SnapTrader

Trading Psyche – Exuberance

2011-11-16T19:21:00.000-08:00

Over the past several weeks I've been posting short articles that relate the psychological aspects of trading. Each post has focused on a particular emotion that we may encounter as traders, and that ultimately we need to deal with in a productive way. Today that emotion is Exuberance. In the words of Alan Greenspan, we might also call it Irrational Exuberance.

I hesitate to call this a rookie emotion, although I do feel that some amount of experience gradually helps us conquer the irrational aspects of this oh-so-good feeling. Conversely, any amount of experience doesn't remove it completely. The specific concern here is that traders might be overly optimistic about their chances for success.

Trading is a tough game. It's hard to be profitable. It's hard to compete with some of the most talented, smartest, and resourceful money managers in the world and do better; yet, that's what we try and do. I'm not trying to be negative, only to be realistic about the fact that trading is a business, and it's a tough one that requires a lot of determination and effort.
I'm not completely sure why this is the case, especially with new traders, but I've often thought that the financial education industry breeds it.

Do you remember the first (or last, or any) really good trading book you read? Do you remember closing the cover thinking, "I can do this!" Do you remember the seminar that you went to, coming away feeling confident that the method you just learned would work for sure? The financial education industry has to sell it that way, otherwise who would attend the seminars and buy the books? Have you ever seen anyone sell a seminar by saying, "This is really tough and we'll try to show you how, but most people will fail... sorry." That's not the way they sell them.

I'm not saying you shouldn't seek out and invest in financial education... you should. But we need to be realistic about what it is. Nobody walks away from a university with an MBA with the kind of optimism that comes out of a two-day seminar. I find that interesting. Bottom line: This is a business, and should be treated as a business. Yes - get an education and learn the business as you would any other. Practice and get experience, as you would in any other business. Here are a handful of things to put this idea in perspective:

Start slow... Again, using the perspective of trading as a business, it's not typical for businesses to start out making money hand over fist. It does happen, but rarely. Plan to take some time. Learn and practice the craft of trading before you try to become a professional.
Guard your cash... In any business, cash-flow is critical. When things aren't going well in a business, companies guard their cash. They cut expenses and reduce risk. It's not different in trading. Cash is part of your trading inventory and must be protected to stay in business.
Have reasonable expectations... I've been in business for a long time and I have a pretty good idea when I look at a business plan whether or not it's reasonable. In most business growth comes slower than expected. We need contingency plans. Trading is no different. Have reasonable expectations about how long it will take to be profitable consistently, and about how much profit there will be. Can you make 15% in a month. Sure... on a single trade. I do it all the time. But to produce large returns on a portfolio over long periods of time is very difficult.
Develop a business plan... Most good businesses have a business plan. Virtually all start-ups that want funding require it. Trading is the same... you need a plan. It should contain your beliefs about the market, your personal approach, specific strategies, money management, personal trading policies, and anything else that guides your trading. I have a well developed plan, but it remains a work in progress, and always will. Just like in any business, we are always learning, trying new things, and adapting to new market conditions.
Review it frequently... Not only does my business have a good business plan, but we review it regularly and make significant updates. Likewise with trading... having a plan is crucial, but it's worthless if you don't use it. A trading plan is a map that will not guide you to your destination unless referenced. I personally review my plan in total monthly, right after each options expiration, and I refer to parts of it more frequently.
Keep good records... Can you imagine a serious business that didn't keep good records? Actually, I can. I've seen them and it's not pretty. Poor record keeping and documentation is an indicator of a poorly managed company and ultimately failure. In trading, I log every single trade. I refer back, particularly to my losers, and evaluate the trade after the fact when I can see all the facts. This is invaluable in learning and improving.
Strive to improve efficiency... Just like in business, trading gets better and more enjoyable as we become more efficient. For me, as a working stiff, it's also a requirement. Over a long time, I have been able to streamline many aspects of my trading exercises, but I am always looking to make it better. I want to spend as little time for as much profit as possible... not unlike any business.

I'm sure there are many more parallels to trading and business that we could learn from, but the main message here is, let's not get deluded into thinking that we can just follow some strategy we read in a book, put on a few trades and our pockets will be overflowing with money. That's Irrational Exuberance.

Good Trading...

Trading Psyche – Introspection

2011-11-07T19:42:00.000-08:00

According to Wikipedia:

"Introspection is the self-observation and reporting of conscious inner thoughts, desires and sensations. It is a conscious mental and usually purposive process relying on thinking, reasoning, and examining one's own thoughts, feelings, and, in more spiritual cases, one's soul. It can also be called contemplation of one's self, and is contrasted with extrospection, the observation of things external to one's self. Introspection may be used synonymously with self-reflection and used in a similar way."

In two words you might summarize the above paragraph as: know yourself. In the world of trading, introspection refers to knowing yourself well enough that your trading style, strategies, and practices are in alignment with your beliefs, limitations, and other constraints that might come as part of our emotional baggage.

Part of taking control of one's psychological edge in trading is to find this alignment. Without it you are working against your very nature. It's a bit hard to explain, but let me try with an example. I know myself well enough to know that I simply can't stomach large losses. Huge draw-downs can be taken in stride by some, but not me.

When I have experienced large losses I found that it was so discouraging that I wanted to give up. It caused me to throw away all of my trading guidelines and policies and things just went from bad to worse. This is when the negative characteristics of Fear come into play. Consequently, I try to develop systems that don't trade that way. I use conservative strategies that produce a good number of wins compared to losses, and losses, while never welcome, are kept at a tolerable level.

Here's another one... I also know that I can't tolerate lots of losses, even if they are small ones. It just doesn't fit my makeup. I'm an optimist and I like my optimism to be fed by lots of victories. I have developed several nice trading approaches that have about a 50/50 success rate, but they work because winners are much larger than losers. I don't like them. If I don't see 65-75% winners (or more) it's just not fun! So, I use approaches that have a high frequency of winners.

