Trading will always be stressful, but self-coaching ensures that it won’t be filled with distress. Remember, your job is to maintain a mindset that keeps your confidence and motivation high: under those conditions, you’ll work harder, learn more, and grow your trading account over time. That doesn’t mean repealing stress; it means creating active firewalls between stress and distress. Risk management is one of the best psychological firewalls of all.

COACHING CUE

Plan for every possible glitch in your trading: if your broker can’t be reached; if you lose your online connection; if your equipment fails; if your data vendor goes down. My own trading station is small, but there is redundancy in each of these areas. I have multiple brokers, multiple online connections, multiple computers, and multiple data streams. There’s always a rehearsed Plan B if something fails when I have a position on. The glitches still cause stress, but not distress.

LESSON 12: ANTIDOTES FOR TOXIC TRADING ASSUMPTIONS

What we expect from life shapes our emotional experience. If we expect good things, we tend to be optimistic and energetic. If we expect negative outcomes, we tend to feel anxiety. If we expect that success will elude us, we’ll feel discouraged and depressed. If we expect perfection, we’ll be continually disappointed with reality.

To no small degree, our emotions are barometers of the degree to which we are meeting or falling short of our expectations. That is an important principle, because psychological research suggests that, if our expectations are biased, we’re likely to experience skewed emotions.

The relationship between emotion and expectation is particularly important for the developing trader. If you are your own trading coach, one of your overriding priorities is to foster the kind of positive experience that will sustain your motivation and learning efforts. Discouraged, defeated, and fearful learners are not effective learners. If you are going to maintain that zone of focus and concentration that maximizes learning efforts, you have to be absorbed in markets. No one can be absorbed if they’re also battling emotional distress.

In the spirit of Ayn Rand, who encouraged people to “check their premises” when they arrived at contradictory conclusions (“I should be happy” but “I shouldn’t be selfish”), I’ll now ask you to check your expectations—particularly if you’re finding that distress is interfering with your learning and development. The following expectations are among the most trader-toxic:

1. A Good Day Is a Winning Day. Here’s an assumption and expectation that ensures that our emotional experience will rise and fall with our P/L. We generally expect to have a good day; by equating a good day with a winning day, we set ourselves up for disappointment when the normal uncertainty of markets leaves us in the red. A good day is one in which we follow sound trading practices, from skilled execution to prudent risk management. Some good days will bring profits, others will not. We can trade poorly and stumble into a profit; we can place a trade with a two-thirds probability of success and lose money as often as an all-star baseball hitter gets a hit. We should expect to have good days, if those are defined by sound trading practice. If sound practices don’t generate profits over time, we may need to tweak those practices. But going into trading expecting profits each day is a formula for emotional letdown.

Never set a goal if you’re not in full control of its attainment.

2. Working Harder at Trading Means Trading More Often. This assumption is that, if you trade more, you’ll learn more and build skills more quickly. The result is overtrading and a likely forfeiture of profits over time to market makers and brokers. Every trade starts as a loser. You’re losing the bid-offer spread if you buy and sell at the market, and you certainly lose a transaction fee. A loss of a single tick per trade due to execution, on top of a substantial retail commission, easily ensures losses of thousands of dollars to day traders who otherwise break even on their trades. As we trade more often without a distinct edge to each trade, our broker becomes richer and we become broker. Pointing and clicking to execute trades is a small part of the process by which traders develop expertise. The lion’s share of development occurs by tracking patterns in simulation and real time, practicing executing and stopping out trades on paper (and in simulation mode) prior to risking capital, and researching trading ideas. By expecting trading itself to generate learning, we ensure that our motivation for learning will lead to overtrading—and a loss of both capital and motivation.

3. Success Means Making a Living from Trading. Here is another expectation guaranteed to generate frustration and discouragement. No developing professional makes their living from their performances during the early years of expertise building. A golfer or tennis player may spend years on a college team and as an amateur before even starting the pro circuit. Star actors or actresses typically spend years in lessons and regional theaters before they see their names under the Broadway lights. Before surgeons make a living from their trade, they spend four years as a medical student, four more years as a surgical resident, and even more years in subspecialty training. Expecting to make a sustainable living from trading within the first years of exposure to markets is wholly unrealistic. More realistic expectations would be to keep losses to a reasonable level, cover one’s costs with regularity, and improve trading processes. There is no path to expertise that doesn’t first require time to develop mere competence. If you expect to make a living from trading much more quickly than people in other fields are able to sustain a livelihood, you are setting yourself up for frustration and failure.

An excellent antidote to these toxic assumptions is to write out your expectations as part of keeping a trading journal. This includes your expectations for each day of trading—your goals for trading well—but also your expectations for your development over time. My goal for my own trading performance is relatively modest: I want to earn more than the riskless rate of return after trading costs, and I want to do that by risking less than that proportion of my capital. In other words, I’m targeting positive risk-adjusted returns; that integrates my performance and process goals. I will be very happy if I average one percent returns on my portfolio per month by risking significantly less than that.

By focusing on risk-adjusted returns, not just absolute profitability, we blend process and outcome goals.

This may not be a realistic target for you, depending on your level of development and your risk appetite as a trader. What is important is not my target numbers, but rather the fact that I have developed realistic, attainable objectives for my trading. If I achieve my expectations, I feel a sense of pride and accomplishment. If I fall short, I can quickly identify that fact, pull back my risk exposure, and make necessary corrections.

A formula for positive trading development is: Always expect success, and always define success so that it is challenging, but attainable. Writing out your expectations for the day, week, month, and year—and ensuring that they’re doable—is a powerful lever over your emotional experience as a trader.

COACHING CUE

A great entry in a daily trading journal: “What would make my trading day a success today, even if I don’t make money?” That simple question leads directly to process goals—the things you can best control.

LESSON 13: WHAT CAUSES THE DISTRESS THAT INTERFERES WITH TRADING DECISIONS?

We become anxious and exit a good trade before it has an opportunity to reach its price target. We become frustrated and take a trade that completely contradicts our research and planning. We’re afraid of missing a trade and enter at the worst possible time. We’re reluctant to take a loss at our designated stop point and wind up with a much larger loss.

All of these are examples of trading behaviors for which all of us as traders can truly say, “been there, done that.” In trading, as in much of life, we learn by making the mistakes our parents and mentors try to protect us from. The key to longevity is making those mistakes early in your development, before you have too much on the line. Mistakes in dating can lead to a great marriage. Mistakes on a simulator can lead to solid real-time performance. Making your errors when your risk is lowest is a large part of success.

But what causes these mistakes, in which the arousal of distress interferes with prior planning and consistent, sound decision-making? Perhaps if we can figure that out, we can shorten the painful learning curve just a bit.

The fields of behavioral finance and neuroeconomics have illuminated how emotions affect financial decisions; check out references at the end of this chapter.

