CHAPTER 7

Learning New
Action Patterns
Behavioral Approaches to
Self-Coaching

 

 

 

Without self-knowledge, without understanding the working and functions of his machine, man cannot be free, he cannot govern himself and he will always remain a slave.

—G.I. Gurdjieff

 

 

 

Behavioral methods in psychology are the outgrowth of early research into animal learning, emphasizing the roles of conditioning and reinforcement in the unlearning and learning of action tendencies. Modern cognitive-behavioral approaches to change treat thinking as a kind of behavior, making use of such methods as imagery and self-statements to modify our reactions to situations. Like the cognitive restructuring framework from Chapter 6, behavioral methods make extensive use of homework assignments in fostering change. The focus is on here-and-now skills-building, not explorations of past conflicts and their repetition in present-day relationships. Behavioral methods have been especially powerful in addressing anxiety problems, as well as issues of anger and frustration. In this chapter, we’ll explore behavioral techniques that you can master as part of your own self-coaching. You’ll find these techniques particularly relevant to help you deal with performance pressures and impulsive behavior.

Because the essence of the behavioral approach is skills-building, you will benefit from these methods to the degree that you are a diligent student. Frequent practice of the techniques and application of skills to new situations is crucial in making the behavioral efforts stick. Pay particular attention to the exposure methods discussed later in the chapter and also summarized in Enhancing Trader Performance. Pound for pound, so to speak, I find these the most useful methods in the coaching arsenal. Let’s take a look at how you can master these methods for yourself . . .

LESSON 61: UNDERSTAND YOUR CONTINGENCIES

The essence of behavioral psychology is that we share many of the learning mechanisms found in the animal world. My cats Gina and Ginger, for instance, have learned that, when I get up at 5 A.M., I will give them some moist food for their breakfast. As soon as they hear me walking about, they come from wherever they’ve been sleeping and hustle into the kitchen, looking up at me with expectation. Because of repetition, they have learned to associate my walking around after a period of quiet with being fed. This is the essence of stimulus-response learning: animals learn to associate response patterns to stimulus situations. The contingencies between situation and response are reinforced over time, strengthening the learned pattern.

Much of our behavior consists of simple responses to particular situations.

In traditional behaviorism, it is not necessary to explain these learned connections with reference to the mental states of the learners. The cats don’t explicitly reason that it must be morning and I am rising for the day, so they should go to the kitchen. Nor does reason enter their decision to come to the portion of the house where we keep the moist food rather than the dry. Rather, the stimulus of hearing me awaken triggers their anticipation, much as hearing a particular old song may trigger associated memories. In the cognitive restructuring approach to coaching, we look to remap the mind and shift the explicit thinking of traders. In the behavioral mode, the goal is to unlearn associative connections that bring negative outcomes and acquire new connections that will be more adaptive.

In behavioral psychology, unlearning is the flip side of learning: if we don’t reinforce a particular contingency over time, the associative links are weakened, and the response patterns eventually die out. If I were to ring a bell each evening and feed the cats but then not feed them in the morning, eventually they would stop coming to the kitchen in the morning. Instead, they would learn to come running at the sound of the bell. You build a behavior pattern by reinforcing it; you divest yourself of the pattern by removing reinforcement.

Many negative behavior patterns in trading, from this perspective, occur because they are either positively reinforced or negatively reinforced. This distinction is important and not well appreciated. Positive reinforcement is like the feeding of the cats: people come to associate something favorable with a particular stimulus situation. Thus, for example, I may associate my early-morning market preparation with a particular emotional state of readiness and mastery. That linkage has me looking forward to the preparation time and sticking with my routines. The contingencies between being prepared and feeling good (or being prepared and making good trades) are reinforced over time until they become ingrained habits.

Negative reinforcement is a bit subtler, and it lies at the heart of why traders seem to cling to patterns that bring them losses. In negative reinforcement, it is the removal of a negative set of consequences, not the appearance of something positive, that strengthens the bond between stimulus situation and response. Let’s say I am in a trade that is going against me and I bail out of the trade at the worst possible time, when everyone else is selling. Intellectually I may know that, on average, this is an inopportune time to join the crowd, but the trade is so painful at that point that the exit feels, for the moment, like a relief. Drug addicts commonly begin their habits first by seeking a high (positive reinforcement), then by seeking to avoid withdrawal (negative reinforcement). The avoidance of pain is a powerful human reinforcement, and it shapes learned action patterns just as effectively as the introduction of pleasure.

Many destructive trading behaviors are the result of pain-avoidance.

One of the most devastating examples of learned behavior patterns in trading is the association of thrills and excitement with the assumption of risk. When traders take too much risk, they experience profits and losses that are very large relative to their portfolio size. Some traders may find these swings stimulating, to the point where they become their own reinforcements. These traders find themselves trading, not for profits, but for thrills. Inevitably, the law of averages catches up to such traders. When these traders go through a series of losing trades, days, or weeks, their high leverage works against them and they blow up. This is not because thrill-seeking traders are inherently self-destructive. Rather, it is because they have learned, through repeated emotional experience, the linkage between risk-taking and excitement.

Research suggests that contingencies between situations and responses are more quickly and deeply learned if they are accompanied by strong emotion. This process is how people can become addicted to powerful drugs after only a few uses. It is also how we can become fearful and paralyzed by a single traumatic incident. An animal that would take weeks to learn a new trick can learn to avoid tainted food after getting sick on it just once. Emotion accelerates behavioral learning. This is the source of many trading problems, and it also opens the door to powerful behavioral coaching methods.

As your own trading coach, it is important that you understand your own contingencies: the linkages between your expectations and your behaviors. Instead of thinking of your trading problems as irrational, think of them as learned patterns that are supported by something positive that you gain or something negative that you avoid. Something is reinforcing your worst trading behaviors: once you understand that contingency, you are well-positioned to remove the reinforcement and introduce new reinforcers of desired trading patterns.

Behavioral coaching is about reinforcing the right behaviors and removing reinforcement from the wrong ones.

To get started, think back to your most recent episode of truly bad trading. I can recall, for instance, a recent incident in which I so convinced myself of a turnaround in a falling market that I held a position well beyond the original stop-loss point. What is the reinforcement in that situation? In my case, I had been on a nice winning streak and I didn’t want that to end. I associated getting out of the trade with breaking my streak; as long as I was in the trade, I could retain hope that my streak would be intact.

That reasoning makes no sense of course and, if pursued to its logical conclusion, I could have given back every ounce of profit I made during the streak just by holding the one bad trade. But the emotional connection was strong: I was attached to the winning—so much so that its pull was greater than the pull of simply trading well.

So take a look at your most recent episode of horrific trading. What gain were you associating with the bad trading? What negatives were you looking to avoid? What was the contingency at work? As previous lessons have emphasized, the first step in the change process is to become our own observers and recognize the patterns that hold us back. Your behaviors, as irrational and destructive as they seem, are there for a reason. A careful behavioral analysis will reveal the reasons—and will position you well for changing those.

COACHING CUE

Identify the emotions that are most painful for you and then track their occurrence during your trading. For some traders, this will be the pain of losing. Other traders respond negatively to boredom or to the helplessness of uncertainty. Many times your worst trading decisions will be the result of trying to rid yourself of those emotions. This negative reinforcement leads to hasty, unplanned trading behaviors that seem to make no sense in retrospect. If you can identify the negative reinforcement at work, you can more consciously and constructively deal with the difficult feelings.

LESSON 62: IDENTIFY SUBTLE CONTINGENCIES

The linkages between situations and our behavioral responses to those linkages are sometimes quite clear. When traders experience fear in a volatile market and prematurely exit a position, we can readily appreciate that they are managing their emotions, not their capital. The relief at being out of a fast market outweighs objective considerations of risk and reward.