Hopefully those examples help with the ways you might know yourself; and here are a few other things to think about as you self-reflect:

Know your trading style: This refers to the examples I gave above. What can you tolerate? What do you like to see? What causes your stomach to churn?
Know your strengths and weaknesses: Some people are great technicians. Others aren't. Some are great money managers, or have great intuition.
Know your physical limitations: I have mentioned many times (it’s the theme of this blog) that I work a full time job. I can't day trade. I need to be able to enter order after hours, and can't even do that too much. Swing trading and Theta positive trading fit my constraints nicely.

There are many other topics on which to self-reflect... these are just a few. The point is, everyone is different when it comes to their psychological makeup and how it's applied to trading. People bring different beliefs and experiences to the table. Knowing yours will help tremendously so that you trade in alignment with those beliefs and experiences, rather than against them.

Good Trading...

Trading Psyche – Confidence

2011-11-01T17:43:00.001-07:00

In this installment exploring the Psychological Edge of trading, I want to briefly discuss the role of Doubt, or said in a negative light – Doubt. In some ways, Doubt is a predecessor to Fear. It seems to touch all of us, and in time will grow into a level of Fear that will cause us to behave differently.

As a retail trader - a working stiff just trying to invest his money wisely - it's VERY easy to think that the Wallstreet guys are smarter than I am. After all, they're making the big money, living in the big city and cruising around in their yachts on the weekend. But the truth is they're not. If you doubt that, just check out the results of most hedge fund and money managers for 2008. The vast majority got completely trashed in that difficult year.

The only reason I bring this up is that the slightest wrinkle in my performance will sometimes cause me to doubt my ability to return a consistent profit. The irony of this is that a little inconsistency in performance may cause me to change my trading approach. In other words, one inconsistency leads to another and the vicious downward spiral begins.

What to do: I hate to harp on this subject yet again... well... but here I go. In my view, it's crucial to have a trading plan with a very clear and actionable set of rules. It must have a quantifiable edge. I know that this series of posts is about our psychological edge, but one edge improves when the other improves. Without confidence in our system and approach we will spend way too much time second guessing ourselves, rather than just trading the plan.

Your psychological edge needs a foundation on which to rest that cannot be shaken. Whenever I doubt myself I always go back to the foundation - the plan. I do the math. I review the edge, I evaluate the execution. Did the plan fail me or did I fail the plan? If things aren't working it's usually the latter.

Without the solid foundation of a sound trading plan you have no guidelines when Fear and Doubt come into play. In other words, if I'm going to be Confident, I need something to be Confident about.

Doubt also leads to confusion. It keeps us questioning our approach and constantly looking for the next great trading system. Commit to a philosophy and proven trading plan and stick with. Only by doing this will you master the approach and build the confidence that leads to what I call GrinVesting.

Good Trading…

Where does the market go from here?

2011-10-25T18:57:00.000-07:00

If I were a serious technical analyst this chart might look really interesting… or scary. The ES (SP500 Futures) has clearly moved into a new trading range, with increased volume supporting it. We are tapping on the pink line of resistance, but the volume has become unimpressive as price has moved up.

Interestingly, if you look at the longer term view, we are now trading in the range where we spent most of 2010. Should we break below the grey box… look out below! It’s a long way down.

This morning I entered the market with only short positions, and quite a few at that. It wasn’t because of this picture, but this sure makes be feel better… and today was a pretty good day.

Good Trading…

Trading Psyche – Volatility

2011-10-25T06:44:00.000-07:00

In my recent series of blog posts on the psychological aspects of trading, I've addressed several specific emotions that traders experience - such as Fear, Patience, Resignation, Greed, etc. While Volatility isn't actually an emotion, I'm using it to refer to the vector and velocity of our emotions, rather than the markets. Are they up? are they down? How are those trading mood swings?

Managing the direction and extremes of our emotions is a critical part of the trader's psychological edge. Specifically, I'm talking about the things that cause us to have up days and down days. What are those things? What are the things that cause us to feel good about our trades or bad about our trades? More importantly, what influences do those feelings have on the next trade?

For me to be successful, I need to be somewhat in control of how my emotions effect my trades. Below I've collected some items that are food for thought. These items might be warning signs, or at least things to consider if they influence your trading at all.

Does the market determine your mood? We live in a world where very few people manage their money actively. Most are content to hand it over to a money manager, or just put it into the "recommended" 401k fund. As a result, their balance ebbs and flows with the markets. When they markets up, they are geniuses for entering that fund. When it's down everyone feels bad about it. What to do: As active traders, it helps to simply recognize that we play by a different set of rules. We actively manage our accounts and the market makes little difference to us.
Does the market influence your trading strategy? Ah... now were getting to a little more practical question. Are we listening to the market pundits, seeing big rallies and plunges, and altering our strategy? Movements, big and small, are a part of the market dynamics and they will happen. I think you could drive yourself crazy if you adjust your trading strategy after every rally or pullback. More importantly, you could end up chasing the market movements which is a sure strategy for losing. What to do: At this point I have to hearken back to what I've said so many times... It's crucial (at least for me) to have a set of trading rules and strategies that you can have confidence in. In other words, I need to trust my trading plan in good times and in bad. I admit it's not easy - that's why this part of trading is so important - but it's important to see each new trade as "just another trade".
Do recent wins and losses influence your strategy? It's very easy to let the most recent series of events influence our trading execution. When things don't go well we want to "tweak" the system. When things go too well we want to "tweak" the system. I'm not saying that trading plans never need refining, but we don't do it in the heat of battle. As I write this, I'm experiencing this right now. I'm having a down day and wondering if my strategies are right. Deep down, however, I know they are right and it's easy for me to quickly dismiss those feelings (although, ask me again after a series of these days) What to do: As I said above, when you have confidence in your approach, a losing trade is "just another trade"... same with a winning trade. If you find yourself gloating over winners and complaining about losers, you may soon find your trading influenced by these recent events. Losses are rarely as bad as they seem, and gains are rarely as good as they seem.
Does the news influence your trading choices? This is a tough one, a there are really important news events that one might think hard about before making certain trade choices. Then of course there's Cramer, Fast Money, and the rest of the talking heads spewing a continuous stream of recommendations. What to do: How you handle news depends on your trading plan. Personally, I am a technical trader and I completely ignore it. There have just been too many times that a horrible news report sends the market into a big rally, or a seemingly good story causes it to drop. I have developed a plan that is simple to follow and is purely based on a set of technical rules. That, however, might not be part of your trading plan. If news is important in your trading plan I give this advice: See if you can figure out a way to quantify it. If you can't do that then decisions become very subjective and it's hard to know when to take what action.
Do you let the market determine your trading "style"? This of course follows closely to the points above... the point is that we should be cautious of changing our approach based on recent events in the market. One of the common ways to get whipsawed in the market is to chase trades and to trade according to different rules after up and down days. For example, you might lift a hedge after a couple of good up days - only to see it followed by a down day. Or you might remove that "insurance" Put you have on a condor after a little rally, only to see it pull back. What to do: The above examples are signs (to me) of discretionary trading. There are a handful of people in the world that have enough intuition to be discretionary traders, but I don't believe it's the rule. The rest of us need a time tested trading plan with a group of strategies that we have confidence in.