To hear traders talk, distress in trading is caused by markets. A market turns slow and range-bound: that is the supposed cause of a trader’s boredom and overtrading. A market reverses direction: that allegedly generates frustration and impulsive trades for the trader. Because their emotions are triggered by a market event, traders assume that the market must be responsible for their feelings. A moment’s thought, of course, dispels this notion. After all, if the market had the power to compel emotional reactions, we would see all traders respond identically in a similar situation. That, however, is not what happens. Not all traders respond to a slow market with boredom and overtrading; not all traders become frustrated and make impulsive decisions when a position reverses against them. There is more to the cause of our emotions than external events.

In order for a market event to generate a negative emotional response, we have to view it as a threat. Let’s say that I’m a trader watching my market become slow and range-bound at midday. If I view that as an opportunity to update some of my ideas and prepare for the afternoon, the slow market will not trouble me in the least. Similarly, I may view the choppy, thin action as an opportunity to get away from the screen, clear out my head, and start the afternoon fresh. Again, the slow action affects neither my feelings nor my trading behavior.

If, however, I start my day telling myself that I must make at least several thousand dollars each day, then I’ll now perceive the slow market as a threat to my trading goal. The narrow, whippy action translates into lack of opportunity, which translates into lack of profit, which translates into lack of success. It’s easy to see, with that mental framework, how I could wind up viewing slow markets as threats to my career. It’s no wonder that the slow market would trigger my distress and overtrading.

But, of course, it’s not merely the slow market that is generating my negative mood and behavior; it’s my perception of that market. Perception is the filter that we place between events and our responses to events. If we place a distorting lens over our eyes, we will see the world in distorted ways. If we adopt distorted perceptions of markets and ourselves, we’ll experience trading in distorted ways.

Can we alter our perceptions? Chapter 6 deals with cognitive approaches to change that restructure thought processes.

So how do we change the filters that turn normal trading experience into abnormal events?

The rule is simple: if you don’t know your filters, you cannot change them. Becoming aware of the expectations and beliefs that shape your perception is essential to the process of shifting your perception.

Here’s a simple exercise that can aid you in becoming more aware of any distorted perceptions you might hold:

Every time you experience a distinctly negative emotional reaction to a market event, consciously ask yourself, “How am I perceiving the current market as a threat?” This turns your attention to your perceptual processes, giving you a chance to separate perceived threat from real threat.

A simple example comes from my recent trading. I really wanted to finish the week on a high-water note in my equity curve and found myself with a nice profit on a Friday morning trade to the long side. As the trade moved my way, I moved my stop to breakeven. The trade continued to go my way a bit before making a small reversal. It then chopped around for a few minutes. I found myself becoming nervous with the trade, as if it were on the verge of plunging below my stop point.

I quickly asked myself, “Why am I nervous with this trade? Why am I perceiving the trade with so much uneasiness?” A moment’s reflection and review of the market told me that the trade was perfectly fine and progressing according to plan. It was my desire to end the week profitably (after an extended flat period of performance, I should add) that turned the potential reversal of a winning trade into a threat. If all the market can do after the run-up is chop around in a flat way, perhaps this is an opportunity to add to the position, I reasoned. I calibrated my risk/reward on the added piece to the position (and for the position overall, given my new average purchase price) and added a small portion to the trade. The added increment wasn’t large enough to dramatically affect the profitability or risk of the trade, but it was an important psychological step: I turned a perceived threat into opportunity.

The key here is to distinguish between actual threats—markets that truly are not behaving according to your expectations—from perceived threat. That requires reflection about markets and about personal assumptions. Once I saw that the trade was proceeding normally, I was free to challenge the filters that were leading me to become nervous with a good trade.

When you think about your thinking by adopting the perspective of a self-observer, you no longer buy into negative thought patterns.

After you identify a perception that turns a normal event into a threat, the next challenge is to find opportunity in that normal event. I might feel threatened by a difference of opinion with my wife, but that threat can be turned into an opportunity for fruitful communication and problem solving. We might feel threatened by a trade that starts modestly profitable but then stops us out, but that threat can be turned into an opportunity to flip our position or reassess our views of that market.

Identify the perceived threat; turn the perceived threat into an opportunity: that is a two-step process that addresses the true cause of emotional reactions that distort trading decisions. By keeping a journal specifically devoted to your thinking and perceiving, you can structure this two-step process and turn it into a habit pattern that you activate in real time.

COACHING CUE

When you talk or IM about the day’s trading, pay attention to how you describe the markets: good, bad, quiet, active. Listen especially for the tone of your descriptions. Many times, your tone and language will give away whether you’re in tune with markets or fighting them. If you become caught up in what you think the market should be doing, you’re most likely to fight it when it does something else.

LESSON 14: KEEP A PSYCHOLOGICAL JOURNAL

When I first began trading, I kept a journal in the form of multiple annotated charts. I looked for every major turning point in the stock market and then investigated the patterns of indicators and price/volume patterns that could have alerted me to the changes in trend. After a while, I found that certain patterns recurred. It was out of those early observations that I learned to rely on patterns of confirmation and disconfirmation among such measures as the number of stocks making new highs versus lows, the NYSE TICK, and the various stock sectors. Later, as I gained new tools, such as Market Delta (www.marketdelta.com), I added to those patterns. For me, the journal was a tool for pattern recognition. Only after an extended time of recognizing patterns on charts, could I begin to see them unfold in real time. It was also only after an extended period of real-time observation that I felt sufficiently confident to actually place trades based on those patterns.

When we keep a psychological journal, the learning principles are not so different. At first, the journal is simply a tool for recognizing our own patterns as traders. These include:

• Behavioral patterns—Tendencies to act in particular ways in given situations.

• Emotional patterns—Tendencies to enter particular moods or states in reaction to particular events.

• Cognitive patterns—Tendencies to enter into specific thinking patterns or frames of mind in the face of personal or market-related situations.

Many of our trading patterns are amalgamations of the three patterns: in response to our immediate environment, we tend to think, feel, and act a certain way. Sometimes these characteristic patterns work against our best interests. They lead us to make rash decisions and/or interfere with our best market analysis and planning. It is in such situations that we look to a journal (and other psychological exercises) to help us change our patterns of distress.

For more on keeping trading journals: http://traderfeed.blogspot.com/2008/03/formatting-your-trading-journal-for.html

But why do such patterns exist? Why would a person repeat an unfulfilling pattern of thought and behavior again and again, even when she is aware of the consequences? Sometimes traders are so frustrated with their repeated, negative patterns that they swear that they are sabotaging their own success. This pejorative labeling of the problem, however, doesn’t help the situation. It only serves to blame the frustrated trader, magnifying frustrations.

As I stressed in my Psychology of Trading book, maladaptive patterns generally begin as adaptations to challenging situations. We learned particular ways of coping with difficult events and those, at first, may work for us. As a result, these patterns become overlearned: they are internalized as habit patterns.

