOLOGY
Time and again, you have seen that the ways in which people are wired to process information clash dramatically with the ways in which they need to be wired to effectively trade the markets. It is for this reason that becoming a successful trader very often entails becoming a different sort of person. Success in the markets is less a matter of learning one or another psychological technique than it is systematically developing one's capacities for sustaining effort and purpose. The parallels to weightlifting strike me as particularly apt: Progressive, sustained, targeted efforts result in extraordinary development.
How can traders begin to develop gymnasiums for the mind and the spirit? Following are 11 of the major themes explored in this book. Together, they form a framework for understanding the psychology of trading and the steps to be taken in self-development.
1.Behavior is patterned. You observe patterns in the markets. You appreciate themes in music and literature. Human behavior is similarly organized. Rarely do you have 12 different problems. More likely, you experience a single, general problem pattern that is manifested in a dozen ways. You cannot change by focusing on each concrete manifestation. The key is changing the underlying pattern.
2.Your trading patterns reflect your emotional patterns. The patterns that interfere with trading are usually extensions of patterns that are present in other areas of your life. The field of behavioral finance has identified information-processing biases that systematically skew decision making, especially under conditions of risk and uncertainty. These biases include overconfidence, endowment effects, and frame-driven biases. Other biasing influences that affect trading are extensions of maladaptive patterns from your personal history. If you become overly enmeshed in your personal relationships, you are apt to enact a similar pattern in your trading. Conversely, if you have difficulty in maintaining commitments in relationships, you might also have difficulty maintaining commitments in trading. Much of problem tracing is a generalization of the cognitive biases and emotional influences that are present in daily life.
3.Change begins with self-observation. It is impossible to break a pattern unless you can see it happening in real time. Most patterns are automatic; you don't recognize when they are occurring. Before figuring out what you should do in a positive way, it is important to stop doing what isn't working. Typically, that means interrupting problem patterns when they first appear and distancing yourself from these patterns. Because such patterns generally appear across numerous facets of life—not just in trading—much of your daily experience can fuel your self-development as a trader. Intercepting and redirecting anger and frustration toward a spouse, for example, will provide powerful fuel for mastering the same emotions during trading. You begin the process of change when you sever your identification with your problem patterns, and you continue that change when you initiate identifications with positive patterns.
4.Problem patterns tend to be anchored to particular states. If there has been a dominant theme in this book, it is that people possess multiple streams of information processing, owing to the brain's division of labor. Some of these streams are verbal and explicit; others are nonverbal and tacit. The ways in which you blend these modes creates distinctive states, each with its own unique experience of self and world. When you enter a particular state through emotional, physical, or cognitive activity, you tend to activate the behavioral patterns associated with that state. As a result, you move in and out of problem and solution patterns many times a day, as your state of mind shifts in response to external, daily events. This vulnerability to state shifts undermines your ability to sustain purpose, making it difficult to adhere to such disciplines as diets and exercise programs. To the degree that you cannot sustain your intentions, you are unlikely to consistently profit from even the best-researched trading plans.
5.Our normal states of mind, which define most of our daily experience, lie within a restricted range of our possibilities. Your immersion in daily routine keeps you locked in routine mind states. This traps you in problem patterns that have been anchored to these states. The heart of counseling is the introduction of new, constructive patterns during times when a person is operating outside of their emotional, physical, and cognitive norms. Attempting different change techniques—such as positive imagery or self-talk—is unlikely to succeed if those techniques are administered during periods of normal, routine functioning. The psychological techniques that are most powerful in accelerating change create positive traumas, providing new experiences during extraordinary states of cognitive and emotional processing. Ordinary human consciousness—not necessarily any abnormalities associated with mental disorders—is the enemy of profitable trading.
6.Most trading occurs in a limited range of states, trapping traders in problem patterns. Traders tend to place greater emphasis on the data they process than on the ways in which they process those data. What you are capable of seeing is determined, in part, by the mind state you occupy. When you are processing the self-relevance of information, you tend to suppress your processing of patterns within that information. This creates distortions in the ways in which you trade, as you make decisions more for psychological reasons than for logical ones. You have seen that traders often occupy different states while they trade compared to while they research and plan their trading. Markets possess the uncanny ability to activate patterns associated with emotional arousal and cognitive bias. As a result, traders find it especially difficult to stick with trading strategies, even when these have been well formulated.