Other times, the contingencies that govern our behavior are far more subtle and difficult to identify. For that reason, such patterns can be extremely challenging to change. If we don’t know what we’re responding to, it’s difficult to shape a different response pattern.

Subtle shifts of mood are one example of stimulus situations that could affect decision-making without our awareness. For instance, some individuals are emotionally reactive to the amount of sunlight they receive and can experience winter blues or even seasonal affective problems during periods of low sunlight. This disruption can affect a trader’s concentration and motivation, interfering with his research and preparation. Similarly, family conflicts can affect mood, which in turn affects trading. One trader I worked with found himself less patient with his ideas, entering and exiting before his signals unfolded. When we looked into the problem, it was clearly episodic—not something that occurred every day. During periods of conflict at home, he was more irritated, and that manifested itself as impatience in his trading.

The problem patterns in our trading are often triggered by subtle shifts in mood and energy level.

Many physical cues can also affect mood and cognitive functioning. These cues include fatigue, hunger, muscle tension, and fitness. I know that I process market data much more effectively and efficiently when I am alert. Anything that affects my energy level adversely will also impair my ability to synthesize large amounts of market information. This is not only because I am less cognitively efficient, but because lack of alertness also affects my mood. In a more fatigued state, I tend to feel less emotionally energetic and optimistic. I won’t look for that creative market idea; I’ll become more discouraged and risk-averse after losses. If I’m not clued into my physical state and its relationship to my mood, I’ll simply think that these periods of lesser performance are random. In fact, most mind and body shifts are as stimulus-response bound as any animal behavior in a learning experiment.

As I emphasized in The Psychology of Trading, a great deal of our learning is state-based: what we know in one state of mind and body can be quite different from what we process in another state. When I am listening to favorite music, my mind is expansive, I can see broad market relationships, and formulate big picture ideas to guide the week’s trade. In a state when I’m pressured for time or distracted by an irritating situation, I suffer from tunnel vision, losing the large perspective. On those occasions, I’m much more likely to make impulsive trades, responding to recent price action rather than broad market dynamics. Often those trades lack good risk/reward qualities; they are much more likely to be losers than winners.

I refer to these subtle environmental cues as triggers, because they can set off behaviors that are unplanned and unwanted. When I’m irritated, for instance, I’ve learned to rid myself of the feeling by simply pushing aside whatever is bothering me. This reaction is a classic example of negative reinforcement. If the thought of doing errands irritates me because I have other things I want to be doing, I quickly push the errands away and focus on what I want to do. The errands don’t get done, of course, and loom as a chronic irritant. My pattern of procrastination is clearly negative reinforcement-based, but it is not helpful: it leaves me with a lingering negative mood and a backlog of unfinished business. Worse still, continually reinforced, the negative mood can become a pattern in my trading. It’s not too great a leap from procrastinating over errands to procrastinating about acting on a losing position.

Many of the behavioral patterns that interfere with our day-to-day lives also find expression in our trading.

Sometimes, when coaching yourself, you won’t know what is triggering your most troubling trading behaviors. They seem to come out of nowhere. That’s when it’s most important to use a trading journal to catalog all the possible factors—physical, situational, emotional, relationship-based, trading-based—that might be associated with your problematic trading. When you engage in this cataloging, you want as open a mind as possible; often, the patterns will be different from ones that you’ve been considering. One trader I worked with experienced trading problems for no apparent reason; only after considerable review did we figure out that these problems occurred when he experienced problems with the firm’s management. The frustration led him to seek gratification from his trading, impelling him to overtrade. He didn’t make a conscious connection between the two; rather, he was trading to manage an emotional state in a simple stimulus /response manner.

The cataloging you undertake in your journal may need to cover a considerable period of time before you notice patterns. What you’re likely to find, however, is that how you trade is affected by your physical and emotional state—which is affected by situational factors at home and work. Understanding these contingencies enables you to build some firewalls into your trading practice, as we will see in the next several lessons. Without such understanding, however, you’re likely to blindly repeat history, losing a measure of self-determination. It’s when we create our own contingencies that we truly possess free will and the ability to pursue our chosen goals.

COACHING CUE

Track your daily physical well-being—your state of alertness, your energy level, your overall feeling of health—against your daily trading results. Many times fatigue, physical tension, and ill health contribute to lapses in concentration and a relapse into old, unhelpful behavior patterns. It is difficult to make and sustain mental efforts when you lack proper sleep or feel run down from a lack of exercise. Very often, our moods are influenced by our physical states, even by factors as subtle as what and how much we eat. When you keep a record of your daily performance as a function of your physical condition, you can see these relationships for yourself and begin preventive maintenance by keeping body—and thus mind—in peak operating condition.

LESSON 63: HARNESS THE POWER OF SOCIAL LEARNING

One of the greatest mistakes traders can make in coaching themselves is to work on their craft in isolation. It is easy to become isolated as a trader, particularly given that all it takes is a computer and Internet connection in one’s home to access the most liquid markets. During my work with trading firms, however, I have consistently seen how access to other professionals aids the learning process. From peer professionals you obtain role modeling, encouragement, and valuable feedback on ideas. A social network of traders also offers powerful behavioral advantages that can aid your self-coaching. Thanks to Web 2.0 and the many online resources available, such social networking can occur virtually, not just within a trading firm.

Psychologist Albert Bandura was one of the first behaviorists to observe how reinforcement in a social context can aid the acquisition of new behaviors. When we observe others rewarded for positive behaviors, the vicarious experience becomes part of our learning. Similarly, when we see others making mistakes and paying the price for these, we learn to avoid a similar fate. In this way, your learning becomes a model for others and theirs provides models for you. Experience is multiplied many times over, accelerating the learning process.

Social learning multiplies experience and shortens learning curves.

Since I first began full-time work as a coach for trading firms in 2004, my own trading has changed radically. I have learned to factor intermarket relationships into my trading, and I have learned to think in terms of risk-adjusted returns, with each trade carefully calibrated for both risk and reward. I am keenly aware of the effect of position sizing on my returns, and I carefully track my trading results to identify periods of shifting performance that might be attributable to market changes. These changes all resulted from observing successful professionals across a variety of trading settings, from proprietary trading shops to investment banks. Since instituting these changes, I’ve enjoyed greater profitability with smaller drawdowns. Seeing how the best traders managed their capital provided me with powerful lessons that I could apply to my own trading.

Perhaps my most effective learning, however, came from observing failed traders. I have seen many traders lose their jobs (and careers) as the result of faulty risk management and an inability to adapt to market shifts. Those failure experiences were painful for the traders, but also for me, as I developed close relationships with many of them. Their pain and the crushing of their dreams was powerful learning for me. I vowed to never make those mistakes myself.

We learn most from emotional experience, including the experiences of others.

When you share ideas in a social network, including self-coaching efforts, you obtain many learning experiences that become your own. Vicarious learning is still learning, whether it’s learning concrete trading skills or learning ways of handling performance pressures. One of the real values of published interviews with successful traders, such as found in the Market Wizards series, is that you can learn from the experience of others. When you actually observe this experience in real time, however, the contingencies are much more immediate and powerful. How a trader in the hole pulls himself out, or how a trader adapts to a changing market, or how a trader successfully prepares for a market day—all provide models for your own behavior. You learn, not just from their actions, but also from observing the results of their actions.