A good example is the tendency to blame oneself when there are conflicts with others. A child in a home fraught with arguing and fighting might adapt to the situation best by blaming himself for problems rather than risk conflict by blaming others. Later in life, with that pattern ingrained, even normal conflicts may trigger self-blame and depressed mood. Such a person, for example, might spend more time and energy beating up on himself after a losing day than learning from his losses.

When we repeat patterns in trading that consistently lose us money or opportunity, the odds are good that we are replaying coping strategies from an earlier phase of life: one that helped us in a prior situation but which we’ve long since outgrown. The task, then, is to unlearn these patterns—and that is where the psychological journal becomes useful.

Just as I used the trading journal to become keenly aware of market patterns, our psychological journal can alert us to the repetitive patterns of thinking, feeling, and acting that interfere with sound decision-making. Such a journal, like the annotated charts that I mentioned, begins with observation: we want to review our trading day and notice all of the patterns that affected our trading. The initial goal is not to change those patterns. Rather, we simply want to become better at recognizing the patterns, so that we’ll eventually learn to identify their appearance in real time.

The psychological journal is a tool for developing your internal observer: learning to recognize what you’re doing, when you’re doing it.

A favorite journal format that I use divides a normal piece of paper into three columns. The first column describes the specific situation in the markets. The second column summarizes the thoughts, feelings, and/or actions taken in response to the situation. The third column highlights the consequences of the particular cognitive, emotional, or action patterns.

The first two columns help us recognize the situational triggers for our patterns. This makes us more sensitive to their appearance over time. The third column emphasizes in our mind the negative consequences to our patterns. Those negative consequences could include emotional distress, losing money on a trade, or failure to take advantage of an opportunity. When we clearly link maladaptive patterns to negative consequences, we develop and sustain the motivation to change those patterns. That third column should spell out in detail the costs of the recurring pattern: how, specifically, the pattern interferes with your happiness and trading success. The clearer you are about the pattern and its occurrence and the more strongly you feel about the costs it imposes on you, the more likely you’ll be to catch the pattern in real time and be motivated to interrupt and change it.

For now, however, your goal should be to identify your repetitive patterns and their consequences—not to try to change those patterns all at once. You cannot change something if you’re not aware of it. The psychological journal is a powerful tool for building that awareness and understanding what is generating your distress. Keep the journal for 30 consecutive days to help you see just about every variation of your most common patterns. It will also begin the process of turning self-observation into a habit pattern—a positive pattern that can aid you in your personal life and in your trading.

COACHING CUE

Begin your psychological journal by tracking your individual trades and focusing on those situations in which your mindset took you out of proper execution or management of those trade ideas. In other words, these will be instances in which you failed to follow your trading rules, not ones in which you followed the rules and just happened to be wrong on your ideas. Replay these trades in your mind—or, better yet, consider videotaping your trading and observing those trades directly—and then jot down what set you off (Column A); what was going through your mind (Column B); and how it affected your trading (Column C). Zero in on how much money that trigger situation cost you. With practice, you’ll build your internal observer and start noticing these situations as they are occurring. That will give you an opportunity to create a different ending to the script.

LESSON 15: PRESSING: WHEN YOU TRY TOO HARD TO MAKE MONEY

Traders call it pressing: forcing trades in an attempt to make money. Sometimes it takes the form of trading too large; other times traders press by trading too often. The hallmark of pressing is trying to make things happen. This is 180 degrees from a mindset in which you trade selectively, when odds are with you. In the latter frame of mind, you let the market come to you and wait for your opportunity. In the mindset of pressing, you want things to happen and you want it now.

The irony of pressing is that it is often the most successful traders—those who are competitive and driven to succeed—that fall victim. They so hate losing that they’ll do anything to win—including trading poorly!

Trading is a bit like flying a fighter plane or playing chess: it requires highly controlled aggression. In trading, the control element comes from knowing when markets present opportunity and when they don’t. One of the best ways of instilling this control is to trade with rules. These may be rules related to position sizing, stop-loss levels, when to enter markets and when to stay out, trading with trends, etc. When rules are repeated and followed over time, they are internalized and become mechanisms of self-control. We can observe this process among children. They so often hear rules about respect for elders or cleanliness that (eventually!) those behaviors become automatic.

The right trading behaviors start as rules and evolve into habits.

These automatic behaviors are important because they don’t require effort and a dedication of mental resources. If we have to make ourselves follow rules each time we confront situations, we will be taxed—and our full attention will not be on those situations. One of the great strengths of the human mind is its ability to automatize rules, so that mental and physical resources can be fully devoted to challenges at hand. This enables us to face those challenges under self-control (i.e., under rule governance).

So how do we make our trading rules automatic? The answer is to turn them into habit patterns. At one time in our lives, “brush your teeth in the morning” might have been a rule that our parents had to impress on us. With repetition, it became habit; most of us need no reminder of the rule or special motivation to follow the rule. This is the kind of automaticity we aim for in trading: where our rules become so much a part of us that they require no special attention or effort.

When we’re pressing to make money, the need to put on trades overwhelms our rule governance. Pressing normally occurs in situations in which we’re frustrated with our performance. Perhaps we’ve lost money, missed out on opportunities, or are just going through a period of flat equity curve. The frustration leads us to try to create opportunities rather than respond to those presented by markets.

In our dance with markets, we want the market to lead. When we attempt to lead the market—when we try to anticipate what may happen instead of identify what is happening—we’re most likely to be out of step with the next price movements. When we are pressing, we are trying to lead the markets, and that has the potential to turn normal losses and flat periods into veritable slumps.

So how do we make trading rules automatic? As with the tooth brushing, it is through repetition. By repeating your rules many times, in many ways, you gradually internalize them and turn them into habits. You will still experience the normal stresses of markets—no one can repeal risk and uncertainty—but you will be so grounded in your decision-making that you cannot fall prey to distress.

When you coach yourself, you can create opportunities for repetition before and during the trading day. This is a several step process:

1. Make a list of your most important trading rules. These rules should include, at minimum, your rules for risk management; taking breaks after large or multiple trading losses; entering at defined signal points; and preparing for the market day. You can’t expect to internalize trading rules if you haven’t first made them explicit.

2. Create a routine before trading begins to review the rules. Mental rehearsals are powerful vehicles for creating repetition. Every one of your trading rules can be captured as a visualized scenario that you walk yourself through mentally while you keep yourself calm and focused. You actually visualize yourself in different trading situations reminding yourself of rules and following those rules. The more extended and detailed the visualizations, the more likely it is that you’ll internalize them as realistic experience.

The more you think about rules and rehearse them, the more they become part of you. Repetition creates internalization.

3. Create a break in your trading day to review your rule-following. Midday break, when markets tend to slow down, is a perfect time to clear out your head, assess your trading to that point, and remind yourself of what you need to do in the afternoon. By turning your list of rules into a checklist, you can simply check yes or no for each rule depending on whether you followed it during the morning. If you did not follow a particular rule, you jot down that rule on a separate piece of paper, tape it to the monitor, and make it an explicit focus for the afternoon trade.

