Monthly Archives: August 2014

Psychology, ‘edge’ and what they ACTUALLY mean in trading

Pin-ball ricocheting through the trading universe of gurus, systems, literature and hype I’ve been repeatedly irritated by everyone’s inability to define two persistent concepts. You’ll hear these tropes over and over…

  1. You need an edge
  2. Trading is 90% psychology

Well thanks you great and ponderous genii but what in heavens name do you actually mean?!?! You may as well be describing clouds to a fish for all the good knowing this will do.

Did I mention this ‘godlike pronouncement from on high’ nonsense irritates me? Oh and by the way, the definitions (when they do appear) don’t necessarily agree with each other. Brilliant eh? #facepalm

I’m feeling quite combative so in this post I will be sticking my neck way out there and proposing some proper definitions.

Let’s take a step back and roll out a big concept… To trade successfully you basically need these three things squared away.

Trading without attachment

Risk

Don’t risk more than you can afford to in each trade. Don’t trade an amount that has a negative impact on your ability to manage the trade or think rationally. If I have to explain to you why this is important we’re basically in deep s**t already.

A large part of the issue around risk seems to be un-realistic expectations which I’ve addressed elsewhere. Summary? Don’t trade like you know what you’re doing. This can be fatal. I will re-visit this in detail in another post and try to remember to post the link back here.

Edge

You have an edge if the trades you take over a statistically relevant period of time have a net positive expectancy. In other words… How you trade needs to make money over weeks, months and years. Your indicator diarrhea based, extensively back-tested blah-blah-blah is of no use if the execution is appalling. Does how you execute, manage and evolve as a trader net you profit over time?

Hand wringing about how you detail or characterise your ‘edge’ is pretty much a waste of time because all you need to know is whether you have one or not. To do this all you can do is look at your results.

If you make money then you have an edge. It is likely that this is the result of a ridiculous amount of study, losses, perseverance, pain, irritation, despair etc. then at some point this becomes familiarity, belief, success, euphoria, process orientation and ultimately boredom.

You should then be able to show/teach another person how you trade. You really know how to do something when you can teach it to someone else so clearly they can pass it on successfully to a third party you’ve never met.

At this point the student/teacher process breaks partly due to issues around risk but mainly because of the third leg of the stool…

Psychology Arousal Control

We make crappy decisions under conditions of emotional arousal or stress. Putting your wang in some random ’cause you’re horny and then giving your girlfriend an STD is an example of arousal leading to making a crap decision.

I’ve crossed out psychology and labelled it ‘arousal control’ because (again) no-one really relates to what ‘psychology’ as a word means in this context. Hopefully everyone has experienced what arousal is at one point or another but please don’t send me emails with examples. Thanks.

Arousal is when our focus narrows and our rational decision making goes completely out of the window. It’s when our monkey brain starts screaming like something trapped in a cage from 28 Days Later. It’s gibbering and throwing poop. Monkey mind needs to STFU because: –

  • If you manage your risk
  • as well as having a trading process that is statistically profitable over time
  • with a mind this is in an un-aroused state

then with these three things in line you have every chance of taking money out of the market in the form profits. With just one of these legs missing your stool will fall over.

So here’s the point of this post.

I used to be worried about my psychology with respect to trading and it would drive me nuts ’cause it’s such a huge topic. You read about it literally everywhere with trading, psychology, psychology, psychology AAAAARGH… I had literally no idea where to begin ‘sorting out my psychology’ and found this very demotivating.

Apologies in advance if the next part comes across as somewhat glib cause you’re not there just yet. It’ll take practice but what I’m going to suggest is very do-able I’m not special in this regard.

If you want to sort out your ‘psychology’ with respect to trading then you need to concentrate on removing the aspect of your response which leads you to make mistakes. It’s okay to have emotions, just not emotions that lead to you to make bad decisions. Even asking yourself simple questions when you are about to make a trading decision can have a huge impact at each stage. Take the arousal out of the equation by whatever means works for you.