Once you enter a social network of capable and motivated peers, the praise and encouragement of the group become powerful reinforcers. Most of us want to be respected by our fellow professionals, and the support of valued peers can be a meaningful reward. This reinforcer occurs among children, who find that they are praised by teachers, parents, and peers for good behavior and not praised when they behave badly. Over time, this differential reinforcement creates associative links for the child, so that he will do the right things even if no immediate praise is available. Similarly, young, developing traders will absorb the praise of mentors like a sponge; this helps them associate the right trading behaviors with favorable outcomes. When you share successes with fellow professionals, you turn social interaction into social learning.

Find experienced traders who will not be shy in telling you when you are making mistakes. In their lessons, you will learn to teach yourself.

For this lesson, I encourage you to locate online networks of traders (or assemble one of your own) in which there is openness about trading successes and failures. Online forums are a possible venue; you can also connect with readers of trading-oriented blogs who participate in discussions. Or perhaps you will choose to write your own blog, openly sharing your trading experiences and attracting like-minded peers. When you network with traders who have similar levels of motivation, commitment, and ability (as well as compatible trading styles and markets), you can establish a framework in which learning follows from shared ideas and experiences. We’ve seen in Chapter 5 how relationships can be powerful agents of change. In the behavioral sense, you want to be part of the learning curves of other traders, so that you can absorb their lessons. A great start is to establish such a mutual learning framework with just one other compatible trader. Their emotional learning experiences become yours; yours become theirs. Their victories spur your ability to do the right things; your accomplishments show them the path to success. This effectively doubles your behavioral learning, supercharging your self-coaching efforts.

COACHING CUE

An increasing number of professional trading firms—particularly proprietary trading shops—are creating online access to their traders, trading, and resources. Several of these firms are mentioned in Chapter 9. Read the blogs from these firms and participate in their learning activities as an excellent way to connect with other traders and model their best practices.

LESSON 64: SHAPE YOUR TRADING BEHAVIORS

Two children, two different homes: both improve their test grades in math; both fail in English. In the first home, the parents praise the improvement in math and encourage similar progress in English. In the second home, the parents call attention to the English grade and demand to know why the child couldn’t pick up that grade as well. Which child will be most likely to show further school progress?

Behavioral psychologists who utilize behavior modification as a means for altering action patterns would support the first set of parents. Positive reinforcement, as a whole, works better than punishment. If we reinforce the right behaviors, the child will learn to do the right thing. If we punish the wrong behaviors, the child will learn to fear us. Nothing positive is necessarily learned.

Punishment fails because it does not model and reinforce the right behaviors.

Many traders seek to motivate themselves more through punishment than praise. These traders focus more on their losing trades than on their winners. They spend more time on weak areas of trading than building and extending their strengths. Such traders learn to associate unpleasant things with trading. These traders anticipate criticism and punishment and find it difficult to stay wholeheartedly engaged with the learning process.

We can see such dynamics at work in the journals many traders keep. One page after another details what the trader did wrong and what he needs to do to improve. Self-evaluations emphasize the bad trading, everything that could have been better. It’s little wonder that these traders find it difficult to sustain the process of maintaining a journal. After all, who wants to face negativity and psychological punishment every working day?

Many traders fail to sustain work on their trading because they find little positive reinforcement in their work.

Trainers use frequent rewards to teach animals tricks. The trainers don’t expect the dog to, say, jump through the hoops all at once. Rather, they will first give a reward each time the dog approaches the hoop. Then the trainer will wait for the dog to go through the hoop before they dole out the reward. Then they’ll lift the hoop just a couple of inches and reward the dog when it jumps through the hoop. Then they’ll add a second hoop and a third . . . they’ll raise the hoops a little at a time . . . all the while requiring new behaviors that are closer to the desired endpoint before giving the reward.

This process is known as shaping. Trainers shape animal behaviors by rewarding successive approximations to desired ends. In a classroom, a teacher might first reward a disruptive student for five minutes of quiet attention. Later, it will take 10 minutes for the student to earn the reward; eventually the reward will require an entire class period of good behavior. Frequent-flyer programs at airlines aren’t so different. At first, you earn bonuses for simply joining the programs. Only after you ride the airline regularly, however, do you earn later rewards. If you want the greatest perks, you have to shape your riding habits to fit the program.

Shaping is a testament to the power of positive reinforcement. Imagine punishing the dog for not going through the hoops. The chances are good that the dog would simply cower in the presence of the trainer; it certainly wouldn’t figure out the right behaviors from the punishment of the wrong.

When you are your own trading coach, you are the trainer as well as trainee. You are teaching yourself to jump through the hoops of good trading. For this reason, you need an approach to coaching that is grounded in positive reinforcement. Your coaching must stay relentlessly positive, building desired trading behaviors—not punishing the wrong ones.

You can keep a positive tone to the learning process by shaping your trading behaviors: rewarding small, incremental progress toward the desired ends.

The first place to implement the shaping approach is in a journal. As an experiment and a worthwhile exercise, try keeping a positive trading journal for a few weeks. Divide your trading into several categories, such as:

• Research and preparation.

• Quality of trade ideas (ideas that carry conviction).

• Number of diversified (uncorrelated) trade ideas.

• Quality of entries (favorable risk/reward for trades; low amount of heat taken per trade).

• Sizing/management of trades (scaling in/out by planned criteria).

• Execution of exits (following profit targets/stop losses).

Each journal entry then focuses on what you did right in each of those categories each week. You write down, in specific detail, your best performance in each of these areas and then you review your entries before trading the next week, with the aim of continuing the positives.

As the previous lesson noted, this use of positive reinforcement and shaping is even more powerful if you conduct your assessment in a social framework, where you exchange your weekly positive report cards with one or more valued peers. This framework allows you to support the progress of others, even as they reward yours.

One of the better pieces of self-coaching from early in my trading career occurred when I set a goal of reaching a certain size in my trading account. I normally don’t emphasize P/L goals, but in this case I wanted a tangible focus on steady profitability. Once I reached the goal, my commitment was to withdraw a portion of money from the trading account and use it for something enjoyable for the family. This emphasis rewarded my longer-term progress, but also brought my family into the positive reinforcement. When I finish this book, one of my personal goals will be to lose some weight—long hours in airplanes and hotels between working with traders have taken their toll. I’ve promised myself a new wardrobe from a Chicago tailor if I reach my weight goals. Each week I’ll be weighing myself and tracking my progress. With every opportunity to snack, I’ll be thinking about that new wardrobe and how I would feel if I didn’t make weight that week. There’s little doubt in my mind that I’ll reach my goal.

Tangible rewards for your success are among the strongest positive reinforcers.

The key to making a positive journal work is shaping. At first, you jot down entries for even very small things that you did right. Later, you only make notations of larger examples of virtuous trading. If you conduct the shaping process properly, you’ll always have good things to write about—even on losing days. This process ensures that you’re always learning, always building on strengths, always keeping your motivation up. The difficult part about self-coaching isn’t just making progress, it’s sustaining the progress. Progress is much easier to accomplish when your focus is building yourself up, not tearing yourself down.

COACHING CUE

What is meaningful for you as a tangible reward for your self-coaching progress? A vacation with loved ones? A new car? One trader I work with donates a portion of his profits to a charity he deeply believes in; helping them out inspires his own efforts. It helps to reinforce the small steps of progress via shaping, but it also helps to have a larger goal that you’re working toward; a goal that is meaningful for you. Remind yourself periodically of the goal; track your progress toward the goal. The psychologist Abraham Maslow recognized clearly: we perform at our best when we are impelled toward positive goals, not driven by deficits and unmet needs.