4. Use the rules at the end of the day as a report card. An end-of-day review will tell you how well you performed in your preparation for trading, your entries, your risk management, and your exiting of positions. Each rule should receive an A, B, C, D, or F grade. Anything less than a Bis a candidate to become an explicit goal for the next day’s trading. In this way, the rules you most need to work on are assured of getting the most attention.

This approach undercuts the tendency to press during periods of frustration by helping you catch yourself in the act of deviating from rules. As a result, frustration is unlikely to escalate into ever-greater violations of sound trading principles. When you cement your rules through repetition, however, you also serve as your own trading coach by preventing frustration from affecting trading in the first place. After all, we can start our day on a frustrating note (perhaps we oversleep), but that won’t lead us to shatter our rule-habits of morning personal hygiene. Behavior patterns, once overlearned, stick with us regardless of our emotional state. That is true self-control.

Good self-coaching is the ability to correct trading problems. Great self-coaching is to develop routines to prevent problems from occurring in the first place. You’ll see the results in your mood—and in the dramatic reduction of large losing trades, days, and weeks.

COACHING CUE

Don’t work at internalizing too many rules at one time. Start with the most important rules that will keep you in the game: entry rules (getting good prices); position-sizing rules (limiting risk per position); and exit rules (setting clear profit targets and stop-loss levels). These three, along with the basic rationale for your trade, can be written down or talked aloud as a trade plan that becomes your guide for trading under control instead of pressing.

LESSON 16: WHEN YOU’RE READY TO HANG IT UP

One of the most difficult manifestations of distress that traders face is despair. I’ve seen it happen to the best of traders: you work hard, you feel as though you’re on the brink of a positive breakthrough, and then you take several steps backward. It feels as though you’re getting nowhere. You’re tired of being wrong, tired of losing money. That excitement that used to greet the start of the market day is replaced with dread. It’s difficult to sustain the research and the morning routines of preparation. If your body could talk, its posture would say, “What’s the use?” You’re ready to hang it up.

Let’s face it: for many, there is a time to give up trading. I know quite a few traders who have been at it for years and have never developed the skills (and perhaps who never had the talent) to simply reach a point of competence where they cover their costs. If you are meant to do something—something that speaks to your talents, skills, and interests—you will display a significant learning curve in the first year or two of effort. If such a learning curve is not apparent, it’s probably not your calling. Hang it up and pursue something that genuinely captures your distinctive abilities. It’s not quitting, it’s not being cowardly. It’s cutting a losing position and getting into something better: a course of action that is as sound in life planning as in trading.

If, however, you’ve progressed steadily and have displayed genuine ability over time, discouragement and depression are your emotional challenges during difficult periods. Becoming your own trading coach requires shepherding yourself through the dark times.

One of my professors in graduate school, Jack Brehm, theorized that depression is a form of motivational suppression. When we perceive that meaningful goals are within our reach, we naturally experience a surge of optimism and energy. This surge helps us make those extra efforts to achieve our goals. Conversely, when we see that valued goals are beyond our reach, nature has provided us with the means to suppress that motivation. After all, it would make no sense to redouble our efforts in the face of unachievable ends. That motivational suppression, taking the form of discouragement and even mild depression, is unpleasant, but it is adaptive in its own way. It turns us away from ends we should not be pursuing, which frees us up for more energizing efforts.

In that sense, the feeling of wanting to give up contains useful information. It is not just a negative emotion to be overcome or minimized. Discouragement tells us that, at that moment, we perceive an unbridgeable gap between our real selves (who we are) and our ideal selves (who we wish to be). We no longer perceive that we have control over our future: our ability to attain goals that are important to us. If we are going to be effective coaches of our trading, we need to address this perception.

Our real selves are always distant from our ideals: the question is whether we perceive ourselves to be competent to bridge the gaps.

The first way to address the real-ideal gap is to consider that, in its context, it may point to something based in reality. Perhaps an edge that we had counted on in trading is no longer present. Perhaps market patterns have changed, such that what was once working for us no longer has the same potential. In that event, our hang-it-up feeling is alerting us that maybe, temporarily, we should hang it up and instead focus our efforts in figuring out what is working in our trading and what isn’t. The key word in that last sentence is temporarily. Just because we’re discouraged doesn’t mean we should feign optimism: perhaps there’s good reason for our motivational suppression. By stepping back, we can investigate possible market-based reasons for our feelings.

Other times, our discouragement may be providing us with information that our expectations are too unrealistic. If, in the back of our minds, we’re hoping or expecting to make money each trading day, we’re setting ourselves up for considerable disappointment when we undergo a streak of losing trades or days that is entirely expectable by chance. In such cases, our motivational suppression provides a clue that we need to investigate, not just markets, but ourselves. When we expect the best, we leave ourselves poorly prepared for the worst.

There’s a third source of reduced drive and motivation, and that’s burnout. Psychological burnout occurs when we feel overwhelmed by the demands that we face. Very often, among traders, burnout signifies a lack of life balance: becoming so immersed in the stresses of trading that recreational, social, creative, and spiritual outlets are lost. While such immersion is possible—and sometimes necessary—for short stretches of time, the immersion leaves a trader impaired over the long run. This is not so much motivational suppression as motivational exhaustion. It is difficult to sustain energy and enthusiasm when we’re operating on overload.

Burnout occurs when we feel that the demands on us exceed our resources for dealing with them.

In each scenario, the trader who serves as his own coach treats the lost drive as information. Maybe it’s a reflection of changes in markets; maybe it’s a sign of unrealistic self-demands or a signal that life is out of balance. If you feel discouraged about your recent trading, your first priority is to identify what that feeling is telling you, so that you can take appropriate action.

If market trends, themes, or volatility have shifted, altering the profitability of your trading setups and ideas, then your action should be a reduction in your risk-taking while you see which patterns, markets, and ideas are working, so that you can focus efforts on those. You also want to review your most recent trading performance to see if you can identify markets and patterns that have continued to work for you, even as others have shifted. Reduce your risk, reassess your trading, and you preserve your capital and turn discouragement into opportunity.

If the feeling like giving up is more a function of your own self-demands, then your challenge is to redouble your efforts at goal setting, making sure that each day and week starts with realistic, achievable goals. When basketball players get into slumps, their coaches will set up plays for high-percentage shots to get the players back on track mentally. Similarly, you want to set yourself up for psychological success by setting achievable goals that move you and your trading forward.

Finally, if burnout is contributing to the lack of optimism, then the challenge is to consciously structure your life outside of trading by ensuring proper time for physical exercise, social activity, and overall time away from markets. An excellent strategy for achieving psychological diversification is to have significant life goals apart from trading. If all the psychological eggs are in the trading basket, it will be difficult to sustain energy and enthusiasm when profits are scarce.

