Thursday, July 20, 2006

The Fundamental Mistake of Trading Psychology

Just as there are two types of trader, there are two basic ways in which psychology can assist traders. The first is by helping traders reduce or eliminate unwanted negative patterns of thought, feeling, or action. This is the trading psychologist’s historical stock in trade. Many traders seek to improve their performance by ridding themselves of bad habits.

There is, however, a second way in which psychology can assist traders that is less appreciated. Even when traders have found their edge and are making money, they may not take full advantage of the opportunities that they have. Instead of losing large sums, they are leaving significant money on the table. Such traders can benefit from psychology by learning how to do more of what works. Their goal is to build positive action patterns, not reduce undesirable ones.

The confusion of these two modes (and how they sometimes can work together) creates what I call the fundamental mistake of trading psychology. Traders assume that, in order to be successful, they need to dig into their problems and eliminate them. Research tells us, on the other hand, that most highly successful people across a variety of fields—from arts to athletics and science—succeed by maximizing their strengths, not by focusing efforts on their weaknesses.

This is such an important topic—and it is so important to avoid the fundamental mistake of trading psychology—that I will post an entire article on the theme to my personal website this weekend.

A recent book by management guru Marcus Buckingham makes this essential point: great businesses (and managers) play to their strengths. They don’t get bogged down in efforts to make themselves less weak in particular areas. Instead, they find ways to compensate for weaknesses and take full advantage of strengths.

Many traders are much more familiar with their weaknesses than their strengths, especially after they’ve gone through a slump. They haven’t truly analyzed their performance to see what they do well. As long as that is the case, they cannot focus on those strengths and learn to apply them to a greater range of situations. The fundamental mistake keeps them problem-focused, when instead they should be building solutions.

Who you ultimately are—and what you’re truly good at—may be different from the person you’re trying to be. Michael Jordan longed to be a baseball player and could have spent untold years working on becoming a decent player. Fortunately, he returned to the NBA and to his very special talents.

After an exhaustive review of my trading performance, I found that I was most successful trading short-term morning patterns in the ES. I would love to be a longer-term trader and (at times of volatility and opportunity) a full-time trader, but that is not where my talents lie. The fundamental mistake would have me work on becoming less bad at trading afternoons or longer-term. The right application of psychology has me learning to build my consistency and grow my size at what I do best.

Sometimes the greatest challenge is the simplest: to just be who we really are and do what we do best—and embrace that for all it’s worth.


Steve said...

I agree that one that is not cut out for trading ala Jordan and baseball ought to hang it up, I do believe that one cannot simply assume they can't 'get there' simply because it hasn't happened yet. I KNOW if I would have bailed out of trading when the clouds were the darkest, it would have been a mistake.

That said and pertaining to your column today, how does one actually separate the elimination of errors from the enhancement of skills? I see great trades, yet I have difficulty taming the 'it looks good, but there are X or Y others reasons that might cause the trade to fail, so I won't take it' thoughts and actions, only to see the trade go very well in my favor, but without me on board. I know this is a common occurrence in other traders, and to me it seems like a deficiency that I need to eliminate.

In my case, the issue is not necessarily improving my market reads (enhancing what I'm good at) but eliminating the over thinking that seems to be throttling my gains.


capmanager said...

Dear Dr. Steenbarger,

I would like to know if you have done a study of what follows a day where the VIX is in day before range BUT the indices break above/below the range (of the prior day).

thank you in advance.

Brett Steenbarger, Ph.D. said...

Hey Gangsta,

*Very* interesting question, but not something I've looked into thus far. I'll do some analysis over the weekend and see what I come up with. Thanks for the idea--


Brett Steenbarger, Ph.D. said...

Hey Steve,

Thanks for the perceptive post. The "overthinking" or second-guessing of solid trade ideas is relatively common among traders and *usually* (not always) is a function of performance anxiety. (Just like the second thoughts someone gets before talking in front of a crowd or introducing yourself to someone you *really* want to meet). Mental rehearsal techniques, where you practice the entry/management of the position in your head while keeping yourself calm and focused, can be very helpful for this.

Your point about differentiating between a normal learning curve and the need to "hang it up" is right on the money. Research suggests, however, that if someone has a real talent for something, it usually shows up in a rapid learning curve. That doesn't necessarily mean you hang it up if your curve is slow. It might mean, however, that you haven't found the right markets or trading styles to exploit your talents.


Manish Chauhan said...


Sometimes you talk like GOD :)

Such an important point and I missed it all these years , Take this as a psychology question . Why do people look at complicated things more and why they undervalue simple things and most powerful (which they dont know) .

Is the main reason the mere looking "Simple" ?

spooztrader said...

Dr. Brett, I finished your book 'Becoming Your Own Trading Coach' a few mos ago, and one of my main takeaways was to journal about not only the negatives, but also the positives, of each trading day. So regardless of how crappy a particular day has been, I always try to find something positive. Some days it's hard of course! Definitely think this is helping me though.