I know I've repeated this theme of "trading rules" a dozen times in this series, but it really is one of the greatest ways to conquer emotional trading. When it doubt, follow your time tested rules. When you feel like things aren't going well and you don't know what to do, just follow the rules.

I will close by sharing a rule from my trading plan. I have a list of what I have labeled "Policies and Practices" in my plan that includes a number of things that support by beliefs about the market. One of them is this: "Never change the rules while a trade is on." It's simple, but critical. Changing the rules in the middle of a trade is tantamount to discretionary trading, and I don't have that ability. If I question one of my trading strategies I will stop trading it, do a thorough evaluation and then determine if I should continue to use it.

Good Trading...

The 10 Attributes of a Great Trader

2011-10-04T00:11:00.001-07:00

I’ve been incredibly busy lately, and not posting much. I will be resuming posts on the psychological aspects of trading shortly, but in the mean time I thought this great article from John Netto was fitting:

The 10 Attributes of a Great Trader

Over the course of my 20 years in the trading arena, poker business, and sports oddsmaking, certain inalienable qualities seem to resonate in those exhibiting consistent success. The process to acquire this skill set is by no means assured and represents a constant work in progress. A process invariably leading us through multiple peaks and valleys, calling into question what compels us to compete in a trading arena that oscillates so easily from unimaginably predicable to perversely difficult.

These attributes are applicable on a much grander scale, as they transcend the world of trading and investing. If you're reading this article, odds are you possess a certain entrepreneurial zeal and penchant for taking on risk. Great leaders, doctors, lawyers, and other prominent people in society will usually possess many, if not all, of these qualities.

These 10 attributes are so important that they make up the core training I conduct for those that attend my mentorship program, any in person multi-day workshop, or those who decide to invest in my fund. They are not listed in any particular order of preference, as all have great significance and overlap with each other. I implore you to use them as a template to decide what is important and how to incorporate them to make substantive improvements to your trading and personal life.

1. Heart/Courage
Trading is a business necessitating one does things causing some degree of consternation from time to time. Trading is an institution yielding few victors at the end of the day. As a result, having the ability to buck the crowd is something which can help you achieve great things. An example of this occurs when a trade setup happens and one must battle the potential pain of a losing trade with the desire to make money. In hindsight, many of these spots look easy after the fact, but the truth remains in real time one must have a great deal of courage to pull the trigger.

2. Intuition
A qualitative virtue recognized by few and held by even less. Our intuition is the byproduct of the analysis performed by our subconscious. It acts much like a muscle and requires exercise to develop and grow. Like a muscle, neglect can cause atrophy. Traders with a strong intuition built on a strong trading strategy put themselves in an ideal position to achieve consistent success in the market. Over time, traders can feel the energy a market gives off and can execute trades from this. It is an invaluable tool in one's trading arsenal.

3. Vision
While total clairvoyance as to future price movement is unrealistic. It is my goal as a trader to assimilate as much information as possible with the goal of playing out scenarios that tie in together. It's not always easy to do, yet understanding trading does not occur in a vacuum and markets do exhibit funny things gets you mentally prepared to deal with these outlier events. Those that can think for themselves and need not rely on templatized news releases for their ideas usually put themselves in a position to benefit from their forward thinking. We have heard many times about leaders who saw an industry trend before it happened. This was no accident. It came as a result of their understanding of their field and what could change it for the better. Traders who gain an understanding of how things can potentially play out and factor that into their trading strategy go a long way to keeping their objectivity when things unfold in a fast and volatile market.

4. Discipline
Nine years in the Marine Corps helped develop this quality, yet its resolve is constantly put to the test. As the Chief Investment Strategist for NetBlack Capital, a Commodity Trading Advisor, I manage money for high net worth investors and institutional clients. I am regularly balancing the pressure of having to produce returns with that of taking on viable market opportunities. This is part of the job and one I take on with great alacrity. However, discipline is more than just taking on a trade when you are supposed to, it's doing your research at the prescribed times, making your Fibonacci grids the night before trading, working out regularly, eating right, keeping a trading journal, and doing the exercises of your life coach. To not have discipline in your life, makes it very difficult to have discipline as a trader. In many ways, our trading is a proxy or microcosm for how we live.

5. Decisiveness
This is a great leadership trait as well as a great attribute for a trader. So many times our success comes down to how we responded during the moment of truth. Having the resolve and confidence to act on our analysis or system is imperative to achieving the most meaningful long term results. In many cases, by the time we feel comfortable; the chance has materially altered from the initial entry and puts us at risk for greater volatility.

There are many things one can do to help themselves become a more decisive trader. One of the most luminous is to put oneself in an environment of traders that act in a decisive manner and regularly experience success. Our live hedge fund trading workshops in New York let attendees trade alongside and network with some prominent money managers and traders. This gives attendees a chance to alter their "trading disposition" and become more decisive, confident traders understanding this is a game of numbers and if you're not losing money at times, you are not taking on the kind of risk necessary to be successful. In many cases, this opens the proverbial floodgates for those looking to get to the next level of trading success.