LESSON 65: THE CONDITIONING OF MARKETS

A large part of money management follows from a deep appreciation of fat tails. Market returns are not normally distributed; they show a higher proportion of extreme occurrences than you would expect from a simple flipping of coins. This is true across all time frames. The odds of a multiple standard deviation move against you (or for you) are sufficiently high that, if you’re in the market frequently over a long period of time, you will surely encounter those periods in which markets stay irrational longer than you can stay solvent.

The distribution of market returns is also leptokurtic: it is far more peaked around the median than a normal distribution. This implies that market moves revert to a mean more often than we would normally expect by chance. Just as a market seems to be moving in one direction—trending—it reverses course and finishes little changed.

It is difficult to imagine a situation better designed to create frustration . Markets produce large moves more often than would be expected if returns were distributed normally, which leads traders to seek large, trending moves. But markets also revert to mean returns more often than we would expect in normal distributions, creating many false trends. If you trade a countertrend strategy, you run the risk of being blown out by a multiple standard deviation move. If you try to jump aboard trends, you’ll find yourself chopped to pieces during false breakouts.

The very structure of market returns ensures a high degree of psychological challenge for traders.

The tendency of markets to make extreme moves amid frequent mean reversion creates interesting and important psychological challenges that affect self-coaching. To fully appreciate this, we need to understand the dynamics of behavioral conditioning.

Let’s say that, each time I ring a bell, I hit you over the head. Soon, you’ll learn to duck as soon as you hear the bell. That is a conditioned response . Days later, you might be in a different location and will still duck if the bell sounds. It’s automatic; not a behavior guided by explicit reasoning. You’ve learned to associate bell and pain, just as Pavlov’s dogs associated a ringing bell with the appearance of meat. Bell rings, dogs salivate. Bell rings, you protect yourself.

Now let’s take our experiment a step further. I ring a similar but different bell and once again hit you over the head. Before long, you learn to duck whenever you hear any bell. This is called generalization. Your conditioned responses (the ducking) have now extended to a class of stimuli similar to the original one.

Much of what we call traumatic stress is the result of such conditioning. In the Psychology of Trading book, I mentioned my car accident in which I was thrown from a vehicle while riding as a passenger. Just as a result of that single, powerful event, I developed an anxiety response any-time I subsequently sat in the passenger seat of a car—even when the vehicle wasn’t moving! I had learned an associative connection between being a passenger and extreme danger; the conditioning stuck with me even though I intellectually knew it made no sense.

Many of our extreme reactions to market events are the result of prior conditioning.

Powerful positive emotional events can yield the same kind of conditioning. The high obtained from certain drugs can be so strong that some people will develop addictive patterns after a single use. Underlying the addiction is the learned connection between the high and the use of the substance. That, too, overrides reason and reorganizes behavior.

One of my greatest failures as a trading coach occurred with a young trader who experienced early market success. He took the time to observe markets, learn short-term patterns, and track his own trading. He started trading small and learned the important lessons about waiting for good entry points, cutting losing trades, and letting his winning trades run to their target points. The trading firm was happy with his progress and gave him significantly greater size to trade. That was where I went wrong. I should have stepped in and demanded that the trader’s increase in risk be more graduated. Instead, armed with his new size, the young trader decided he would try to compete with the more experienced traders at the firm. He traded full size in his positions and his profits and losses swung wildly. Unprepared emotionally for those swings, he became impulsive and, one day, abandoned all discipline, blowing himself up on a single trade he allowed to get away from him. He never recovered from that loss and eventually had to start over at another firm.

It is impossible to remain emotionally stable if you greatly amplify your P/L swings.

When traders are undercapitalized and still hope to trade for a living, they too are impelled to take high levels of risk to achieve their desired returns. The result is that their portfolio swings wildly, with gains and losses that represent a large portion of total account value. These financial swings bring emotional swings, both positive and negative. The larger the financial swings, on average, the larger the emotional swings. The larger the emotional swings, the greater the potential for the development of learned, conditioned responses that disrupt future trading.

When a trader undergoes an emotionally harrowing loss, many of the situational factors associated with that trade may become associated with the emotional pain. Some of these situational factors, from the trader’s physical state to the particular type of movement in the market, may be quite random. Nonetheless, they can trigger the emotional pain, much like sitting in a passenger seat triggered my anxiety following the automobile accident. A trader who consulted me about problems pulling the trigger on good trade setups experienced precisely that problem. He had lost significant money shorting the market during an uptrend, incurring several large losses. Subsequently, even when his trades were small in size, he felt fear whenever he tried to short the market. The feelings associated with his loss came back as a conditioned response, inhibiting his trading. This is the dynamic behind the flashbacks that occur during post-traumatic stress: stimuli associated with the initial trauma trigger memories and feelings from that painful incident.

The problem may have been just as severe had this trader made large money on the initial trade instead of losing. The emotional impact of a windfall profit, like the impact of a crack cocaine high, would bring its own conditioning, leading him to pursue similar gains (and highs) in future trades. It is poorly understood by traders that, psychologically, outsized gains are just as problematic as outsized losses. The fat tails of returns threaten fat tails of psychological response, interfering with sound perception and decision-making.

For this reason, when you’re your own trading coach, you don’t want patterns of extreme returns. Steady, consistent profits are far better for psychological performance than wild swings up and down, even though they may lead to the same ultimate returns. Stated otherwise, good risk-adjusted returns are better for the psyche than extreme patterns of returns. It’s not how much you make, but how much you make per unit of risk taken that will keep you in or out of the performance zone.

Your assignment for this lesson is to track the variability of your returns as intensively as your overall profitability. By variability of returns, I mean the absolute value of daily/weekly changes in your portfolio value: how much your account swings up or down on average each day. As markets change in their volatility and as you shift in your level of conviction about trades, you’ll see changes in this variability. This tracking will tell you when you run more and less risk. On the whole, you’ll want greater variability when you trade well and have many solid ideas; you’ll want to cut your risk (lower the variability of returns) when you don’t see markets well and when good trading ideas and moves are scarce.

Track the volatility of your returns, not just their direction. Volatility affects trading psychology every bit as much as winning and losing.

When you track the variability of returns, you’ll also be able to see when your swings in profit/loss are outliers from your historical norms. This will be an excellent alert that your levels of risk may be sufficient to generate those large emotional swings that will produce unwanted conditioned responses. Traders tend to love volatility when they’re making money and hate volatility when they’re losing. Psychologically, it makes sense to keep the volatility of your returns within bounds: markets may possess fat tails, but with prudent position sizing, your returns can remain stable. You don’t want markets conditioning your learning: you want to be your own coach, directing your own learning.

COACHING CUE

The psychological research on trauma suggests that processing a very stressful event verbally—out loud or in writing—can be extremely helpful in making sense of that event and divesting it of enduring emotional impact. When we repeat something again and again, it becomes familiar to us and no longer evokes powerful emotion. If you encounter outsized gains or losses in your portfolio, double down in your use of the trading journal or in your conversations with peer traders to thoroughly process what happened and why. As noted above, this process is just as important following large gains as following large losses. When highly emotional events bypass explicit processing, that is when we are most vulnerable to the effects of conditioning.

LESSON 66: THE POWER OF INCOMPATIBILITY

Earlier we saw how much of what we learn is state-dependent. We associate particular outcomes with specific physical and emotional states. These associative links trigger unwanted behavior patterns when we enter those states. The classical conditioning mentioned in the previous lesson is an excellent example: if we experience overwhelming anxiety due to large losses, exiting the market may provide immediate relief. Subsequent experiences of anxiety in the market may trigger the same exiting behavior even when it would be in our financial interest to hold the position. The association between the anxiety and perceptions of danger may be so strong that it overwhelms our prior planning.

