Whats in Your Head - Becoming a Trader (2005).pdf - Swing Trading Collection - snorri

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Saturday, June 25, 2005

July, 2005

Investing with a Conscience

WHAT’S IN YOUR HEAD? Becoming a Trader

by: By Brett N. Steenbarger, Ph.D., and Doug Foster

Mind Machines: Re-Program For Success

This article is

published in the

following issue:

The field of trading psychology is generally associated with techniques to

help traders manage their emotions, improve discipline and sharpen

decision-making. Forgotten, however, is that the science of psychology

began as an experimental discipline to identify principles of learning.

Since those pioneering 19th century investigations, psychology has made

significant strides in understanding how we acquire information and skills.

In this article, we will explore some of these advances and illustrate their

implications for the development of trading prowess, drawing upon our

experience of coordinating a training program for professional traders.

Beat the Demons!: Use Your Emotions as an

Indicator

Why Smart Traders Do Dumb Things:

Understanding Prospect Theory

DON’T BE YOUR OWN WORST ENEMY: Beat

Mental Barriers to Successful Trading

July, 2005

Volume 4, No. 7

Before we describe the training program that we coordinate at our

proprietary trading firm, a disclaimer is in order. All too many articles that

appear in trading publications are thinly veiled promotions for the authors’

products or services. Such infomercials must be read with more than the

normal grain of salt. In describing our training program, we are not

soliciting applications from would-be traders; nor are we trying to

convince readers to abandon their day jobs and pursue trading as a

full-time occupation. Indeed, as you will see below, we have numerous

reasons – based on our experience – for dissuading people from such

courses of action. Instead, we use our training program to illustrate the

learning process involved in the development of trading talent and the

ways in which psychology can facilitate that learning curve.

OPTIONS OVER EASY: The Incredible

Versatility of the Credit Spread

Sentiment Analysis in Options: Trading

Opportunities at Extremes

Day Trading FX?: Ignore the Fundamentals at

Your Peril

The Learning Process

When we began the training program, we drew upon Brett’s prior

experience as a faculty member of a medical school and divided the

curriculum into introductory (“internship”) and advanced (“residency”)

phases. A popular phrase that captures the philosophy of medical

education is “see one, do one, teach one.” The idea is that people learn

first by observing, then by supervised doing, and finally by instructing

others. It’s not that didactics are unimportant – book learning and lectures

make up the lion’s share of a medical student’s first years of education –

but when it comes to application, nothing substitutes for the hands-on

experience of seeing and doing.

Looking for a Trading System That Suits

You?: 9 1/2 Steps to Help You Get It Right

Hot Stock Sectors for the Second Half! Know

Which Earnings to Use

Ten New Tips for Trading Chart Patterns

Trading the Indicators: Be Your Own Analyst:

Understanding Cycles

Research in the psychology of learning strongly supports this educational

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approach. Studies conducted and reviewed by K. Anders Ericsson, Ph.D.,

find that the acquisition of expertise in most fields (art, sports and games of

skill such as chess) is a function of deliberative practice. Experts, such as

Olympic performers and chess masters, tend to spend far more time than

non-experts in structured, goal-oriented practice with feedback. Indeed,

University of California, Santa Cruz, researcher Dean Keith Simonton,

Ph.D., cites a wealth of evidence that suggests it takes ten years of such

immersion in a discipline before greatness can be achieved. Given this

reality, it is clear that no amount of lecture time or reading, in and of itself,

can produce a skillful surgeon, artist or trader. One learns surgery by

observing surgeons, assisting them, practicing techniques on models,

conducting simple procedures, and finally graduating to more challenging

ones. Similarly, we find that developing trading proficiency begins with

observation and repetitive practice.

Dividend Investing: The Search For Returns

Health Care Costs: Can we turn lemons into

Lemonade?

The introductory phase of the training program consists of intensive

exposure to different trading markets. Although much briefer, it is similar

to the educational experience that medical students receive during their

initial four years of training. It combines didactic instruction with

observation of successful traders and structured hands-on trading

experience. Each practice trading session is preceded by a set of objectives

for the group to work on, such as “limiting the size of losing trades.” The

feedback at the end of the session then focuses on the traders’ ability to

meet the objectives.

Search our list of close to 1,000 trader terms,

concepts and definitions by using one of the

search options below.

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Having a Mentor

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Several factors have convinced us that mentorship is an essential element

in the development of trading prowess.