6. Patience
The market, as much as anything in life, has a way of transforming us from cool, calm, collected individuals into irrational, impulsive, and disoriented speculators. Clearly it's in our interests towards long term profitability to spend the majority of our time in the former group rather than the latter. Acknowledging when things aren't going our way is the first step to becoming a more patient trader, but it's having the patience to wait things out until we find a more harmonic rhythm that contributes immeasurably to one's success.
As traders, it's the losing positions that invariably do us in. A number of the bigger losers many traders experience came as a result of not being patient and waiting on the right opportunity. Many of us tend to press when things aren't working out or we just had a losing trade. Traders can begin to play catch-up and go on emotional tilt. It's the paradox of trading in many ways. The same competitive drive we use to drive our success has components that hasten our failure.
When going through my daily checklist I put out to members of my mentorship program, I always emphasize the markets provide a multitude of chances to trade. One need not force action when the setups aren't right. Traders who get into positions with "the best of it", or edge, significantly increase their chances for success in the long run.

7. Confidence

This comes from a number of areas and is developed through successful implementation of a strategy. It is also a byproduct of the unwavering belief in what you are doing will be successful. This is critical when you are in a position and at the moment of truth self doubt has a way of creeping in. It's tempting to deviate from your plan during these occurrences. While I'm not suggesting you not be flexible in your position management, having the belief in what you are doing goes a long way in your success. In fact, it's the confidence in your trading skill set that can give you the ability to make a decision to get out of a position knowing that things aren't working out. This conviction is a hallmark of great leaders and inspires others.

8. Focus
The array of information that hits us at breakneck speed can at times challenge us. Having a game plan to lock in on and isolate the markets, strategies, and goals outlined in advance helps us stay on the path to success. In trading as in life, stuff happens that is unexpected and can help us deviate. A series of losing trades or health issues we weren't expecting. Having the focus to keep things in perspective and understand what your goals are contributes immensely to keeping one's focus. A common thing I work on with my life coach is making a list of goals and what I plan to do to achieve these goals. My success coach, Nazy Massoud (www.mentaledgetrading.com) holds me accountable and keeps me focused at times when life or the markets would rather have it another way.

9. Being Dynamic/Fluid/Flexible
The markets are not a static entity, nor should the people who trade them be. While in no way does this attribute undermine one following a game plan in trading, being open minded to new ideas and innovations keeps you ahead of the curve. The markets today are seeing new technology, exchanges, overnight rules, and legislation that can impact price movement and your ability to conduct your business in a more structurally efficient manner. An example of this is Alchemy Ventures (www.alchemyventures.com), a structured finance firm out of New York and San Francisco; they have created an investment structure that significantly reduces the inefficiencies of the investment allocation, risk management, and the reporting process to the end investor. With this type of financial engineering available in the markets, staying attuned to innovative ways to generate returns are just a few of the ideas that will benefit one considerably.

10. Willingness to Learn and Improve
This is a highly competitive game and educating oneself is essential to understanding the evolving components discussed in Attribute 9. With the extensive information availed to us, having colleagues or mentors to lean on is critical. I dedicate a certain amount of time each week to reading articles about things such as yield curve analysis, the money markets, structured finance, banking, legal issues, politics, and other relevant industry news. I also lean on certain market experts in aggregating my information for making my trading decisions.

by John Netto of OSOKTrading.com

Bear Market Rally?

2011-09-16T07:01:00.000-07:00

This bear market rally is amazing. It’s sometimes hard to see how people get so optimistic within our economy. In my Larry Levin update this morning he commented on this and really nailed the context of this market:

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There was a lot of economic data today. Let’s have a look-see…

Inflation (CPI)? 100% WORSE than expected? – Check
Current account deficit horrible? – Check
Empire State manufacturing data 145% WORSE than expected? – Check
Industrial Production still in the toilet? – Check
Weekly jobless claims FAR WORSE than expected? Yes, AGAIN – Check
Philly Fed Survey WORSE than expected? – Check
Global central banking INTERVENTION ignites the 3rd consecutive preposterous hopium rally with a Dow close of +186 points! PRICELESS!

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I couldn’t have said it better!

Good Trading…

Incredible Day Trading System Results!!!

2011-09-15T19:06:00.000-07:00

Over the past few weeks I’ve been playing around with the robotic trading system from Think Or Swim called Prodigio. It’s actually a very cool system and promises to bring just about anyone into the inner circle of system trading. It allows trading systems to be developed without any scripting or coding and then allows those same systems to be deployed on the Think Or Swim platform, making them fully automated… yes, it’s that cool.

It took me a little while to get familiar, but once I did I decided to tackle a trading system on a different time frame than my normal swing trading style. High frequency day trading seemed logical, and it wasn’t too long before I had something that looked interesting… or so I thought. The platform allows you to develop your system and then backtest it, even on intraday data.

And now the results of the backtest…

What you see below is the equity curve for a simple mean-reversion system which trades on 5-minute bars. It’s not a lot different than what I do on daily bars, but it’s done much more quickly. Consequently, profits are smaller on each trade, but I can get MANY more trades.

As usual, this doesn’t account for commissions or slippage, yet at first glance looked really promising. Just as I was about to start browsing www.YachtWorld.com, I saw something fishy.

And now the other shoe drops…

Take a quick look at these statistics and see if you spot anything that doesn’t look right. Get it? Right, 11,264 profit dollars for more than 12,000 trades. Average profit is less than $1 per trade. And remember I didn’t include commissions or slippage. At this point, that feeling of deep disappointment, and “I just wasted a lot of time”, came over me. Doh!

I entered 0.005 per share of commission (my rate), and ran the backtest… LOSER! I tried a few fixes, but at this point I just don’t see how a retail trader can scalp stocks and make it work. Anyone have any ideas?

Good Trading…

Trading Psyche– Greed and Detachment

2011-09-08T19:05:00.000-07:00

The next emotion I want to deal with in this series of posts on the psychological aspects of trading is Greed. You don't have to hang around trading circles for long before hearing something like, "The markets are ruled by fear and greed." I don't know whether "ruled" is the right descriptor, but fear and greed are powerful influences on anyone entering the trading game.