Boredom, for many active traders, can be as noxious as strong anxiety. It may be associated with failure to make money, or it may have much earlier negative associations: being lonely or feeling abandoned as a child. If you get into a trade—particularly a risky one—you immediately relieve the boredom, but you create a new trading problem. In such cases, the trading behaviors triggered by the state are more psychological in their origins than logical.

If trading is associated with an aversive state, we tend to do what is necessary to alleviate the state, even at the expense of our portfolios.

One of the simplest behavioral techniques for breaking these bonds of conditioning is to place yourself in a state that is incompatible with the one that triggers your problematic trading. Thus, for instance, if you find that anxiety triggers hasty and ill-timed market exits, you would work on placing yourself in a calm, relaxed physical condition that is incompatible with anxiety. If boredom were your nemesis, you would cultivate activities that hold your interest during slow markets. When I am fatigued, I find that a round of vigorous exercise not only makes me more alert, but also triggers positive action patterns, as I tackle work that had previously seemed overwhelming. If you’re not in a state that supports sound decision-making, your self-coaching focus turns from the markets to yourself and doing something different to shift your state.

Two of the methods I have found particularly helpful in maintaining states incompatible with one’s triggers are controlling breathing and muscle tension during trading. When I focus on the screen and breathe deeply and slowly while I follow the market, I minimize the physical manifestations of any form of overexcitement—from overconfidence to fear—and stay in a highly focused mode that I have learned to associate with good trading. When we slow ourselves down through deep, rhythmical breathing, it is difficult to be simultaneously speeded up and excited. The careful breathing thus acts as a dampener on extreme emotion. It reinforces self-control and discipline at the most elemental level.

In my own trading, I’ve found that problematic trading tends to occur when I am physically tense, especially when I tense the muscles of my forehead. I rarely knit my eyebrows and wrinkle my forehead when I am comfortable in a situation. Conversely, I am prone to headaches and associate forehead muscle tension with tension headaches, which can pose a considerable distraction. By purposely keeping my forehead relaxed—widening my eyes slightly and going into a temporary stare—as I maintain the slow, deep breathing, I can sustain a state incompatible with the ones that occur when I’m on edge. Instead of waiting to become tense or nervous and then performing exercises to reduce these feelings, I proactively pursue and maintain an incompatible state before problematic trading occurs.

Control the arousal level of the body as a powerful means of controlling the arousal level of the mind.

I can often recognize my physical level of tension by my seating position. When I am comfortable, confident, and relaxed, I sit in the chair firmly, with my lower back and behind flush with the seat back. When market events trigger a stress response, however, I find myself leaning forward, with my seat near the end of the chair. Over time, this position gives me a backache in my lower back. I know that I’m not comfortable with my trading or with the markets when I feel that pain. Often, I’ll readjust my seating, reorient my breathing, and find it easier to view the markets from a different—and more promising—angle.

The principle of incompatibility can also extend to thinking behaviors. Cognitive-behavioral work treats thinking as a discrete behavior that can be conditioned and modified just like any muscular behavior. If we tend to engage in negative thinking during trading, we can enter a mode of thinking that is incompatible with negativity before trading problems occur. I frequently have one of my cats sitting beside me as I’m trading, usually Gina. It’s nearly impossible for me to become consumed with negative or angry thoughts when I am petting Gina. She alternates between licking me and rubbing her face against mine, all the while purring loudly and making kneading movements with her front paws. Stroking the cat helps me stay in touch with loving, caring feelings that are incompatible with the nastier emotions that can emerge during frustrating market periods.

One of the states that is most disruptive to my trading is what I would call a chaotic state, in which I feel as though I’m a step behind markets, not really understanding what is going on. It’s a confused state, but also a frustrated one, as I don’t feel in control in the situation. I’ve learned that if I place myself in environments that are incompatible with chaos, I am in a much more balanced frame of mind. Such environments are ordered and well organized—my notes and materials are readily at hand—and they are designed to evoke positive feelings. Music is particularly effective for me in this regard. It is also harder for me to feel chaotic if I have gone through a routine of research and track markets prior to the New York stock market open. I organize my ideas in advance to help me feel more organized, settled, and in control.

You can structure your trading routines to make them incompatible with stress and distress.

When you are your own trading coach, you have wide latitude in modifying your environment—inner and outer—so that it does not trigger states that are associated with poor trading. One trader I worked with loved trading in a room with other traders (he joined a prop firm) because, in the social setting, he was too embarrassed to engage in behaviors he might lapse into on his own. He found that he was much more prudent about risk-taking and much less emotionally volatile when he was accountable to others. The key is to find a state or situation that is incompatible with the triggers for your worst trading and then build that into your normal trading routine.

A simple way to get started is to complete the following sentence:

I trade my worst when I

Once you write your answer, your assignment is to create the incompatible situation. For example, I would complete the sentence with “don’t do my homework.” I know that my day’s preparation for the trade has a huge bearing on my odds for success that day. I also know that I’m least likely to do my homework diligently if I oversleep or am fatigued. When I build stretching and physical exercise into my early mornings, I enter an energized state that prepares me for the homework: I’ve learned to associate the vigorous, energetic state with being prepared and engaging in my preparation. After you observe the differences in your states when you trade your best and worst, you’ll be able to construct similar activities that proactively keep you in an optimal trading mode.

COACHING CUE

I mentioned above how chaotic feelings are a trigger for my worst trading. If markets aren’t making sense to me, my mind feels scrambled and trading seems rushed. I’ve learned through hard experience that a powerful way to create a state incompatible with that chaos is to temporarily lower my trading size until I regain a feel for markets. With much less at risk, I don’t feel pressured and yet can stay actively engaged in markets. When we control our risk we can control our emotional reactions to markets: it’s tough to panic when you have little on the line. Markets seem to move slower—and our feel for them returns—when we’re not distracted by emotions triggered by risk and uncertainty.

LESSON 67: BUILD ON POSITIVE ASSOCIATIONS

In the cognitive-behavioral framework, we can utilize imagery as a stimulus to evoke desired responses, triggering our own positive, learned patterns. Making use of imagery in this fashion can help us create positive associative links, triggering our best trading behaviors.

Let’s say we have a trader who anticipates an early-morning entry into the market based upon a researched setup. Before the market opens, she visualizes the setup and her execution, noting the feelings of satisfaction from making a good decision. This positive mental rehearsal acts as a preparation for the actual trade, as she follows the behavioral pathway she has laid down in advance. I call this anticipatory reinforcement: by imagining the positive benefits of doing the right things, we strengthen positive associative links and make it easier to act on our learning in real time.

Many traders conduct anticipatory reinforcement in reverse: they dwell on negative outcomes and feared scenarios, undercutting their own sense of efficacy. This, in essence, is anticipatory punishment, and it leads traders to miss opportunities or to not act on them. I’ve found over the years that much of what separates the excellent traders from the average ones is not so much their ideas, but what they do with those ideas. Two traders will have positions go their way and then pull back a bit. The first trader, anticipating punishment, fears losing his gain and takes a quick, small profit. The second trader, anticipating reward, adds to the position on the pull back and reaps large gains. Same idea, different outcomes, all as the result of conditioned patterns of thinking.

Our ways of thinking can reflect conditioned responses; that’s how markets can control our minds.

When we reinforce positive patterns, we not only strengthen these but also begin the process of extinguishing negative patterns. In behavioral theory, a stimulus-response connection is extinguished over time if it is not reinforced. The animal that was given food each time it performed a trick will eventually stop performing the trick if food is not forthcoming. Behavioral patterns, in this way, not only have to be learned but also actively reinforced to find active expression in our trading. We can unlearn negative behavior patterns simply by withdrawing their reinforcement and by introducing more powerful rewards elsewhere. This is a powerful principle.