Being your own trading coach doesn’t mean talking yourself into feeling good. Sometimes there are good reasons for lacking positive emotion. The superior coach will listen for those reasons and turn them into prods for constructive change.

COACHING CUE

How psychologically diversified are you? How much stress and distress are you experiencing in your social life, your family life, and in your general emotional state? How much satisfaction are you experiencing in each of these areas? What sustains you when trading goes poorly? What problems from your personal life creep into your trading day? How is your physical fitness? Your quality of sleep and concentration? Your energy level? It’s worth evaluating the nontrading aspects of life as well as your market results with monthly reviews. If the other parts of your life are generating distress, it’s only a matter of time before that compromises your focus, decision-making, and performance.

LESSON 17: WHAT TO DO WHEN FEAR TAKES OVER

Fear is a normal emotional response in the face of danger. Under conditions of fear, we are primed for flight or fight: running from the source of danger or confronting it. As we’ve seen, sometimes the dangers we respond to are not objective sources of threat, but ones that we interpret as threats. When we are prone to perceiving normal situations as threats, fear becomes anxiety. We experience the full flight or fight response, but there is nothing to run from or fight. The danger is in our perception, not in the environment.

When we feel nervous in a trade or feel nervous about putting on a trade, it’s important to know whether our response is one of fear or one of anxiety. Is there a genuine danger in the market environment, or is the danger in our head?

Let’s say that I am short the S&P 500 index (SPY) and we get to a prior level of support. There is a bout of selling as the NYSE TICK moves sharply to -500. SPY hits a marginal new low for the move, but I notice that other indexes—the NASDAQ and Russell—are not making fresh lows. The -500 TICK is well above the prior lows in the TICK for that move. I see signs that the selling is drying up. Nervously, I wait to see if any fresh selling will come into the market. My order to cover the position is ready to go, and my finger is poised over the mouse to execute the order. A few seconds go by and the market moves down a tick, up a tick, down a tick. Volume declines, my nervousness with the trade increases. In a flash, I act on my emotion and cover the position. The odds of the support holding, I decide, are too great to risk losing my profit in the trade.

In this scenario—based on a trade I made just a day ago—fear was adaptive. There was a real danger out there. (The market subsequently moved significantly higher over the next half hour). I knew to trust my feelings and act on my fear, because I could point to specific sources of danger: the established support level, the drying up of volume and TICK, and the nonconfirmations from the Russell 2000 and NASDAQ 100 indexes. Years of experience with intraday trading told me that moves are unlikely to extend in the short run if they cannot carry the broad market with them on increasing downside participation (volume, TICK).

Fear is the friend of trading when it points to genuine sources of danger: a felt discomfort with a trade will often precede conscious recognition of a change in market conditions.

Note that had I identified fear as a negative emotion and tried to push past or ignore it, an important discretionary trading cue would have been lost. When you are your own trading coach, your goal is not to eliminate or even minimize emotion. Rather, your challenge is to extract the information that may underlie those emotions. This means being open to your emotional experience and, at times, trusting in that experience. Blind action based on emotion is a formula for disaster, particularly when what we’re feeling is anxiety and not reality-based fear. But to ignore emotional experience is equally fraught with peril. When you ignore feelings, you cannot have a feel for markets.

So what do you do when nervousness enters your decision-making process?

In The Psychology of Trading book, I liken such feelings to warning lights on the dashboard of a car. The nervous feeling is a warning, a sign that something isn’t right. When you see the light go on in your car, you don’t ignore it or cover it up with masking tape. Rather, you use the warning to figure out: What is wrong? What should I do about it? Depending on the specific dashboard light, you might want to stop driving altogether and take the car into a repair shop. That’s like exiting the market: the risk is just too great to proceed.

When nervousness hits, the first thing you want to do is simply acknowledge that fact. Saying to yourself, “I am not comfortable with the trade right now,” cues you to extract the information from your experience. The next step is to ask, “Why am I not comfortable? Has something important changed in the trade?”

This latter question is crucial because it helps you distinguish realistic fear from normal anxiety you might feel in an unfamiliar or uncertain situation. I recently bumped up my average trading size per position and, at first, felt some nervousness in my trades. When I asked myself, “Why am I nervous?” I couldn’t find anything wrong with the trades: they were performing as expected. This led me to acknowledge that I was just feeling some anxiety about the increased risk per trade. I reassured myself of my stop levels and overall trading plan, so I was able to weather the anxiety and benefit from the increased risk. I needed to carry out that internal dialogue, however, to see if my body’s warning light—the nervousness—was based on a market problem or a problem of perception.

Fear is a warning light; not an automatic guide to action. It is our mind and body’s way of saying, “Something doesn’t look right.”

When I work with a trader in live mode (i.e., coaching them while they are trading), I have them talk aloud so that I can hear their thought process regarding a particular trade idea. I mirror back to traders the quality of their thinking about their decisions, so I can help them figure out when nervousness is warranted (the trade doesn’t really have favorable expectancies) and when it might not be (it’s a good idea, but you’re feeling uncertain because you’re in a slump).

When you are your own trading coach, you can place yourself in talk-aloud mode as well or—if you’re trading in a room with other traders, as at many prop firms—you can use a brief checklist to review the status of your idea or trade. The checklist would simply be a short listing of the factors that should either get you into a trade or keep you in a trade. It’s your way of using the nervousness to differentiate discomfort with a good idea and discomfort with an idea because it isn’t so good. Many times, fear is simply fear of the unknown, the byproduct of making changes. As Mike Bellafiore notes in Chapter 9, that doesn’t mean you shouldn’t take the trade.

I have been trading for long enough that my checklist is well established in my mind. There was a time, however, when I needed to have it written out and in front of me. Is volume expanding in the direction of my trade? Is more volume being transacted at the market bid or at the offer? Is a growing number of stocks trading at their bid or at their offer? Even a very short-term trader can review such criteria quickly, just as a fighter pilot would check his gauges and radar screen in a dangerous combat situation. A fear response cues you to check your own gauges, to make sure you’re making decisions for the right reason.

You can use your fear as a cue to examine your trade more deeply and adjust your confidence in the idea, up or down.

If you can use fear in this way, even negative emotions can become trading tools and even friends. Your homework assignment is to construct a quick checklist that you can talk aloud or check off during a trade (or prior to placing a trade) when you are feeling particularly uncertain. This checklist should prod you to review why you’re in the trade and whether it still makes sense to be in it. In this way, you coach yourself to make your best decisions even when you’re at your most nervous. Confidence doesn’t come from an absence of fear; it comes from knowing you can perform your best in the face of stress and uncertainty.

COACHING CUE

Find a positive change in your trading that makes you nervous and then pursue it as a trading goal. As I describe in The Psychology of Trading, anxiety often points the way to our greatest growth, because we feel anxiety when we depart from the known and familiar. Trading a new market or setup, raising your trading size, holding your trades until they reach a target—these are nerve-wracking situations that can represent great areas of growth and development. In that sense, fear can become a marker for opportunity.