I dealt with Fear a bit in a previous post, and now it's worth taking a look at the role Greed can play. The simple Webster's definition of Greed is:"excessive desire to acquire or possess more than one needs or deserves"

I'm not here to tell anyone what they "need or deserve" in a broad sense. In trading, however, the attempt to acquire more than "one deserves" might mean doing somewhat unnatural, or unwise things to attempt gaining more than your trading strategy will support. There are many ways this might manifest itself in one's thinking... for example, you might find some of the following internal dialog taking place:

"I'm up so I can take some chances with the house's money". Uh, not really. First, the pattern of behaviors that attained this level of gain seems to work... why change it? Second, you're supposed to be up. Trading is a business. It's supposed to be profitable if done well; so the idea that I can play fast and loose with gains is an extremely poor business model. The position sizing that got you to this point was a good idea before the big gains, and it's still a good idea now.
"I can do no wrong... every trade is a winner." Well, good for you... you won a few. If you trade long enough you will eventually end up with a nice string of winners. This is especially the case if you engage in relatively high probability setups. With options trading, far-out-of-the-money credit spreads and many other high probability strategies tend to yield many winning trades in a row. Guess what? You haven't changed the long term statistical probabilities. Eventually you will have your share of losers. The thinking of "I can't lose" causes us to take extraordinary risk that will damage our account balance when the inevitable loser hits. Gloating will usually get you into trouble.
"I'm winning but I could win faster if..." The desire to gain more faster, is a sign of Greed typically leading to a change in trading rules. Perhaps you are tempted to change the rules of your trades, or the position sizing, or the number of trades you are taking. Again, the rules that got you here are the very ones you are thinking changing. Think long and hard about that before taking any action. Certainly we can improve our trading approaches over time, but as I've said often, changes in strategy are not to be done during the heat of battle. Especially this they're working, you have lots of time to think and evaluate before taking on a new strategy.

Generally, the feeling of wanting to go faster occurs when we've had a few nice wins, or win things are going particularly well. One of the most important things to remember at all times is: The rules that got you here (entries, exits, positions sizing, adjustments, vehicles, etc.) were good when you established them, and are most likely still a good idea. Be very slow to change your trading strategy if it is working.

Trading, when done well and according to fixed rules, will probably be boring. If I find that it gets exciting I am probably over-trading. It’s not designed for entertainment or excitement, but is more like working in a factory on an assembly line, doing the same thing over and over again, and producing a quality product.

In case you haven’t figured out by now (and by the title of this post), the cure for greed is detachment. Rather than getting wrapped up in the outcome, maintain a healthy detachment from it, and continue to trade your plan. This is one of the best reasons to have a concise trading plan to guide you through the roller coaster of emotions every trader encounters.

Good Trading...

Trading System Performance in September

2011-09-01T19:29:00.000-07:00

September is upon us, and for many investors that means, “Put on your flack jacket!'” September has been the most consistently poor performing months of all time. I’m not here to write specifically about that, but I can point you to a number of great posts that have already done so:

Woodshedder’s blog on iBankCoin

Michael Stokes’ MarketSci blog

Rob Hanna at Quantifiable Edges

All of these guys have provided great data and evidence about the past stinky results of September, but I wanted to provide a view of what the past results of the MultiStage Trading System has done:

As you can see, the September MS results are nothing to write home about. Some years September is worse, sometimes better than average; and overall, it’s about a typical month. Naturally I don’t have any idea about what this year will produce, but in the past the increased volatility (as noted by Rob Hanna) has made up for the declining market.

Good Trading…

Trading Psyche: Persistence

2011-08-31T19:28:00.000-07:00

As we continue our series of posts on honing our psychological edge in trading, the next emotion on the docket is Resignation. When a trader reaches such a point of despair as to "throw in the towel" they are there. When one is resigned to losing, they've probably gone through most of the emotions (and signs along the way) related to Fear already. It’s at this point that our ability to persist is truly tested.

I'd like to say this is rare, but in the past three years, if you've been involved in trading - even in the slightest sense - you probably know people who have reached this level of grief. Even in the past couple of weeks the market has tested our resolve. Lots of people lost a lot of money last year, and many took on resignation in an act of desperation. Here are a few thought patterns that might be warning signs:

"I'm down huge... I don't have much else to lose." This kind of internal dialogue is a desperate attempt to regain big losses. It's a gambler's thought pattern. Unfortunately it causes the trader to ignore position sizing rules and take unwarranted risk. This is what we often call trading to get even... and it's a bad idea.
"I've been losing... I need to change my trading plan." Well, maybe you do, maybe you don't. A few losses, cause Fear. Fear ultimately leads to Resignation if left unchecked. Changing trading strategies in the heat of battle is another act of desperation that will sometimes do more harm than good.
"I give up". Big losses can sometimes lead a trader to simply decide that this business isn't for them. That may actually be the best thing a person could do. It's unfortunate that it gets to that point for many people, but if it's not working (and sometimes it just doesn't) quitting - at least for a while - may be an excellent idea. Even if not permanently, taking a long break is sometimes wise. It allows one to regroup emotionally, evaluate strategies, evaluate the trading plan, and make some new decisions about the business.

What to do: Resignation is normally a response to long and/or extensive losses. The very best bit of direction I can give is to closely monitor position sizing and the trading plan. Changing to unplanned position size, or altering trading rules should be evaluated carefully.

You might also consider maximum loss rules for your trades, AND for your portfolio. In my research I have noticed that great traders seem to hold up okay with drawdowns under 3-4%. When they get bigger than that unnatural things start to happen. With that in mind I have some max loss rules for my overall account for a given month. I also have a ladder approach that allows bigger position sizing only after a period of success. If I have extensive or prolonged losses, I move down the position sizing ladder.

Unfortunately, sometimes losses happen fast. This has been experienced by many in the past few weeks, and at other times during highly volatile market activity. In those cases one has to make the careful decision about whether persistence is a good idea. Evaluate your trading plan. Evaluate your ability to remain consistent and disciplined; in other words, your ability to execute. If your plan is solid and you believe in it, execution is all that remains. Drawdowns happen, and the persistent execution of a winning plan will shrink them away.