The emotional part of your brain (when aroused) is a terrible trader so you need to practice managing it when engaged in this activity. This is why gurus and the trading literature keep banging on about following rules. Ironically having rules and being discretionary cannot logically fit into the same box – hence discretionary trading is hard to teach.

Having been able to observe what I do/did and then dial back the monkey/arousal part of my brain when I see it kicking in means you’re now seriously tipping the odds in your favour.

How have I managed to actually do this?

You can’t change a behavior till you know it from every angle in order to combat it. It will seek to continue doing it’s job because there is a reason for it’s existence – just unfortunately when trading it’s not useful.

The job of this part of the brain is to hyper focus in case of danger or ’cause you’re going to have to fight someone else for the chance to mate. Your job is to trick this part of your brain to back off so your more rational/experienced/conscious and process driven thinking can help you make the most of the dice roll trade.

Which is where the other two legs come back in. If your risk isn’t in control this is very hard to do. If you haven’t got a clue how/why your trades make money then quieting the monkey will be extremely difficult if not impossible. Let’s assume you’ve got these two parts sorted though… What else can you do to help re-frame what you’re doing?

  1. Rinse as much emotion as possible out of the event you’re engaged in. What happens next must have absolutely no bearing or impact on your life, self esteem, emotions, hopes, fears or dreams. Win/loss or whatever means nothing. Consciously think about this when looking at getting into or managing a position. Breath deeper if you need to.
  2. Really treat this experience as an opportunity to learn more – especially at a physiological level. With practice you can observe/feel your mind and it’s almost like trying not to go over the edge (ahem… you know what I mean). If you going to make a knee-jerk reaction based on your mind running about then STOP and don’t do anything till you’re sure you are going on something you can justify – a proper REASON has to exist for you to take action
  3. Do not engage in the mental gymnastics associated with chains of events. You may have taken three losers (or winners!) in a row. Taking or managing this trade has completely bugger all relationship to anything that went before. Don’t fall into this trap. Events that follow each other are NOT correlated at all in any way. I can’t overstate how important this is.
  4. Do not look at your P&L – if you want to mess yourself up emotionally by 200% then feel free to do this. This is partly related to point 3 above of course. You’re involved in a one off single and unique event – stop dreaming about the Ferrari
  5. Breathing – like any stressful event just breathing and being an observer is a very effective way to ‘step back’ from what you’re looking at. In the end though (like everything) it takes practice over and over again. Keep practicing keeping your mind in check.

Having finally realised this I’ve stopped worrying about my ‘psychology’ and have been focusing on dialing back my emotional knee-jerk reactions when executing and managing trades. This has meant I’ve actually been looking at what’s happening, following my rules (edge), managing risk and taking the emotion out of each event.

In some ways the fact I’ve previously meditated regularly and still do this (not as often as I should) gives me an advantage because I can usually take a few breaths and step back from the ‘omfg it’s going against me I’m a terrible human being I’m never going to make it why did I get into this position what am I doing with my life‘ insanity. After all, it’s only a trade and I didn’t bet my house/car/self-esteem on it.

Practice taking a step back, looking objectively at the trade as a single, un-correlated event and things begin to sort themselves out. Practice this 100 times and it begins to be less of an issue.

Update: +22 | +2 | -2 | +0 | +24 | -10 | – 8 | +10

My particular problem right now? I’ve not had enough practice doing this when my trades are in the green ’cause that last one should have been +30 😉

brain

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Some new observations about psychology and so on

It seems my post title’s need work since I may as well call this one ‘blah, blah, blah, blah, blah.’ but let’s go with it anyway… I’ve long stopped being concerned about turning this blog into a ‘thing’ since I write here to help clarify my own thoughts rather than add more noise to the signal.