LESSON 18: PERFORMANCE ANXIETY: THE MOST COMMON TRADING PROBLEM

Imagine you’re about to give a presentation to a group of people as part of a job interview process. You very much want the job, and you’ve prepared well for the presentation. You’re nervous going into the session, but you remind yourself that you know your stuff and have done this before.

As you launch into your talk, you notice that the audience is not especially attentive. One person takes out his phone and starts texting while you’re talking. Another person seems to be nodding off. The thought enters your mind that you’re not being sufficiently engaging. You’re losing their interest, and you fear that you might also be losing the job. You decide to improvise something original and attention grabbing, but your nervousness gets in the way. Losing your train of thought, you stumble and awkwardly return to your prepared script. Performance anxiety has taken you out of your game, and your presentation suffers as a result.

Performance anxiety occurs any time our thinking about a performance interferes with the act of performing. If we worry too much while taking a test, we can go blank and forget the material we’ve studied. If we try too hard to make a foul shot at the end of a basketball game, we can toss a brick and lose the game. The attention that we devote to the outcome of the performance takes away from our focus on the process of performing.

This is a common problem among traders, probably the most common one that I encounter in my work at proprietary trading firms and hedge funds. Sometimes the performance anxiety occurs when a trader is doing well and now tries to take more risk by trading larger positions. Other times, traders enter a slump and become so concerned about losing that they fail to take good trades. A trader may feel so much pressure to make a profit that she may cut winning trades short, never letting ideas reach their full potential. As with the public speaker, the performance anxiety takes traders out of their game, leading them to second-guess their research and planning.

More on performance anxiety and how to handle it: http://traderfeed.blogspot.com/2007/04/my-favorite-techniques-for-overcoming.html

As we’ve seen in this chapter, our distressful emotions don’t just come from situations: they are also a function of our perception of those situations. If I’m convinced that I’m a hot job candidate and believe that I have many job options, I won’t feel unduly pressured in an interview or presentation. When I came out of graduate school, I went to a job interview in upstate New York and was asked by the clinic director to identify my favorite approach to doing therapy. I smiled and told him that I preferred primal scream therapy. That broke the ice, we had a good laugh, and the interview went well from there. I knew that, if this interview didn’t work out, other opportunities would arise. That freed me up to be myself.

Had I told myself that this was the only job for me and that I needed the position badly, the pressure would have been intense. I would have been far too nervous to joke in the interview and probably would have come across as wooden and not very personable. If I had viewed the possibility of losing the job as a catastrophe, I would have ensured that I could not have interviewed well.

Traders engage in their own catastrophizing. Instead of viewing loss as a normal, expectable part of performing under conditions of uncertainty, traders regard losses as a threat to their self-perceptions or livelihood. When traders make money, they feel bright about the future and good about themselves. When they hit a string of losing days, they become consumed with the loss. Instead of trading for profits, they trade to not lose money. Like the anxious job interviewer, traders can no longer perform their skills naturally and automatically.

A common mistake that traders make is to try to replace catastrophic, negative thoughts with positive ones. They try repeating affirmations that they will make money, and they keep talking themselves into positive expectations. What happens, however, is that they are still allowing a focus on the outcome of performance to interfere with performing itself. The expert performer does not think positively or negatively about a performance as it’s occurring. Rather, he is wholly absorbed in the act of performing . Does a skilled stage actress focus on the reaction of the audience or the next day comments of reviewers? Does an expert surgeon become absorbed in thoughts of the success or failure of the procedure? No, what makes them elite performers is that their full concentration is devoted to the execution of their skills.

Thinking positively or negatively about performance outcomes will interfere with the process of performing. When you focus on the doing, the outcomes take care of themselves.

What gives these expert performers the confidence to stay absorbed is not positive thinking. Rather, they know that they are capable of handling setbacks when those occur. If a given night’s performance doesn’t go quite right, the actress knows that she can make improvements in rehearsal. If a surgery develops complications, the surgeon knows that he can identify those rapidly and take care of them. By taking the catastrophe out of negative outcomes, these experts are able to avoid crippling performance anxiety.

One of the most powerful tools I’ve found for overcoming performance anxiety in trading is to keep careful track of my worst trading days and make conscious efforts to turn those into learning experiences. This turns losing into an opportunity for self-coaching, not just a failure.

Let’s say that you have a very reliable setup that tells you that a stock should be heading higher. You buy the stock and it promptly moves your way. Just as suddenly, however, it reverses and moves below your entry point. You note that the reversal occurred on significant volume, so you take the loss. In one frame of mind, you could lament your bad luck, curse the market, and pressure yourself to make up for the loss on the next trade. All of those negative actions will contribute to performance pressure; none of them will constructively aid your trading.

Alternatively, you could use the loss to trigger a market review. Are other stocks in the sector selling off? Is the broad market dropping? Has news come out that has affected the stock, sector, or market? Did your buy setup occur within a larger downtrend that you missed? Did you execute the setup too late, chasing strength? All of these questions offer the possibility of learning from the losing trade and quite possibly setting up subsequent successful trades. For instance, if you notice that a surprise negative earnings announcement within the sector is dragging everything down, you might be able to revise your view for the day on the stock and benefit from the weakness. When you are your own trading coach, you want to get to the point where you actually value good trading ideas that don’t work. If a market is not behaving the way it normally does in a given situation, it’s sending you a loud message. If you’re not executing your ideas the way you usually do, you’re getting a clear indication to target that area for improvement. A simple assignment that can instill this mindset is to identify—during the trading day (or during the week, if you’re typically holding positions overnight)—at least one very solid trading idea/setup that did not make you money. That good losing trade is either telling you something about the market, something about your trading, or both. Your task is then to take a short break, figure out the message of the market, and make an adjustment in your subsequent trading.

By acting on the idea that losses present opportunity, you take a good part of the threat out of losing. That keeps you learning and

COACHING CUE

If you track your trading results closely over time, you’ll know your typical slumps and drawdowns: how long they last and how deep they become. Know what a slump looks like and accept that they will arise every so often to help take away their threat value. Many times you can recognize a slump as it’s unfolding and quickly cut back your trading and increase your preparation, thus minimizing drawdowns. Most importantly, if you accept the slump as a normal part of trading, it cannot generate performance anxiety. Indeed, it is often the slumps that push us to find new opportunity in markets and adapt to shifting market conditions. Much of success consists of finding opportunity in adversity.

developing, and it keeps you in the positive mindset that best sustains your development. Every setback has a purpose, and that’s to help you learn: to make you stronger. Performance anxiety melts away as soon as it’s okay to mess up.