Overall, position sizing is both the remedy and the prevention to triggering this desperate emotional state. Pay close attention to it.

Good Trading...

Black Swans are More Common

2011-08-26T18:18:00.000-07:00

In these crazy market conditions traders often consider how rare events like those in the past few weeks are. There has been a ton of stuff published about how unique the current gyrations and extremes have been, and many by some of my favorite writers and bloggers.

I thought it was interesting to note, however, the data gleaned by Bloomberg indicating that these rare events are becoming not so rare. This chart tells the story:

Good Trading…

Trading Psyche: Patience

2011-08-23T19:19:00.000-07:00

Two weeks ago I began the first part of a series of posts about honing our Psychological edge in trading. It's amazing how often this comes up. Virtually every trading newsletter, educational group, and professional addresses the psychological aspects of trading at some point, and virtually all agree on it's critical importance.

I will also confess at this point, that the most recent events in the market have been trying. As an aggressive trader using leverage, the most recent few weeks have been quite a challenge, leaving me in a substantial drawdown position. In times like these a trader’s psychological edge is more important than ever. If I believe in my strategy (and I do) I have to stick with it… but I’m losing. How can that be? Emotions want to play a bigger role when traders are under stress, and I am no different.

I've chosen to address this topic through the many emotions that a trader might experience over time. Last time, I discussed the role that Courage/Fear can play, and today I move on to Patience. Patience is one of the most difficult, yet valuable traits that great traders can acquire. Of course, some are naturally better than others, but we all suffer with impatience to some degree.

The biggest problem with impatience is that it leads to over trading. Trader's have this idea that "I am a trader, therefore I trade." It's not, however, how the pros are thinking. What is "over trading"? Generally, it means taking trades that are close enough to your criteria, but not quite there. OR, it frequently can be identified when we take trades off before they are fully mature. With more sophisticated trading strategies it might mean making too many adjustments, or adjusting before it's really required.

Over trading causes commissions and slippage to mount, which is bad enough, but it gets worse. The plan I designed and tested... the one I have confidence in... is designed with specific trading rules in mind that make it work. The tweaks I make along the way just to trade aren't necessarily tested. The results are unknown... and may be worse.

What to do: One of the greatest skills that a trader can develop is the ability to NOT trade. Effective traders are able to occupy themselves productively when they are not managing trades. They might do research, improve their skills, backtest, forward test, read the SnapTrader blog, and perform many other important activities. I keep a list of non-trading "things to do" that help me improve my trades, while not over-trading. For the true SnapTrader, this isn't really a problem. We don't have time anyway. But for a full time trader, designing a work day that includes NON-trading time can be extremely valuable.

Good Trading…

On Vacation…

2011-08-15T15:58:00.001-07:00

You won’t likely see posts from me for about a week… I’m on vacation.
If you’re bored feel free to click an ad or two on the right and see what our sponsors are saying.
Good Trading…

Trading Psyche: Fear and Courage

2011-08-11T19:53:00.000-07:00

A couple of days ago I said I would start a series of posts on honing our psychological edge as traders. I suggested that psychology plays such an important role that it can easily overwhelm (positively or negatively) our trading system or strategy.
To a great degree, managing our own psyche means managing the many emotions that come up throughout our trading days, and careers. I'll address the many facets of trading psychology through the lens of those emotions - the first one being Courage.
Courage is one of the first emotions that traders hear about, but it’s generally mentioned by addressing it’s antithesis - Fear. It doesn't take long before you hear some talking head mention fear and greed in the markets. Fear is a real emotion however, and manifests itself in many ways. So, here are a few things that might be signs of fear (lack of courage) influencing our trading:

Not taking trades. I've said it to myself many times: "I just took a trade like that and lost... should I do it again?" Even if I know I have a time-tested set of trading rules I might start to question the rules. Systems that are proven (at least in the past) often rely on taking all the trades. What to do: If you find yourself not wanting to take trades that are based on your own reliable criteria, try this... Stop trading and take a step back. Review your trading plan. When you are comfortable and confident that it works, make a commitment to trade it precisely according to the rules for a period of time. That might be a week, a month, three months... it depends on if you are a day trader, swing trader, etc. Then at the end of that time (and write it on your calendar) make an appointment with yourself to evaluate the results. Did the approach work? Do you need to reevaluate your strategy? The point is, don't make the decision to skip trades in the heat of battle. Plan the trades, and then trade the plan.
Trading with scared money. Worrying about losing money you need to put food on the table is one of the quickest ways to sabotage your trading. It causes you to not be able to stomach the losers that will come. What to do: If you find yourself losing your appetite after a loss, reduce your position size. There are many people who will give a formula for maximum risk, like 2% per trade, but I think this is a personal thing. For me, it varies depending on which system I’m trading. Therefore, I set my position size accordingly. If you have a solid plan that wins over the long haul, a tolerable loss can be taken in stride, especially when they happen infrequently.
Changing the rules. This is very similar to the first item above. It's very easy to have your trading plan start to experience "strategy creep". In other words, the trader says,"That loss I just took could have been avoided if I had just made this tweak." Then one tweak leads to another, and so on, until the strategy is different and completely untested. We do this because fear has crept in. We are afraid to lose and continually try to solve the problem. What to do: The solution for this, in my view, is the same as above. Step back, reevaluate your strategy, make a commitment to trade exactly according to the plan, and then evaluate. Analyze, Plan, Execute. It's very possible that the plan isn't good, in which case you need to reevaluate and alter it; but NOT in the heat of battle.

By the way, fear is not a useless emotion. It tells us something. Is it telling you that you can't afford to lose that money? Reduce size. Is it telling you your system doesn't work? Evaluate. But it can also trigger a survival instinct that might be the worst thing for our trading success. People who are afraid tend to search for less painful solutions. Losing is painful and triggers fear. But losing is also a part of trading. Therein lies the conundrum. That's why I believe I need to take a proactive approach to manage my fear responses and develop the courage to follow my proven plan.
Good Trading...