As an aside I went through ‘wordpress’ list of ‘blogs I follow and ended up deleting 60% of the entriest since most people who were active 1-2 years ago seem to have stopped writing.

My own post frequency has died on it’s arse since I’m focusing on doing rather than writing about stuff and then NOT doing anything. It seems every time I come back to WordPress they’ve also changed the UI… shows you how big these gaps are becoming.

However I felt beholden to recommend the following book (not a trading book) and make an additional observation since it might help someone out there. Off we go…

Struggling with placing trades

So here’s the thing… I’m sure I’ve written about this whole topic before. I have a few persistent behaviors I get into when looking at placing trades. Some or all of these may occur: –

  1. I look for confirmation of my idea by other traders
  2. Manage to talk myself out of placing the trade at all
  3. Get scared off by the big red/green candle and don’t do anything

Issue number 1 is simple to fix. Don’t canvas other people’s opinions or spend too much time worrying about everyone else. Since it really has to come down to me in the end the opinions or others are essentially meaningless.

Issue numbers 2 and 3 are allied to that basic human emotion of fear. That part of your brain which has been programmed since time immemorial to stop you taking risks. Since science-fiction like reprogramming options aren’t available it means the only option is to re-frame the conscious decision making process around the circumstances of placing the trade.

So on to the serendipitous solution where I ran smack into The Obstacle is the Way by Ryan Holiday. Which can be summarised as follows…

The one thing you must do is, by definition, outside of your comfort zone. Avoiding or hoping for the perfect circumstances before proceeding is foolish and delusional. The obstacle lies in the path which must be taken since victory doesn’t come from fleeing from the battlefield.

The book describes how seeking comfort or ‘ease’ is actually robbing us of our capacity to evolve and experience new things. Taking on the experiences that scare us knowing that these are the exact things we must become familiar with is immensely powerful psychologically. I’ll prove this point with my own experiences later on.

Struggling with change in general

I am not happy with certain aspects of my life. There are characteristics, habits and behaviors I have which I don’t actually like very much.

  1. I eat chocolate when I’m stressed at work and don’t sleep for long enough
  2. I don’t eat particularly healthily anyway which compromises my time in the gym
  3. I waste a lot of time consuming media (films/games) instead of creating (I love to write) or spending time learning new skills
  4. The list goes on…
  5. and more…

While this intersects with some of the ‘avoidance’ behavior of my lizard brain not wanting to expose itself to change/risk/the unknown I heard something the other day which literally scared the crap out of me.

There is no future version of yourself. The person you are now is the person you will be in the future.

I had recently spent some time getting my head around the fact that if I actually did want to have a different life then the person I’d have to be would have to be significantly different… and then… nothing happened. Once I heard this phrase the reason became very clear.

I hadn’t been making the effort to change my habits in the present because some ‘amazing future version of me’ would have it all nailed down and it would happen ‘in the future’. In the meantime what I had was an amazing way of excusing myself for my lack of effort, focus and will-power.

All of my less than optimal habits associated with how I use my time, pursuing my goals around trading, diet and fitness have been deferred to this amazing future me.

The ‘future version of me’ will never ever appear unless I focus on changing the only version of me that actually exists. The person I am now – in this moment

So I am in the process of continually reminding myself the ‘future me’ (who I have dearly loved and cherished for many years)  has to die. I’ve never been one for reminiscing about the past – as anyone who has encountered my shocking memory will know – but I’ve previously held on very tightly to ‘someday’.

It appears this is not a profitable belief so it’s going to get crushed.

Ah yes, taking on experiences that ‘scare’ us

There’s a lot more behind this which I’ll go through in another post but by accepting the obstacle as part of the path I’ve actually had these results +22 | +2 | -2 | +0 | +24

I know 5 trades don’t make a track record (at all) but these are the ones I’ve taken within this new mental framework. Way less mental pressure and actual emotional distance from the whole experience. I might even say ‘fun’ 😀

Thanks for reading

Rob