One common learned pattern among traders is the connection between anger/frustration and aggression. When traders become frustrated by market conditions—say, a choppy, directionless trade—they react out of anger and lash out by placing trades to get even with the offending market. This pattern—relieving anger by lashing out—may make traders feel better for the moment (negative reinforcement), but it leads to poor decisions and losing trades.

How can we use positive associations to unlearn this pattern of revenge trading?

Suppose a trader engages in a thorough examination of his trading during the choppy markets of the past month. He investigates charts to identify the choppy periods and then reviews all his trades from these periods, pulling out the most successful ones. What he may find is that his successful trades in choppy conditions are more selective (fewer in number); that they are placed near the edges of trading ranges; and that they are held for shorter periods of time to capitalize either on breakouts/false breakouts or on moves back within the range. His losing trades, on the other hand, tend to be placed in the middle of the range and are held for longer periods, reversing before they can hit distant price targets.

Armed with this bit of self-coaching information, the trader now can view the choppy period as one of opportunity, not threat. When he notices a trading range going into the day’s trade, he can use imagery to rehearse calm caution when the market is trading near the center of the range. He can also mentally rehearse entries near range extremes, including his placement of modest price targets. When he rehearses these trade ideas, it is with the feelings associated with his prior winning trades. Over time, with repetition, he learns a positive association with range-bound, choppy markets. His prior behavior pattern, built on frustration and its removal, is no longer reinforced. It faces gradual extinction, as he builds the more constructive associative patterns.

Find the market conditions that are most challenging for you and then identify how you trade them best. This process turns threat into opportunity.

Since the late 1970s, I have traded actively and gained a pretty good feel for many short-term market patterns, including patterns of volume and intraday sentiment. Many times I first become aware of these patterns with a gut feeling: something seems right or not right about the market action. I have learned through hard-won experience that I suffer in my performance if I ignore these intuitions. They are not based on hopes or fears; they are the result of implicit learning over a period of years. In my mental rehearsals, I include scenarios in which I act upon this feel for the market, recalling specific, recent trades in which I saved myself considerable grief by not overriding my judgment. This rehearsal of positive associations has created a kind of intrinsic reinforcement: I actively look forward to the emergence of those gut cues and am mentally prepared to act on them when they arise.

As I mentioned in the previous section, I have many positive associations to music. Indeed, as I’m writing this, I’m listening to music from a group called Edenbridge, a kind of music that I find both energetic and uplifting. My writing today began at 6:30 A.M., and it is now two hours later and I’m going strong. The association of the music with the writing keeps me in a positive state of mind. It keeps me looking forward to the writing, even when the editing process can become tedious. With these positive connections activated regularly, my more negative patterns of procrastination are not reinforced and gradually lose their strength. It is not necessary for me to fight my tendency to procrastinate; such internal conflict would likely create writer’s block. Rather, I create a positive source of motivation that outweighs the negative reinforcement value of avoidance.

A good example of the power of anticipatory reinforcement is occurring right now as I am writing this. I’m on a 15-hour flight to Hong Kong on my way to working with traders in Asia. The cabin is dark, and I’m feeling tired. I’ve promised myself, however, that I can take a long-awaited rest after I finish this chapter. I find myself more motivated as I get closer to my goal; by the time I get to rest, I will have earned it. Ultimately, the positive reinforcement of living up to my deal and earning the rest outweighs any negative reinforcement value of avoiding the writing out of tiredness.

Find your strongest motivations and link those to your best behaviors.

Your coaching assignment for this lesson is to create what-if scenarios for the day’s trading, rehearsing the good, planned trades you would make in each scenario. These rehearsals should be detailed and vivid, accompanied by a visualization of the pride and satisfaction you experience when you trade well. For every single what-if outcome, you should envision a concrete response that embodies good trading. In this way, you plan your trading as well as your trades, but you also strengthen the bonds of positive learned patterns and extinguish the negative patterns. As your own trading coach, you have the power to be teacher as well as student: the shaper of behavior as well as the one whose behavior is shaped. If you take the active learning role that lies at the heart of the behavioral approach, you become the programmer of your own patterns.

COACHING CUE

I find it helpful to help traders identify the highlights of their trading from the past week: what they did especially well. From these highlights, we frame ideas about what the trader is really good at—what makes her successful. We then use this what I’m good at idea to frame positive goals for the coming week: how the trader is going to enact those strengths in the next few days. Because these are goals we track together, we create a situation of anticipatory reinforcement and a momentum for continuing best practices. This is a process you can carry forward with trading colleagues: share what you do best and how you put your best talents and skills into practice. Focus on your best trading and you begin the process of extinguishing your worst practices.

LESSON 68: EXPOSURE: A POWERFUL AND FLEXIBLE BEHAVIORAL METHOD

If I had to name a single behavioral method that is of greatest value to traders, it would be exposure. As I described in my chapter on behavioral methods in the Enhancing Trader Performance book, exposure is a technique that enables you to reprogram those stimulus-response triggers that set off faulty trading.

A major idea underlying exposure is that the avoidance of negative experience itself becomes a reinforcer, preventing people from overcoming learned fears. Let’s say, for instance, that I have taken large losses on a short position and now experience fear whenever a buy program hits the tape and moves the index higher by several ticks. I can avoid that fear by simply exiting the position. While that avoidance is a relief, it never addresses the learned connection impelling my behavior. Indeed, it reinforces my fear by acting on it. It is impossible to overcome a fear when you give into it.

We overcome fear by facing it successfully.

In exposure work, we intentionally expose ourselves to the situations that set us off. Generally, this process begins with imaginal exposure (facing situations in realistic imagery) and progresses to in vivo (real time) exposure. These exposures pair the trigger situation with learned skills that invoke a state incompatible with the bad trading. Thus, in the example above, we might rehearse a calm, focused state of mind while vividly imagining the market moving higher against us.

Think about what this accomplishes. On one hand, we immerse ourselves in thoughts and images of something we find threatening. We force ourselves to experience our worst fears. At the same time, however, we make special efforts to keep ourselves calm and controlled. We talk to ourselves in calming ways, slow our breathing, and keep our bodies relaxed. We do this again and again, repeating the imagined scenarios until we are able to stay completely calm and focused throughout. In that way, we extinguish the learned connection between the situation and the fear.

Exposure methods are ways to reprogram our emotional responses to situations.

Two steps are important to make exposure effective:

1. Before you try to expose yourself to imagery of your trigger situations, make sure you’ve thoroughly learned the coping skill that you’ll be using as part of the pairing. For example, you want to practice a deep breathing, muscle relaxation routine every day for at least a week to ensure that you can focus and relax yourself on demand. At first, practicing the technique may take 20 minutes or so to get quite relaxed; later it will take only 15, then 10. Eventually, with enough practice, you’ll be able to relax and focus yourself quite effectively with just a few deep breaths. You want to get to that point before undertaking the imagery work. The idea is to internalize the coping skill before you try to pair it with threatening situations.

2. Repetition is the key to effective exposure work. You don’t just imagine a stressful situation, keep yourself calm, and then go on with your day. Rather, you imagine the situation in great detail, with multiple variations. You won’t imagine very stressful situations until you’ve been able to keep yourself thoroughly relaxed with less stressful imagined scenarios. If that means you repeat a single scenario five times until it no longer elicits anxiety, that is fine. The goal is to unlearn the connection between the situation and the unwanted response and train yourself to a new connection: between the trigger situation and staying in the zone.