LESSON 19: SQUARE PEGS AND ROUND HOLES

One of the central concepts of Enhancing Trader Performance is that each trader can maximize his development and profitability by discovering a niche and operating primarily within it. A trading niche has several components:

• Specific Market and/or Asset Classes. Markets behave differently and are structured differently. Some markets are more volatile; some are more mature and offer more market depth; some offer more information than others. The personality of the market must fit with the personality of the trader. Someone like myself, who thrives on data collection and the analysis of historical patterns of volume and sentiment, can do quite well in the information-rich stock market; not so well in cash currencies, where volume and moment-to-moment sentiment shifts are more opaque.

• A Core Strategy. The trader’s core strategy or strategies capture her ways of making sense of supply and demand. Some traders gravitate toward trend trading; others are contrarian and more countertrend in orientation. Some traders rely mostly on directional trade; others on relational trades that express relative value, such as spreads and pairs trades. Some traders are highly visual and make use of charts and technical patterns; others are more statistically oriented and model-driven.

• A Time Frame. The scalper, who processes information rapidly and holds positions for a few minutes, is different from the intraday position trader and even more different from the swing trader who holds positions overnight. A portfolio manager who trades multiple ideas and markets simultaneously engages in different thought processes from the market maker in a single instrument. Your time frame determines what you look at: market makers will pay great attention to order flow; portfolio managers may focus on macroeconomic fundamentals. Time frame also determines the speed of decision-making and the relative balance between time spent managing trades and time spent researching them. My personality tends to be risk-averse: I trade selectively over a short time frame. I know many other, more aggressive traders who trade frequently and others who hold for longer periods and larger price swings. Time frame affects risk, and it determines the nature of the trader’s interaction with markets.

• A Framework for Decision-Making. Some traders are purely discretionary and intuitive in their decision-making, processing market information as it unfolds. Other traders rely on considerable prior analysis before making decisions. There are traders who are structured in their trading, relying on explicit models—sometimes purely mechanical systems. Other traders may follow general rules, but do not formulate these as hard-and-fast guidelines. My own trading is a combination of head and gut: I research and plan my ideas, but execute and manage them in a discretionary fashion. Each trader blends the analytical and the intuitive differently.

What you trade and how you trade should be an expression of your distinctive cognitive style and strengths.

My experience working with traders—and my own experience in the school of hard trading knocks—is that much of the distress they experience occurs when they are operating outside their niche. Ted Williams, the Hall of Fame baseball slugger, offers a worthwhile metaphor. He divided the plate into a large number of zones and calculated his batting average for each zone. He found, for instance, that pitches low and away provided him with his lowest batting average. Other pitches, those high and directly over the plate, provided sweet spots where his average was quite high. With certain pitches, Williams was a mediocre hitter. With others, he was a superstar. The source of his greatness, by his own account, was that he learned to see the plate well and wait for his pitches.

A trader’s niche defines his sweet spots. Certain markets I trade well, others I don’t. Certain times of day I trade well; others fall short of breakeven. If I extend or reduce my typical time frame, my performance suffers. If I trade patterns outside my research, I suffer. Like Williams, I trade well when I wait for my pitches. If I swing at the low and away balls, I strike out.

One theme that emerges from the experienced traders in Chapter 9 is that they know which pitches they hit, and they’ve learned the value of waiting for those pitches.

The implication is clear: Our emotional experience reflects the degree to which we’re consistently operating within our niche. That is true in careers, relationships, and in trading. When there is an excellent fit between our needs, interests, and values and the environment that we’re operating in, that harmony manifests itself in positive emotional experience. When our environments frustrate our needs, interests, and values, the result is distress. Negative emotions, in this context, are very useful: they alert us to potential mismatches between who we are and what we’re doing.

When you are your own trading coach, your job is to keep yourself within your niche, swinging at pitches that fall within your sweet spots and laying off those that yield marginal results. This means knowing when to not place trades, not to participate in markets. Equally important, it means knowing when your advantage is present and making the most of opportunities. A common pattern among active traders is that they will trade too much outside their frameworks, lose money, and then lack the boldness to press their advantage when they find genuine sweet spots. It’s easy to see careers lost by blowing up; less visible are the failures that result from the inability to capitalize on real opportunity.

I recently talked with a day trader who was convinced that he would make significant money if he just held positions for several days at a time. Though it looked easy to find spots on charts where such holding periods would have worked, in real time that trade was much more difficult. It was not in the trader’s wheelhouse; it was outside his niche. Calibrated to measure opportunity and risk on a day time frame, he found himself shaken out by countertrend moves when he tried holding positions longer. Worse still, he mixed his time frames and tried to convert some losing day trades into longer-term holds. Outside his niche, he began trading like a rookie—with rookie results.

What is your wheelhouse? What do you do best in markets? If you could trade just one strategy, one instrument, one time frame, what would these be? Do you really know the answers to these questions: have you truly taken an inventory of your past trades to see which work and which have been low and outside?

There is nothing wrong with expanding your niche in a careful and thoughtful way, much as a company might test market new products in new categories. But just as management books tell us that great companies stick to their knitting and exploit core competencies, we need to capitalize on our strengths in our trading businesses. As we will see in Chapter 8, you are not just your own trading coach: you are the manager of your trading business. That means reviewing performance, allocating resources wisely, and adapting to shifting market conditions.

The greatest problem with overtrading is that it takes us outside our niches—and therefore out of our performance zones.

Here’s a simple exercise that can move you forward as the manager of your trading business. At the time you take each trade, simply label it as A, B, or C. A trades are clearly within your sweet spot; they’re your bread-and-butter, best trades. B trades are your good trades: not necessarily gimmes or home runs, but consistent winners. C trades are more marginal and speculative: they’re the ones that feel right, but are clearly outside your wheelhouse.

Over time, you can track the profitability of the A, B, and C trades and verify that you really know your niche. You can also track the relative sizing of your positions, to ensure that you’re pursuing the greatest reward when you take trades in your sweet spots and assuming the least risk when you’re going after that low, outside pitch.

The more clearly you identify your niche, the less likely you are to get away from it. That clarity can only benefit your profitability and emotional experience over time.

COACHING CUE

If you categorize your trades/time frames/setups/markets as A, B, or C as outlined above, you have the start for good risk management when you go into slumps. When markets do not behave as you expect and you lose your edge, cut your trading back to A trades only. Many times, slumps start with overconfidence and getting outside our niches. If it’s the A trades that aren’t performing, that’s when you know you have to cut your risk (size) and reassess markets and trends.

LESSON 20: VOLATILITY OF MARKETS AND VOLATILITY OF MOOD

I recently posted something important to the TraderFeed blog. I took two months in the S&P emini futures (ES) market—January and May, 2008—and compared the median volatility of half-hour periods within the months. During that period, overall market volatility, as gauged by the VIX, had declined significantly. The question is whether this day-to-day volatility also translated to lower volatility for very short time frame traders.