Drawdown Doldrums

2011-08-10T20:35:00.000-07:00

In a comment on an earlier post, Otto asked if I have experienced the kind of drawdowns I am seeing now in the past. He specifically asks about backtesting, but I can offer up a similar experience both in backtesting and in real life (yes, that’s with real money).

The time is October of 2008, and I, along the the rest of the investment community, thought the world was coming to an end. While the SPX dropped from well over 1500 to a low around 670 during a broader time frame, my big drawdown happened during a short span starting at the tail end of September, 2008 and ending in early October (the Lehman days). During that time, composed of about 10 trading days ending about 10/10, the SPX lost about 1/4 of it’s value, dropping from 1207 to about 885.

Simultaneously, my portfolio, and you can see here the backtested results, lost about 30% of it’s value from the recent high. The recent decline has a rather strong correlation to the moves of 2008. I have suffered a drawdown of about the same size, and the market has dropped just a little less than the 2008 decline, albeit much faster.

There have been other drawdowns of substance, but this is the only other one I’ve experienced of this magnitude. The real question before us is what happens next. Of course I have no idea, but you can see in the picture above that equity recovery came rather fast. Now, be assured that REAL equity recovery never comes quite as fast as back-tests, and it didn’t for me in 2008, but it did come and I ended the year with a decent gain.

Will that happen this time. Only time will tell. Part of the reason it worked in 2008 was that volatility remained high. If you’ve read any of my posts in the past you will know that my system does well during times of high volatility. At this point I still believe in my strategy and will continue to trade the best way I know how and with the approach that has worked for me in the past.

Good Trading…

ZIRP… Excuse me…

2011-08-10T18:58:00.000-07:00

You may be familiar with ZIRP, our “zero interest rate policy”, and that Ben Bernanke announced yesterday that the banking infrastructure will enjoy at least two more years of free money. I enjoyed an insightful clip from Larry Levin, who had this to say about it:

“But I don’t believe that; I deem today’s FOMC statement to mean ZIRP is here forever. Said another way, we are following the path of Japan. The country is in such a mess that the Fed’s prior TRILLIONS of “liquidity” has done absolutely nothing – but they’ll keep doing it anyway.

When the FOMC statement was released there was the usual back and forth trade; however, the market did not like the lack of a direct QE3 comment - initially. The S&P was slammed to a new daily low but didn’t stay there for long.
Once the low was in, Goldman Sachs gave its trading desk and all who listen to it the “buy signal” it wanted. In a note to clients Goldman said…

The committee adopted an even easier policy stance than expected. First, the committee now anticipates that economic conditions are likely to warrant exceptionally low levels for the federal funds rate "at least through mid-2013" instead of "for an extended period." Although some form of strengthening of the guidance language was expected and the new guidance remains conditional on the economic outlook, we see this step as a dovish surprise. Three members--Fisher, Kocherlakota and Plosser--dissented from this decision, the largest number of dissents since November 1992.

Moreover, the committee effectively signaled an easing bias saying that it discussed "the range of policy tools necessary to promote a stronger economic recovery" and that it "is prepared to employ these tools as appropriate." In our view, this leaves open the possibility of further asset purchases ("QE3") should the economic outlook deteriorate further from here.

When this was released, the S&P was roughly at 1107.00 and immediately went up. By the close the S&P exploded an additional 69.00-points!

Although the Fed is constantly saying the economy is on the mend (read: lying), it apparently sucks so badly that we need ZIRP for at least two more years. Additionally, you will find these uplifting comments in the FOMC release…

“moderated” (the economy)
“flattened out” (spending)
“considerably lower” (growth)
“deterioration” (economic indicators)
“downside risk” (to the future)

No but really, it’s all good!”

Well, Mr. Levin doesn’t pull any punches, and it’s one of the reasons I like reading his point of view. At some point the endless market manipulation will have to stop and we will have to deal with the reality of our economy. I don’t think that’s a political statement… just a fact.

Good Trading…

Where’s Your Trading Edge?

2011-08-08T18:49:00.000-07:00

In order to be successful as a trader, whether professionally or part-time, it’s important to find an edge of some sort. That edge can come in many different shapes and sizes, but whatever it is, it gives you a statistical probability of victory against the markets. For some people it is a superior entry formula, exit, analysis of fundamentals, or any one of a million other things (that number is probably low).

I'm quite serious when I say there are literally millions of winning formulas for trading. Of course, there are trade-offs to all of them; but in general it's not hard to find a winning approach. I also believe that in order for an edge to be really useful it needs to be quantifiable. For example, I’ve posted several basic systems and examples the provide a quantifiable edge. I'm not suggesting that anyone trade these systems, but it serves as a great example of what it means to calculate your edge.

My main point is that it’s not too hard to find a tradable edge. Why then are so few traders successful over the long haul? I don't know what you think, but for me this is a long hard lesson that I've learned through much experience and many mistakes. The psychological side of trading is far more important than the mechanics. In other words, finding or creating a system is the easy part. Executing that system in real time, with great consistency, is much more difficult.

Most professional traders agree that the psychological side of trading is many times more important that the details of the trading plan. I once attended a workshop where the speaker suggested that successful trading was 90% psychological. I have NO earthly idea how you could put a number on it like that. However, it's fair to say that it's pretty important and shouldn't be overlooked.

Okay... so what exactly is your edge. If psychology is so important, wouldn't any mechanical edge be overwhelmed by this weightier part of trading? And if it's so important, wouldn't it be useful, maybe even much more useful to find our edge in that realm. Maybe superior discipline and trading psychology IS your edge!

With that last thought in mind, I will be posting a series of blog articles that might be useful for honing the psychological portion of our trading skill set. I wrote about this a couple of years ago, and now seemed like the right time to revise and update this information. I hope you enjoy and find it useful. In these most turbulent market times, this aspect of trading is more crucial to remember than ever, at least for me. Stay tuned.

Good trading...

July Wrap-up

2011-08-03T18:56:00.000-07:00

Much to my delight, July saw the return of some decent volatility, particularly toward the end of the month. You can see the VIX chart below (the index that tracks the implied volatility of the SP500), which tells the story quite nicely:

When trading with a strategy which thrives on volatility, this is a welcome site. Consequently, the second half of July was quite active and enabled my Covestor.com portfolio to end the month +5.92%. Increasing volatility results in more activity in my account. If one has an edge in his trading strategy, then more trades = more profit.

