What Makes for Success: Five Perspectives From Trading Psychology

 Here are a few observations from my recent research and work with traders:1)  The success of a trader is directly related to the speed by which they turn losing trades and drawdowns into actionable improvements.  The best traders engage in active review processes to ensure that they learn from setbacks.  Those reviews also allow them to learn from successes.  A major source of poor performance among traders is failing to engage in timely and regular deliberate practice.  Successful market participants study themselves intensively, just as they study markets intensively.  Unsuccessful participants don't study; they are too busy trading.2)  There are two types of traders:  a) those who are risk-takers and need to learn to limit losses; and b) those who are risk-minimizers and need to expand gains.  We tend to manage our trading the way we manage risks and rewards in other areas of life, because--ultimately--we are managing ourselves emotionally.  The challenge is to understand how we are wired and how to best express and manage that in our trading.  Many trading problems occur when we attempt to take risk in ways that interfere with our self-management.3)  I'm hearing more from relatively inexperienced traders who are harvesting money by selling option premium.  It makes me cautious.  The history of 2023 thus far has been for game-changing news to greatly impact how markets trade--and how they trade relative to one another.  Note the recent interest in the shadow banking system and its vulnerabilities:  here, here, and here.  After recent banking concerns, it wouldn't take much of a headline to throw markets into a tizzy.  The idea is to maintain flexibility even when acting decisively.  Maintaining "conviction" has not worked well for many traders thus far this year.4)  Recent posts have focused on breadth as measured sector-by-sector--and especially the phenomenon of breadth thrusts.  My latest research examines differences in breadth between U.S. sectors and how these are related to SPX returns going forward.  At present, consumer staples shares are outperforming consumer discretionary stocks by a pretty good margin over 5 and 20-day periods.  Going back to 2020, when that has occurred, next 10-20 day SPX returns have been negative and significantly below average.  Shifts to more defensive positioning among sectors appear to precede overall market weakness, an idea I'll be exploring in detail going forward.  Breadth shifts may be as important to forward returns as breadth thrusts.5)  Imagine that you are at a racetrack and you are allowed to alter your bets at set intervals during the race.  No doubt you would alter your risk taking as the race evolves.  The best traders develop good bets, but then actively update risk and reward over the life of the trade to maximize gains and minimize losses.  The inability to update one's "bets" in the face of changing market conditions has been a major source of performance problems so far this year.  Many traders lack a robust process for walking forward and updating risk and reward in real time.Further Reading:Overcoming Self-Criticism and Trading on Tilt.  

Nov 29, 2023 - 00:18
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What Makes for Success: Five Perspectives From Trading Psychology

 

Here are a few observations from my recent research and work with traders:

1)  The success of a trader is directly related to the speed by which they turn losing trades and drawdowns into actionable improvements.  The best traders engage in active review processes to ensure that they learn from setbacks.  Those reviews also allow them to learn from successes.  A major source of poor performance among traders is failing to engage in timely and regular deliberate practiceSuccessful market participants study themselves intensively, just as they study markets intensively.  Unsuccessful participants don't study; they are too busy trading.

2)  There are two types of traders:  a) those who are risk-takers and need to learn to limit losses; and b) those who are risk-minimizers and need to expand gains.  We tend to manage our trading the way we manage risks and rewards in other areas of life, because--ultimately--we are managing ourselves emotionally.  The challenge is to understand how we are wired and how to best express and manage that in our trading.  Many trading problems occur when we attempt to take risk in ways that interfere with our self-management.

3)  I'm hearing more from relatively inexperienced traders who are harvesting money by selling option premium.  It makes me cautious.  The history of 2023 thus far has been for game-changing news to greatly impact how markets trade--and how they trade relative to one another.  Note the recent interest in the shadow banking system and its vulnerabilities:  here, here, and here.  After recent banking concerns, it wouldn't take much of a headline to throw markets into a tizzy.  The idea is to maintain flexibility even when acting decisively.  Maintaining "conviction" has not worked well for many traders thus far this year.

4)  Recent posts have focused on breadth as measured sector-by-sector--and especially the phenomenon of breadth thrusts.  My latest research examines differences in breadth between U.S. sectors and how these are related to SPX returns going forward.  At present, consumer staples shares are outperforming consumer discretionary stocks by a pretty good margin over 5 and 20-day periods.  Going back to 2020, when that has occurred, next 10-20 day SPX returns have been negative and significantly below average.  Shifts to more defensive positioning among sectors appear to precede overall market weakness, an idea I'll be exploring in detail going forward.  Breadth shifts may be as important to forward returns as breadth thrusts.

5)  Imagine that you are at a racetrack and you are allowed to alter your bets at set intervals during the race.  No doubt you would alter your risk taking as the race evolves.  The best traders develop good bets, but then actively update risk and reward over the life of the trade to maximize gains and minimize losses.  The inability to update one's "bets" in the face of changing market conditions has been a major source of performance problems so far this year.  Many traders lack a robust process for walking forward and updating risk and reward in real time.

Further Reading:

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