Preparation for unforeseen events: Distributions of price changes in

financial markets display “fat tails.” These unusual events occur much

more often than one would expect under conditions of normality. Such

events – large swings that occur in the face of news events or out-of-line

economic reports – are difficult to prepare for because they occur so

infrequently. Experienced mentors can help new traders identify markets

that are trading unusually and adjust trading accordingly. Just as attending

physicians help medical students identify diseases that don’t conform to

textbook presentations, senior traders can orient new traders to markets

that are moving atypically.

Creation of a constructive learning environment: Traders are by nature

competitive and often are unwilling to voice uncertainty, doubt or

discouragement. Mentors provide traders with an open forum to voice

ideas about what they may or may not be seeing in the market place. They

also provide a safe and private setting for constructive criticism in which

new traders need not feel threatened or harshly judged.

Support: As trading has increasingly moved from the pit – a very close

interpersonal medium – to the screen, it has become difficult for

professional traders to benefit from the accumulated wisdom of peer

traders. Mentorship was frequently built into the process of becoming a pit

trader, as experienced traders would oversee – and even stake – their

protégés. This provided substantial support in an environment that was

otherwise harsh and competitive. Traders learning their craft on the screen

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frequently lack this support, yet compete in an environment that is no less

challenging.

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Master the Various Elements

Structuring the practice with goals and rapid feedback is essential to the

learning process. Research in sports psychology finds that athletes gain

significantly more from practice if it includes specific goals and prompt

feedback regarding the meeting of these goals. An interesting set of studies

reviewed by Ericsson found that championship chess players rarely played

for fun. When they played, it was to study openings, hone their end game,

etc. Similarly, passively following markets is unlikely to have the same

benefits as directed practice focusing on concrete guidelines for entering

and exiting trades.

There may be a second reason why chess masters avoid leisure play.

Research summarized by Singer, Hausenblas, and Janelle in their

excellent text, Handbook of Sport Psychology (2nd ed.), finds that learning

is enhanced by breaking tasks down into component pieces and working

systematically upon each. For example, a beginning chess player would

not start his or her training by exclusively playing entire games. Rather,

there would be a concentrated focus on learning opening moves and

strategies, followed by dedicated attention to the middle game, defenses

and endings. Training in the martial arts is similar, where intensive

practice of individual movements precedes practice and tournament

matches.

Our experience is that beginning traders too often want to learn trading by

actually trading. This is similar to the martial arts novice starting with

tournament competition. Segmentation of the trading process into

component elements, such as pattern recognition, order execution and

trade management – combined with intensive rehearsal of the segments –

is far more likely to yield long-term skill acquisition.

It’s All About the Practice

Research summarized by Timothy Lee and colleagues in the Handbook of

Sport Psychology also notes that simulations are valuable in skill

development. A number of trading software programs, such as eSignal,

offer simulation modules that allow traders to rehearse strategies in

real-time. While such simulation cannot fully capture the pressures of

trading with real money on the line, it is an effective bridge between

casual paper trading and “going live.” More importantly, it permits

repetitive practice on the aforementioned components of trading – with

built-in profit/loss (P/L) feedback.

Lee and colleagues also note that mental rehearsal has been found to

produce effective training results in the sports world, especially with

respect to the cognitive elements of performance. A trader, for example,

can effectively rehearse the mindset he would like to adopt during trading

(and his self-instructions during trading) by structuring guided-imagery

sessions that simulate a segment of a trading day. Over the course of such

practice, new traders learn many things about themselves – how they

handle risk and frustration, how they perform under scrutiny and how well

they can stick to basic trading rules. Most important, like medical students,

they learn the answers to two questions:

• Do I really want to do this for a living?

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• If so, which area of trading would I choose for a specialty?

Finding a Niche

The importance of this latter question cannot be overstated. One

sometimes hears that there is no difference between trading one market

and trading another: “Trading is trading.” Our experience is quite

different. Traders who are successful in one market segment (such as

equity indexes) do not necessarily find success tackling another segment

(such as forex). Just as the specialties of medicine involve different

combinations of interests and aptitudes, the various types of trading

(scalping, spread trading, position trading, discretionary trading, systems

trading) call upon unique skill sets. There is no better way to discover the

fit between a trader, trading style and market than to actually observe

one’s own enthusiasm, frustration and progress across different situations.