As a beginning exercise, here is a very basic exposure routine that you can apply to almost any trading patterns that you wish to change. I have found that this works very well for reprogramming anxiety responses to market situations and frustration/anger responses. Any time a situation evokes an exaggerated emotional and/or behavioral response from you, exposure methods can be used to alter your reactions:

Step 1. Seat yourself comfortably, listening to relaxing music through headphones. While listening, close your eyes and breathe deeply and slowly. Keep yourself still physically and keep your mind focused on the music.

Step 2. Start with lower part of your body and gradually tense and relax the muscles, performing several repetitions with each muscle group before moving higher along your body. Thus you tense and relax your toes several times, then your flex your foot, then your lower leg, etc. All the while you are tensing and relaxing, you are breathing deeply and slowly and staying focused on the music.

Step 3. Once you reach the top of your body, tensing and relaxing the muscles of your face, you then take a few more deep breaths and notice your body’s relaxation.

Step 4. With the music still playing, imagine in detail a trading situation that you anticipate. Visualize the position you’re in and the market movement. Imagine the market behaving in a way that normally would trigger your fear, frustration, etc. All the while, you are breathing deeply and slowly, keeping your muscles relaxed, and playing the music in the background.

Step 5. When you feel yourself tense up or experience fear or frustration, stop the visualization (freeze the frame) and simply go back to breathing deeply and slowly and listening to the music. Once you’re relaxed again, continue the scenario from where you left off. Make sure you freeze things and keep yourself calm and focused when trigger responses start to affect your visualization.

Step 6. If you had to interrupt the visualization to keep yourself calm, repeat the exact same scenario the same way until you can get all the way through without having to freeze the scene. At that point, you’ve extinguished the response to the situation.

Step 7. After you master one scenario, construct variations of the scenario, perhaps making each one a bit more stressful. Once again, don’t move on to another scene until you’ve been able to keep yourself fully relaxed and focused during the scene you’ve been rehearsing. If you can stay calm and focused during a visualization of a moderate stress, make the next visualizations more threatening. Don’t stop your exposure work until you have tackled your absolute worst fears.

This basic exercise enables you to extinguish emotional and behavioral responses to trading situations that can lose you money. If you rehearse staying calm and focused in stressful situations, you build a new learned connection and reprogram your behavioral responses. This process is effective for situations in which you’ve been through extreme losses, and it is also quite useful in reprogramming patterns of overtrading. When you coach yourself to face and overcome your worst fears, you build confidence, resilience, and a sense of efficacy, empowering yourself in situations where you had seemed powerless.

COACHING CUE

Imagery can be powerful in programming new responses, but consider extending your exposure work to live trading. Such in-vivo exposure, beginning with small trading size and gradually ramping up to full size with success, is the single most effective technique for reprogramming traumatic experiences in trading, such as large losses that overwhelm mood and confidence. By re-creating the market conditions that caused the trauma in imagery—and then facing those conditions in simulated and actual trading—all the while rehearsing self-control skills, we can regain a sense of mastery over trading. It takes repeated experiences of safety during exposure work to undo traumatic stresses. Eventually, the emotional learning that we can face our fears without terrible things happening sinks in and contributes to a newfound confidence.

LESSON 69: EXTEND EXPOSURE WORK TO BUILD SKILLS

In the previous lesson, we saw how exposure methods can be used to deprogram negative behavior patterns. Just a small adjustment in the technique is needed to create positive learning by rehearsing and reinforcing proper trading behaviors.

The fundamental difficulty of trading is that we know what to do (enter on pullbacks in a trend, size positions appropriately) when we are out of the heat of battle. When stressed, however, or when we face unusual opportunity, we find that other behavior patterns are triggered and it is much more difficult to do the right things. I work with a good number of experienced portfolio managers and proprietary traders, and even they make the occasional rookie errors, in which they are swayed by situational influences. Techniques that reinforce the right actions can be useful for the pros as well as beginners.

One trader I worked with was bedeviled with the problem of regret. He would enter a longer-term position and, while it was going his way, he was fine. As soon as the position retraced some of the gains, however, he began to regret that he hadn’t lightened up at the more favorable price levels. This regret was a very tangible psychological influence for him. At times, it became outright guilt as he convinced himself that he had done the wrong thing.

What happened as a result of this pattern is that he would inevitably assuage this guilt by waiting for the profits on the trade to move back to their high water mark so that he had an exit approximating the one he had missed. The problem was that this cut his original trade idea short. Many times he would take his profit on the first rebound from the retracement, only to see the position move toward his initial target without him on board. Then the trader experienced massive regret and guilt. This led him to seek additional home run trades (to relieve his newest guilt), only to make the same mistakes on these trades as well. By the time I met with this trader, all he could talk about was how much he could have made if he had just traded the way he planned.

Many traders are shaken out of good trades when they aim to not lose, rather than aim to maximize profits.

The exposure work for this trader was straightforward. As the previous lesson outlined, we first just worked on the skill of staying calm and focused. I used the heart-rate variability (HRV) biofeedback unit for this work (www.heartmath.com). He had to concentrate and breathe rhythmically and deeply while keeping his HRV readings high. The trader was able to use the biofeedback unit for practice at home and he could track his skill-building by keeping the majority of his readings in the highest bin for a continuous period of five minutes or more. He found that he could keep his readings high by focusing his attention (counting in his head), keeping physically still and relaxed, and breathing from his diaphragm in a smooth, gradual fashion.

Once he had mastered the skill of keeping himself in the HRV zone, he used visualization to walk himself through his trade setup, including his profit target and stop. He vividly imagined the market moving in his favor, but instead of imagining himself being pleased with this outcome (which was what happened in his usual trading), he mentally reviewed his original trade plan and told himself that nothing had changed to alter the plan: it was working as anticipated. I asked the trader to simply repeat this part of the visualization over and over until he no longer reacted to the initial gain with excitement (and with a mental accounting of his paper profits). Instead, he visualized staying calm by reaffirming his plan for the trade.

Getting excited by gains in a trade is the first step toward getting panicky when those gains are threatened.

Only after the trader had mastered this aspect of the trading situation did we proceed to imagining that the market retraced some of its initial move, eroding a portion of his gain. Again and again, he imagined this retracement while breathing deeply and slowly and staying focused on the computer screen (which displayed his biofeedback readings), until the imagery of the retracement no longer brought fear or concern. At that point we mentally rehearsed the pullbacks all over again, this time while not only staying calm and focused but also while mentally reviewing his trade idea and his exits. Our trader spontaneously began to focus his attention on how proud he would feel if he just stuck with his ideas and saw them through. This pride, for him, was the opposite of the guilt he had been feeling. When he invoked this sense of pride, he not only extinguished his old behavior, but also positively reinforced his discipline.

The key to making this work is mentally rehearsing the right trading behaviors while you’re in the state that normally triggers the wrong ones. When you’re your own trading coach, your challenge isn’t simply to figure out the right things to do. Rather, your job is to be able to act in the right ways in situations that normally pull for all the wrong trading behaviors. If you practice good trading when you’re not in realistic trading situations, it is much less powerful than overcoming learned connections as they’re occurring.

Of course, we can extend the power of exposure by shifting from imagery-based work to actual trading. Typically I’ll have a trader start trading small size at first while engaging in the deep breathing and concentration and implementing trading plans. While the trade is on, the trader keeps her biofeedback readings in the optimal range and rehearses the plan for that trade. During the troublesome retracements, the trader simply repeats what she had practiced in the imagery: staying focused on the trading plan and keeping physically calm through the regular, deep breathing. Once this process is successful with small trades, the trader can gradually increase size back to the normal level of risk, performing the biofeedback work at each new size level.

Utilize biofeedback during trading and you can often detect departures from the performance zone before you are consciously aware of them.

