Friday, May 1, 2015

Trading Psycology - Behavioral Patterns That Sabotage Traders

Consider the following psychological scenarios:
* A student needs to pass an anatomy course final exam in order to successfully
complete his first year in medical school. Because his first several exams were on
the borderline between passing and failing, the course grade entirely rides on the
final. As the time approaches for the big test, the student finds himself
increasingly worried about the test—particularly when he misses questions from
his practice exams. The worry interferes with his sleep, which in turn makes him
even more concerned that fatigue will prevent him from doing well. By the time
he takes the exam, he is tired and nervous and misses many questions, often by
second-guessing right answers.
* A young woman has never been particularly uncomfortable in public speaking
situations, but now is asked to give the most important presentation of her career.
The result of this presentation could spell the difference between landing a major
client for her firm vs. losing the client to a competitor. During the talk, she
notices that the audience members from the firm she is wooing don’t seem
especially attentive. This suddenly raises her anxiety, and she desperately tries to
spice up the presentation. When she loses her place in the talk, she becomes
flustered, and finishes the presentation on a hesitant note.
* A basketball player has been the team’s leading scorer, but starts out a game
missing his first five shots. The opposing team is double-teaming him, and he is
having difficulty breaking free for open looks at the basket. Determined to take
matters into his own hands, he decides to penetrate the opposing defense and draw
fouls. Instead, he picks up two quick charging calls. Now fearful of being taken
out of the game for his fouls, he searches for his shot by moving a little further out
on the perimeter. When these shots don’t fall, he stops looking for his shot and
throws two errant passes.
* A trader has several winning trades in a row and, feeling confident, increases his
size to take advantage of his hot streak. The position initially goes in his favor,
but quickly reverses when large orders push the market lower. Forced to puke his
position, he realizes he has lost all of the profit from his previous, winning trades.
He is driven to regain the money and reenters the market, only to get slammed by
a second wave of selling. He now feels like he has entered a cold streak and
begins trading hesitantly, with reduced size. By the time the market closes, he is
down on the day and the week. He feels like a jerk for becoming overconfident
after his gains.
No doubt you can detect a pattern in each of these situations. The individual is in a
performance situation where he/she experiences pressure to succeed. The situation has
taken on a distinct importance in the person’s eyes, and now he/she is focused on the
results of the performance—not just the performing itself. This dual focus—worrying or
focusing on the outcome of performance while trying to stay immersed in the
performance—is the common element behind all performance anxiety. Such anxiety is
the single most common trading problem I have encountered in my interviews with
How can traders reduce their level of performance anxiety? Here are a few strategies that
I have found to be effective:
1. Focus on process goals when thinking about trading, rather than profits/losses –
Traders like to set goals for themselves, yet often as not, monetary goals end up
creating unnecessary pressures. More effective goals are ones that focus on the
process of trading, such as limiting losses to two ticks if you’re a scalper or
holding trades until a trailing stop is hit. A nice mindset is, “If I just trade the
right way, the profits will come.” This takes much of the pressure off the
2. Tackle risk incrementally. Risk places a psychological magnifying glass on
situations and greatly increases the opportunities for performance pressure. A
foul shot in the first minutes of a basketball game is the same foul shot in the final
seconds of a tied contest, but there is a huge psychological difference. Traders
who try to radically increase their size quickly find that the trade that worked out
with 1 contract may not work with 10, because of pressures to (too) quickly limit
losses or take profits. A gradual ramping up of size is far more effective than an
impulsive leap for which one is emotionally unprepared.
3. Step away from the screen. The self-talk during periods of performance anxiety
actually interferes with the accurate processing of market data, because the part of
the brain responsible for perceiving and acting upon market patterns is not being
activated. It is far better to step away from the screen and refocus on what the
market is giving you than to act blindly on one’s fears and compound an alreadydifficult
4. Use mental rehearsals to make threatening situations familiar. This is perhaps
the single most effective technique I have found for reducing and eliminating
performance fears. By using guided imagery to repeatedly face threatening
situations and mentally rehearse how one would like to respond, one can
eliminate much of the stress when those situations actually occur. The goal is to
so often face the performance fears in your mind that the coping response
becomes automatic, like a habit pattern.
5. Anchor mental rehearsals to distinctive mind states. This is one of the best
strategies covered in my book. By learning to place oneself in a state of unusual
calm and focus, and then by repeatedly rehearsing coping strategies for
threatening situations, a trader can create a link between the mental state and the
coping response. When there is a stressful performance situation, all the trader
needs to do is invoke the rehearsed mental state and the coping behaviors that
have been overlearned will come to the fore. For instance, if you continually
mentally rehearse a strategy for holding onto winning trades while sustaining a
calm focus, recreating the calm focus during the next winning trade will make it
easier to summon the self-talk and behavior associated with holding the position.
6. Perform a mental checklist before trading. Eliminating perfectionistic
expectations at the start of the trading day can go a long way toward reducing
performance pressures. Any time the word “should” enters one’s thinking about
trading, it’s time to step back. “Shoulds” include internal demands to make a
certain amount of money, to trade with a particular frequency, to make back
money that has been lost, to not leave money on the table, etc. Because
performance anxiety is often fueled by excessive self-demands, setting and
affirming reasonable trading goals through the trading day can go a long way
toward reducing performance pressures.
7. Get a life. When something becomes all-important, the pressures that accompany
performance increase exponentially. Traders who trade for a living and who have
little else going on in their lives are especially vulnerable to performance anxiety.
If trading is your whole world and trading isn’t working, it’s going to feel like
your world is collapsing. By placing one’s self-esteem eggs in many baskets,
traders can ensure that the inevitable drawdowns and cold periods will not disrupt
their self-confidence.

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