7. People in general, and traders specifically, enact solutions as well a
s problem patterns. If a person were wholly dysfunctional, he or she would not survive. Most people have dysfunctional patterns, anchored to specific states, and exceptions to those patterns, which are anchored to different states. The challenge is, thus, one of making the shift from one set of states to another. Identifying constructive patterns that already exist and learning to access them in an intentional manner is one of the quickest means of psychological change. This requires self-observation with a different focus. The purpose is to identify occasions of success in formulating and following trading plans. The goal is to become highly aware of those situations—within and outside trading—in which you do function as a highly intentional human being. Once you distill the essence of what you are doing when you are at your most intentional, you will be better equipped to recruit those capacities in trading.
8.Although emotional mind states are associated with distortions in the processing of market information and in trading, eliminating emotion is not necessarily the secret to improving trading. Removing a negative will not, in itself, create a positive. Traders can utilize positive emotional experiences to identify constructive solution patterns and to create an anchoring of new, positive patterns. Successful traders appear to cultivate new trading methods, based on careful observation and research, and to anchor those methods to distinctive cognitive, physical, and emotional modes. In so doing, they become highly attuned to market patterns. These traders also become sensitive to markers of change in those patterns, much as therapists are attuned to their clients. Effective traders thus experience significant emotion, but they do not become lost in their feelings. They have so finely calibrated themselves that they can utilize their emotions as market data, informing their research strategies.
9.Success in the markets often comes from doing what doesn't come naturally. An important research study conducted by Charles Lee and Bhaskaran Swaminathan at Cornell University found that high-volume rising stocks tend to continue to outperform the market over a period of months, but they subsequently underperform over a period of years. (The Nasdaq tech stocks from the late 1990s through the early years of the twenty-first century are a prominent example.) Lee and Swaminathan refer to this phenomenon as a momentum life cycle. My own research suggests that these life cycles occur on even shorter time frames, especially within the noisy equity futures markets. The market that rises on high volume and high TICK tends to continue upward in the short run and then correct. Conversely, when large pluralities of issues are making new lows, some of the finest prospective returns on the long side are seen. It is human nature to extrapolate trends into the future and to climb aboard high-momentum markets and seeming breakouts. It is also human nature to become committed to these positions, even in the face of evidence that they are not working out. Traders' emotional reactions to the markets serve as hypotheses for how other traders may be responding—which, ironically, may be the worst way to play the inevitable reversals of market life cycles. Emotional tugs to enter a roaring market or to abandon a plunging one very often point the way to successful contrary trades.
10.The intensity and the repetition of change efforts are directly responsible for their ultimate success. The new, constructive patterns that are likely to stick are the ones that have become associated with highly distinctive states of mind and that have been overlearned. Conditioning new patterns to a distinctive state of mind makes it easier to summon those patterns any time you reenter that state. This connection becomes internalized most readily when it has been rehearsed intensively. It is rare that insight alone will create change; more often, doing things differently allows you to make the change part of your ongoing repertoire. The greatest challenge to changing yourself as a trader is also the greatest challenge to change in therapy. It is relatively easy to initiate change, but it is far more difficult to sustain it. Without consolidation, people are likely to relapse into their habit patterns. An essential ingredient in change is to repeat a desired pattern again and again in the same way, at the same time, in the same situations on every occasion that presents itself. At first, enacting new behaviors will require conscious effort. With repetition, however, the behavior becomes automatic, an internalized part of the self.
11.Trading success is a function of possessing a statistical edge in the markets and being able to exploit this edge with regularity. Trading failure is most likely to occur when you trade subjective, untested methods that possess no valid edge or when you are incapable of consistently applying edges that are available. Improving your psychology as a trader by itself will not confer an objective edge. Developing or purchasing a valid trading system will not in and of itself make you a great trader. The development of trading systems and the development of yourself as a trader thus must proceed in concert. You are only as good as the methods you implement and as your ability to implement the methods. My very strong sense is that the process of discovering patterns in the market and of formulating plans for trading these helps to cultivate those very capacities for sustained effort and purpose that subsequently empower trading. Immersion in the markets as an analytical, neutral observer enables traders to remain neutral and analytic during periods of market turmoil and uncertainty.