If there are challenging market situations, the best approach to master them is to face them directly while you stay grounded in your best trading practices. With the use of imagery, this conditioning work can be accomplished outside of market hours and without taking risks. With repetition, the mentally rehearsed patterns feel increasingly natural, as the old, learned connections fall away. It is not always comfortable doing exposure work—and the better you do it, the less comfortable it will be—but you cannot coach yourself through discomfort unless you’re willing and able to tackle it directly. Rehearse your best trading practices while you’re in your most stressful situations; it is one of the most effective training techniques you can employ.

COACHING CUE

It is helpful to formulate your best trading practices as specific, concrete rules so that these rules can be rehearsed in detail during the exposure work. Among the rules I’ve found most helpful for this work are:

• Generating trading ideas by identifying themes that cut across sectors and/or asset classes.

• Waiting for pullbacks in a trend before entering a position.

• Establishing my target price at the outset of the trade, so that I can enter the trade with a profit potential that exceeds the loss I’m willing to take.

• Sizing my trade so that I’m risking a fixed, small percentage of my portfolio value on the idea.

• Adding to longer-term trades on pullbacks after they have gone my way and remain profitable.

• Exiting trades on my planned stop-loss points or at my designated profit target.

Trading rules will differ for each trader depending on their markets and trading style. The important thing is to know what you do when you are most successful, so that you can cement these positive patterns, even as you expose yourself to challenging trading conditions.

LESSON 70: A BEHAVIORAL FRAMEWORK FOR DEALING WITH WORRY

We hear a great deal about fear and greed, and all of us have experienced bouts of overconfidence and frustration. On a day-in and day-out basis, however, few problems are as thorny for traders as worry.

Worry occurs when we anticipate an adverse outcome and its consequences. We can worry about missing an opportunity or about being wrong in a trade. We can worry about the future of our trading career or, sometimes, worries from personal life outside of trading can affect decision-making. It is common, for instance, for young traders to experience more stress after they have married, had children, or purchased a new home. With the added financial responsibilities come worries.

Worry is problematic for traders for several reasons:

• It undercuts confidence. It is difficult to maintain optimism and focus on progress while anticipating negative outcomes.

• It interferes with concentration. Thought and emotion directed toward worries are taken away from tracking market patterns.

• It leads to impulsive decisions. For most people, worry is so noxious that they will take action to reduce their concerns. Such action is not necessarily in the best interest of one’s trading account.

• It is not productive. Rarely does worry lead to concrete, constructive problem solving. Worrying about negative outcomes does not generally help people achieve positive ones.

It is difficult to make sense of worry from a behavioral vantage point. No one truly enjoys worry, so it is unclear why the behavior persists. This is especially puzzling for chronic worriers. They do not enjoy focusing on negative things and typically are not happy people. So what keeps them worrying?

Visualizing worst-case scenarios and how you would handle them is constructive; worry reinforces a sense of hopelessness and helplessness in the face of those scenarios.

To make sense of worry, let’s review the difference between thinking about a negative event and actually experiencing that event. I can think about losing money in my trading and the thought does not bring particular anxiety or concern. If, however, I vividly imagine a particular trade that I am planning and visualize myself taking a loss on a large position, I can generate palpable experiences of nervousness. Abstract thought rarely generates strong emotion. Imagery, on the other hand, acts as a surrogate for reality. Think about sexuality and nothing happens; imagine an erotically charged scene and the body responds.

From a behavioral vantage point, worry is a form of thinking and, as such, it can function as a negative reinforcer. Let’s say that I anticipate a stressful meeting with the risk manager at my trading firm. My underlying fear is that he will reduce my capital and express a loss of confidence in me. Rather than experience the hurt and resentment that such a meeting would engender, I worry about making the meeting on time, what I’ll say in the meeting, what I might miss in the markets while the meeting is going on, etc. None of these worries has the power to evoke strong emotion. Rather, the worries serve as distractions from the difficult feelings I would experience if I actually visualized outcomes of the meeting. If I avoid experiencing these feelings, worry serves as a negative reinforcer. Strange as it might seem, worry is not so noxious when the alternative is facing scary outcomes.

Worry can possess reinforcement value in other ways, as well. If I were feeling out of control in my trading, that feeling would be unpleasant to dwell upon. If I worry about details in the work I’m going to have done on my house, I shift my focus to something more controllable. While it may seem that I worry about negative outcomes—and, in the example, I am—the psychological reality is that I substitute a lesser concern for a greater one when I worry. What we worry about is usually not what is scariest to us. Indeed, it is a diversion from the scariest scenario—and therein lies its reinforcement value.

Worries about small things usually mask larger concerns.

Exposure work can be a great antidote to worry. When we expose ourselves to our greatest concerns—our worst-case scenarios—we can plan for these possibilities and mentally rehearse positive coping. If, for instance, I’m threatened by an upcoming meeting with the risk manager at my firm, I’ll look at the worst case outcome—a large cut in my capital—and figure out a trading plan that will focus on my most successful trading and bring me back to my prior portfolio size. Once I anticipate the worst and figure out how I’d deal with it, I take the catastrophe out of the situation. That eliminates the need for worry-based diversions. Worry thinking can’t be a negative reinforcer if it is more noxious than the alternative of facing possible outcomes constructively.

A great way to coach yourself past worry is to make note whenever you catch yourself worrying and ask, “What am I really fearful of? What’s the real issue here?” What you generally find is that there’s an unresolved situation looming in the background. Until the situation is faced squarely, it intrudes in your work and affects your mood. Suppose you find yourself worrying about whether a specific trade will work out. When you stop and reflect, you realize that you’ve sized the trade and placed your stop-loss point in such a way as to make such worry unnecessary. So what is the real concern? Perhaps the fear is of one’s future as a trader. Perhaps it’s a conflict at home. Whatever the real problem is, you want to visualize the situation vividly and walk yourself through your most constructive response. Then visualize the situation and solution again—and again. With repetition, the worst-case scenario will become routine. It will no longer evoke strong emotion. And that will leave you with little reason for worry.

COACHING CUE

Worry can be a great signal that we are harboring larger concerns about our basic trade ideas. When I find myself glued to the screen, following the market tick by tick during a longer-term trade, I know that something is wrong. Beneath the worries about the market’s moment-to-moment action, I have deeper concerns—perhaps that my basic idea is wrong all along. This can be a useful signal: when we’re comfortable with trades, we don’t need to worry over every tick in the market. And when we are worrying about those ticks, it’s a good sign that we’re not comfortable with our position—and that can lead to constructive reevaluation and planning.

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 coaching processes at the home page on the blog for Chapter 7: http://becomeyourowntradingcoach.blogspot.com/2008/08/daily-trading-coach-chapter-seven-links.html

Chapter 9 of Enhancing Trader Performance details several strategies for changing behaviors that interfere with trading decisions, including a step-by-step description of exposure-based methods. See also Chapter 8 of that book for cognitive and cognitive-behavioral techniques.

A detailed account of behavioral approaches to change can be found in the chapter “Brief Behavior Therapy” by Hembree, Roth, Bux, and Foa in The Art and Science of Brief Psychotherapies, edited by Dewan, Steenbarger, and Greenberg (American Psychiatric Publishing, 2004).

Articles relevant to behavioral views of trading can be found among my collected articles, including the articles on “Behavioral Patterns That Sabotage Traders” and “Techniques for Overcoming Performance Anxiety in Trading”: www.brettsteenbarger.com/articles.htm

Articles on emotional intelligence, staying in the zone, and balancing trading with the rest of life can be found in Psychology of Trading, edited by Laura Sether (W&A Publishing, 2007).