The importance of finding a fit between traders and trading styles and

markets also is supported by psychological research. Studies reported by

Simonton find that highly successful performers are characterized by an

early aptitude and passion for their fields. Traders are most likely to

succeed at trading when they find a niche that piques their interest and

motivation. We find that traders are most likely to progress in their

training if they feel a special affinity for the market they are trading and

the way they trade in it.

Advanced Learning

Once a medical student finishes the initial four years of training, he is not

qualified to practice and, indeed, cannot even obtain a license. Practice

normally begins only after another several years of residency training in

which the new doctor develops proficiency in a specialty.

Just as resident physicians assume greater responsibility as their training

progresses, advanced students of trading start with very small positions

and gradually grow their position sizes. The medical dictum, “Above all

else, do no harm,” applies equally to new traders. The goal at the start is

to survive one’s learning curve. A worthwhile philosophy for new traders is

that a rise in position size must always be justified by recent trading

results. You must earn the right to trade two lots before abandoning a

one-lot default; you must show profitability in simulation mode before

going live. The goal is not to trade, but to trade successfully.

Earlier we mentioned that two questions are answered during the initial

weeks of learning: the desire to be a trader and the area of trading to be

selected as a specialty. One question that is not addressed is whether or

not aspiring traders actually possess the skills needed to be financially

self-supporting as a trader. There is a good reason for this, once again

grounded in psychological research. If the development of competence

and expertise requires sustained deliberative practice, it is unlikely that

students will have enough exposure in a brief time to see a meaningful

emergence of skills – especially if the practice is scattered among different

skill components and trading specialties. A research program conducted by

Dr. Arthur Reber at Brooklyn College found that it took thousands of

trial-and-error sequences with immediate feedback before people could

learn to recognize and anticipate complex patterns within data. To amass

those trials under realistic trading conditions – and to observe the

emergence of skill – requires months, not weeks.

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Personality Characteristics of Success

Listed below are several of the personality characteristics that researchers

have found to be correlated with high degrees of success in a chosen field:

A high degree of belief in oneself – D. W. MacKinnon concludes, “The truly

creative individual has an image of himself as a responsible person with a

sense of destiny about himself as a human being.”

Capacity for sustained effort – An early investigation by Catharine Cox

found that, “Youths who achieve eminence are characterized not only by

high intellectual traits, but also by persistence of motive and effort,

confidence in their abilities and great strength or force of character.”

Aggressiveness – Dean Keith Simonton has observed, “Attainment of

distinction in any endeavor is a function of both cognitive and motivational

traits of character. For both creators and leaders, eminence is a positive

function of intelligence and aggressiveness.”

Passion for their pursuits – Simonton further finds that, “Geniuses cannot

spend so many hours without an inherent passion for what they do.

Therefore, we might do better to say that all the motives that can stimulate

the energies of the [creative] human being all converge on a single

activity, a monomaniacal preoccupation.”

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Time Is a Predictor of Success

Trading is not unique in the length of its learning curve. Studies of young

chess masters have found that the single most important predictor of a

player’s rating is the number of hours spent in serious study and practice.

Janet Starkes at McMaster University in Ontario, Canada, and her research

colleagues examined the facets of such practice across such domains as

figure skating and musical performance. She found that practice was most

predictive of success when the practice was associated with high levels of

effort and concentration. It is thus the quality of rehearsal – and not just

the quantity – that appears to be important in advanced training. One can

practice for months under less-than-optimal conditions of a challenge and

fail to see meaningful skill development.

This is where coaching is particularly important in such fields as sports,

musical training and the martial arts. It is very difficult for students to

gauge the level of challenge that is sufficient to build skills and yet not so

difficult as to generate undue frustration and discouragement. A useful

analogy is bodybuilding: setting a weight machine at a setting that is too

low will not build strength; setting it too high can promote harm. The most

helpful training is often at levels of difficulty that lie just beyond the

student’s comfort level – a level that can be set and monitored by a coach.

Going to School

For this reason, formal instruction and supervision is a common feature of

advanced learning process across performance domains. In the trading

world, we have similarly found that sitting traders in front of a screen and

expecting that they will pick up trading simply by observing markets and

trying to trade is not realistic. (Would we sit a new chess player in front of

a board and say, “Go at it?”) Successful training requires mentorship,

which entails a one-to-one relationship that adapts the learning process to

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Whats in Your Head - Becoming a Trader (2005).pdf

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