Sadly, increasing volatility is frequently associated with bear markets, or strong down-trends. This was no exception. The last several days of July ushered in a rather strong correction, which continues into the first few days of August.

You can see that this chart of the SP500 is almost the inverse of the VIX chart. That’s usually the way it goes. It appears, that in spite of the debt ceiling debacle being set aside, that investors are starting to show their concern over the state of our economy.

To learn more about how volatility trading systems work in the context of corrections and bear markets, you might read my 6-part series called “Profiting in a Bear Market”. It’s largely the story of how my MultiStage Trading System – a volatility based strategy – fared during past bear markets and in times of high volatility.

Good Trading.

SPX Falls Below 200-day MA…

2011-08-02T19:46:00.000-07:00

After a couple of attempts at the 200-day moving average (in June), this time the SPX made a bold statement. Today’s massive close down clearly broke through this common point of support, as well as taking out the recent lows from June. Not to mention, that’s a heckuva big red bar.

From a pure probability perspective, so many red bars together – seven in a row - would call for a bounce in the short term. I would guess we will see it tomorrow or the next day. But beyond that, “Look out below”!

The markets seem to finally be responding to our country’s dismal economic conditions. With the debt ceiling crisis side-stepped we might expect a rally. This massive sell-off in the face of that news tells me that investors are aware of the ugly big picture. Hold on to your britches.

Good Trading…

Smith at #2!

2011-08-01T19:24:00.000-07:00

Covestor.com now has about 186 models that are managed by investors, which can then be mirrored by subscribers. Making the top ten feels noteworthy to me, although consistency is far more important. After a rough May, June and July have come back nicely. I managed to take a snapshot right before the end of the month showing me at #2 for the month.

Check out the guy at #1! He killed it in July. My portfolio ended July at nearly +6%, so even a little better than what was reflected in this snapshot. Seriously, I really shouldn’t boast about this kind of thing. I’m happy about the performance, but I know that good months and bad months can come at any time.

Good Trading…

Updated MSv8 Backtest Results:

2011-07-29T19:42:00.000-07:00

Yesterday I published some ridiculous and bogus numbers from what I thought was a valid backtest. I mentioned at the time that I still had some validation, and I probably should not have posted them until I had done some more homework, but… well… I did.

In any case, they are not accurate. Once I perform backtests I then validate results by performing walk-forward trade-by-trade testing. After that I then trade them live in small sizes. In my walk-forward testing I discovered something called “look-ahead bias”. It was only in one small parameter, but it was enough to radically skew the results. Look-ahead bias simply means that you are using data from the future… that which can’t be known at the time of the trade.

I was using a volatility factor that was reading the data on the day of the trade. Since the trade is done at the open, I can’t know any of the data for that day until after the day is over, and therefore after the trade is already on. This is an easy thing to discover during validation, and it is now corrected.

The corrected results are still quite good, but not quite as ridiculous as before.

As you can see, there is still a lot of green, which means relatively consistent profits. I like that.

Just to be clear, testing and validation is still not complete. I just felt like I needed to say something since I published the wrong results prior. More to come on this.

Good Trading…

MSv8 Backtest Results

2011-07-28T10:08:00.001-07:00

A few days ago I mentioned that I was working on an update to the MultiStage Trading System that would provide more market exposure. The current version is typically in the market only about 25% of the time, which means I spend a lot of time sitting on the sidelines when the market is moving.

This more recent enhancement provides looser tolerances under special circumstances and gives me far more market exposure… nearly 75%. One of the fantastic developments, however, is that it also works in a very complimentary way to the old system.

This is not unusual when you attack the criteria from a different perspective, but I have rarely seen it work out this nicely.

These are preliminary results and I still have a fair amount of validation to do, but I like it so far. In the spirit of full disclosure, be aware that this contains no commissions or slippage. Generally, I believe these numbers are unattainable for many reasons, but it’s the plethora of green that I’m enjoying at the moment. Consistency is one of the most sought after characteristics of any trading system, and this one delivers.

Good Trading…

In Search of Volatility

2011-07-15T19:18:00.000-07:00

One the frustrations that I have voiced regarding the MultiStage Trading System is that I don’t have enough “exposure”. I often go through long stretches without exposure to the market, and in all cash. The good part about this is that I avoid some of the nasty reversals and market drops. Cash can be a safe place at times. At the same time, however, I miss out on many profitable moves. In a system like this profits just trickle in.

Don’t get me wrong, I’ve been trading this system (or some previous form of it) for years and I’m quite satisfied with the results. But with average exposure at about 25% I always feel like I’m missing something.

As I’ve commented many times, my trading system thrives on volatility. Some of the most profitable years are also the most volatile. For example 2008, while awful for trend traders and most fundamental investors, was a banner year for this system. The question I’ve been solving is, “What shall I do in less volatile times?”

I have gone in search of volatility, thinking I might find volatile markets outside of equities that could replace typical equity trades. The problem is I can’t predict volatility very well, and often by the time I get in, the move is over. What to do?

Enter: MultiStage Trading System v8

I’ve been busily working away on a modification to the MultiStage Trading System that moves me in the right direction. I am integrating a measure of volatility into the system and it will then modify candidate trades dynamically to take advantage of lower volatility conditions.

This is a work in progress, but it looks promising and should increase market exposure. Increasing exposure simply means more trades. If you have a positive edge in the strategy, more trades = more profit. Stay tuned for more details on the MSv8.

Good Trading…

Covering My Shorts…

2011-07-11T18:27:00.001-07:00

No, this has nothing to do with my attire.

The market made the expected downdraft and at this point I’ve covered just about all of my short positions. Since the Big Short post the S&P has pulled back about 20 points (about 1.5%), and taken most of the market with it.

As discussed in my last post, I only wish I had taken larger positions. I had some nice short positions, but never got more than about 20% of my cash deployed. Oh well, still a decent collection of profits for the amount at work… and in only two days. I can’t complain.

Good Trading…