Changing yourself as a trader requires the recognition that you are every bit as patterned as the markets you're trading. Change begins with repeated and intensive self-observation. Keep a journal of all trades, the reasons you made the trades, the states you were in while placing the trades, and the outcomes of those trades. Over time, isolate the trades that went awry and the patterns common to those. Then isolate the successful trades and their shared ingredients. Imagine that, trapped within you, is a self-destructive trader about to go bankrupt and a master trader poised on the brink of success. How does that self-destructive trader make decisions? How does that master trader operate? Once you can answer those questions, you are better positioned to do less of what doesn't work and more of what will bring you to your goals.
I strongly suspect that even the most successful traders have a constructive side and a destructive side—a self that is capable of mastering the markets and a self that is capable of implosion. The traders who are ultimately successful have found ways of continuously accessing the mastery they possess. The ones who fail may be every bit as knowledgeable and experienced, but they remain locked in states that undermine their goals. Overcoming problem patterns is only half the game. The equal challenge is to cultivate successful patterns that can be invoked at will. This is only possible to those who have developed a high degree of intentionality—the capacity to sustain significant effort and purpose.
CHANGING YOUR MIND: APPLYING THE PRINCIPLES
It is not uncommon in counseling to hear people lament, "I know what my problems are, but what can I do about them?" Intuitively they recognize that insight is necessary but not sufficient to generate and to sustain change. Once you know, it becomes time to do. What can you do to effect change now in your trading patterns?
Change, like problems, follows particular patterns, many of which are illustrated by the counseling cases from the previous chapters. If you distill these change patterns, however, you can see that there are three broad change strategies that are of greatest relevance to traders:
1. Dampening intrusive emotional patterns. It is not unusual to find particular emotional reactions interfering with the processing of real-time market information. This is why so many traders believe that the holy grail of trading psychology is to eliminate emotional influences altogether. When you notice a pattern of anxiety, euphoria, discouragement, or self-blame interfering with your trading, the first step is to identify specific situations that elicit the emotional reaction. For instance, one trader might overreact to missed opportunities; another might face his or her strongest reactions when handling larger positions.
Knowing what "pushes your buttons" is half the battle. This requires cultivating the Internal Observer, your ability to stand back from your immediate situation and perceive the p
attern that you are enacting. Keeping a journal is a helpful method for developing the habit of self-observation, as is meditation. I have generally found that slowing the mind and body and removing myself temporarily from situations goes a long way toward activating my Observer.
Once you have identified the triggers for these disruptive emotional reactions, it is possible to dampen the reactions by repeatedly exposing yourself to the triggers under controlled conditions. For instance, if you find yourself reacting to declining markets with anxiety and self-doubt—even when you don't have a position on—repeated exposure to declining markets, in paper trading and in real time, can be very helpful. The key to controlling anxiety is performing a highly non-emotional activity during the exposure. Relaxation exercises under conditions of intense cognitive focus, for example, can be performed during the exposure to declining markets, as you literally train yourself to respond less emotionally to the downdrafts. It is not necessary to wait for actual market drops to perform this exercise; invoking meditative calm while vividly imaging declining markets can also prove useful. As mentioned earlier, performing such exercises with intensity and frequency will cement the new pattern, allowing you to respond to actual declining markets with greater calm and focus.
One variation of this exercise, derived from eye-movement desensitization and reprocessing (EMDR) therapy, involves engaging in a boring, routine pattern while exposing yourself to a highly emotional market situation. One pattern I use involves repetitively tapping fingers on my knees, alternating one and two taps on the left and the right knees. The boredom of the routine pattern is paired with the emotional situation (such as a stop being hit), extinguishing emotional reactions and allowing for a more neutral processing of market action.
The Psychology of Trading Page 39