The results were eye-opening: In January, when the VIX was high, the median 30-minute high-low price range was 0.60 percent. In May, with a lower VIX, the range dwindled to 0.28 percent. In other words, markets were moving half as far for the active day trader in May than January.

Let’s think about how that affects traders emotionally. The trader whose perceptions are anchored in January and who anticipates much greater movement in May will place profit targets relatively far away. In the lower volatility environment, the market will not reach those targets in the time frame that is traded. Instead, trades that initially move in the trader’s favor will reverse and fall well short of expectations. Repeat that experience day after day, week after week, and you can see how frustration would build. Out of that frustration, traders may double up on positions, even as opportunity is drying up. I’ve seen traders lose significant sums solely because of this dynamic.

Alternatively, the trader who is calibrated to lower volatility environments will place stops relatively close to entries to manage risk. As markets gain volatility, they will blow through those stops—even as the trade eventually turns out to be right. Once again, the likely emotional result is frustration and potential disruption of trading discipline.

Both of these are excellent and all-too-common examples of how poor trading can be the cause of trading distress. It may look as though frustration is causing the loss of discipline—and to a degree that is true—but an equally important part of the picture is that the failure to adjust to market volatility creates the initial frustration. Any invariant set of rules for stops, targets, and position sizing—in other words, rules that don’t take market volatility into account and adjust accordingly—will produce wildly different results as market volatility shifts. For that reason, the market’s changes in volatility can create emotional volatility. We become reactive to markets, because we don’t adjust to what those markets are doing.

Poor trading practice—poor execution, risk management, and trade management—is responsible for much emotional distress. Trading affects our psychology as much as psychology affects our trading.

Personality research suggests that each of us, based on our traits, possess different levels of financial risk tolerance. Our risk appetites are expressed in how we size positions, but also in the markets we trade. When markets move from high to low volatility, they can frustrate the aggressive trader. When they shift from low to high volatility, they become threatening for risk-averse traders. The volatility of markets contributes to volatility of mood because the potential risks and rewards of any given trade change meaningfully. In the example from my blog post, that shift occurred within the span of just a few months.

Note that traders can experience the same problem when they shift from trading one market to another—such as moving from trading the S&P 500 market to the oil market—or when they shift from trading one stock to another. Day traders of individual equities will often track stocks on a watch list and move quickly from sector to sector, trading shares with different volatility patterns. Unless they adjust their stops, targets, and position sizes accordingly, they can easily frustrate themselves as trades get stopped out too quickly, fail to hit targets, or produce outsized gains or losses.

Many traders crow about taking a huge profit on a particular trade. All too often, that profit is the result of sizing a volatile position too aggressively. While it’s nice that the trade resulted in a profit, the reality is that the trade probably represents poorly managed risk. Trading 1,000 shares of a small cap tech firm can be quite different from trading 1,000 shares of a Dow stock, even though their prices might be identical. The higher beta associated with the tech trade will ensure that its profits and losses dwarf those of the large cap trade. That makes for volatile trading results and potential emotional volatility.

Risk and reward are proportional: pursuing large gains inevitably brings large drawdowns. The key to success is trading within your risk tolerance so that swings don’t change how you view markets and make decisions.

Do you know the volatility of the market you’re trading right now? Have you adjusted your trading to take smaller profits and losses in low volatility ones and larger profits and losses when volatility expands? If you’re trading different markets or instruments, do you adjust your expectations for the volatility of these? You wouldn’t drive the same on a busy freeway as on one that is wide open; similarly, you don’t want to be trading fast markets identically to slow ones.

One strategy that has worked well for me in this regard is to examine the past 20 days of trading and calculate the median high-low price range over different holding periods: 30 minutes, 60 minutes, etc. I also take note of the variability around that median: the range of slowest and busiest markets. With this information, I can accomplish several things:

• As the day unfolds, I can gauge whether today’s ranges are varying from the 20-day average. That gives me a sense for the emerging volatility of the day that I’m trading. This helps me adjust expectations as I’m trading. For instance, the S&P e-mini market recently made a 12-point move during the morning. My research told me that this was at the very upper end of recent expectations, a conclusion that kept me from chasing the move and helped me take profits on a short position.

• When I see that volatility over the past 20 days has been quite modest, I can focus on good execution, place stops closer to entry points, and keep profit targets tight. That has me taking profits more aggressively and opportunistically in low volatility environments, reducing my frustration when moves reverse.

• When I see that volatility over the past 20 days is expanding, I can widen my stops, raise my profit targets, adjust my size, and let trades breathe a little more. Not infrequently, the higher volatility environment will be one in which I can set multiple price targets, taking partial profits when the first objective is hit and letting the rest of the position ride for the wider, second target.

Note that what’s happening in the above situations is that I am taking control over my trading based on market volatility. Instead of letting market movement (or lack of movement) control me, I am actively adjusting my trading to the day’s environment. That taking of control is a powerful antidote to trading distress, turning volatility shifts into potential opportunity.

The Excel skills outlined in Chapter 10 will be helpful in your tracking average volume and volatility over past market periods.

As your own trading coach, you want to monitor your mood over time. When you see your mood turn dark and frustrated, you want to examine whether there have been changes in the markets that might account for your emotional shifts. Many times, these will be changes in the volatility of the markets and instruments you’re trading. Establish rules to adapt to different volatility environments as a best practice that aids both trading and mood.

COACHING CUE

If you know the average trading volume for your stock or futures contract at each point of the trading day, you can quickly gauge if days are unfolding as slow, low-volatility days or as busy, higher-volatility days. If you know how current volumes compare to their average levels you can identify when markets are truly breaking out of a range, with large participants jumping aboard the repricing of value. If you can identify markets slowing down as that process unfolds, you can be prepared and pull your trading back accordingly.

RESOURCES

The Become Your Own Trading Coach blog is the primary supplemental resource for this book. You can find links and additional posts on the topic of stress and distress at the home page on the blog for Chapter 2: http://becomeyourowntradingcoach.blogspot.com/2008/08/daily-trading-coach-chapter-two-links.html

Make sure that you structure your learning process as a trader in a way that will build success and confidence. This process will help greatly with the management of stress and distress. That topic—and especially the topic of how to find your trading niche—is covered in depth in the Enhancing Trader Performance book, including a section on psychological trauma. A detailed discussion of how emotional states affect trading can be found in The Psychology of Trading. Links to both books can be found on the Trading Coach blog (www.becomeyourowntradingcoach.blogspot.com).

If you’re looking for a book specific to stress and trading, you might look into Mastering Trading Stress by Ari Kiev, MD (www.arikiev.com), which is written by an experienced trading coach.

How do emotions affect financial decisions? Two good books are Richard L. Peterson’s Inside the Investor’s Brain, published by Wiley (2007) and Your Money and Your Brain, written by Jason Zwieg (Simon & Schuster, 2007).

Information on the research of James Pennebaker regarding writing as a way of coping with stress and distress can be found on his page: http://pennebaker.socialpsychology.org/