Trading Psychology 2.0 Read online

  Table of Contents

  Title Page

  Copyright

  Epigraph

  Preface

  Introduction

  Prelude

  Chapter 1: Best Process #1: Adapting to Change Emil's Restaurant

  The Single Greatest Barrier to Adaptation

  The Power of Flexible Commitment

  Flexibility and Trading

  The Rebuilding of Maxwell

  The Perils of (Over)Confidence

  Tapping Core Motivations

  Why Discipline Doesn't Work

  The Purpose of Purpose

  Turning Adaptation into a Routine

  The Limits of Trader Discipline

  The Emotionally Intelligent Trader

  Readiness for Change

  Self-Assessment Exercise

  Tapping the Sense of Urgency

  See-Feel-Change: The Importance of Optimism

  The Dangers of Trader Isolation

  Changing the Internal Dialogue

  The Perils of Perfectionism

  Relapse

  Summing Up: Moving from Contemplation to Action

  Taking and Sustaining Action: Identifying Opportunity

  Self-Assessment Exercise

  Taking and Sustaining Action: Identifying Threats

  Where to Look for Fresh Directions

  Chapter 2: Best Process #2: Building on Strengths The Trader in a Slump

  Why Strengths Are Key to Performance

  Finding Strengths in the Smallest Places

  What Are Your Strengths?

  Self-Assessment Exercise

  How Strengths Interact to Create Successful Experience

  What Strengths Don't You Possess?

  Can Your Strengths Also Be Weaknesses?

  Making Our Strengths Stronger

  The Excellence Principle

  Making a Habit of Developing the Right Habits

  A Look at Character Strengths

  Higher-Order Integration of Strengths

  Revisiting Multiplier Effects in Development

  Subjective Well-Being: The Most Important Emotions in Trading Psychology

  Self-Assessment Exercise

  Well-Being and Personality

  What Research Teaches Us about Well-Being

  How Can We Cultivate Well-Being?

  Eliminating Drains on Our Energy

  Conscientiousness: The Underappreciated Ingredient of Success

  Biofeedback as a Strategy for Enhancing Well-Being

  Using Meditation to Build Positivity

  Using Self-Hypnosis to Feed Positivity

  A Workout for Mind and Body

  Special Topics in Well-Being: Love

  Special Topics in Well-Being: Affinity Groups

  Special Topics in Well-Being: Gratitude

  Putting It All Together: Trading, Strengths, and Well-Being

  Chapter 3: Best Process #3: Cultivating Creativity The Trader as Entrepreneur

  Allen, the Trading Entrepreneur

  The Success of the Trading Entrepreneur

  Trading and the Crisis of Management

  Trading and the Crisis of Creativity

  Creativity Provides Food for Our Strengths

  What Is the Creative Process?

  Finding Problems as Part of Finding Answers

  Can We Become More Creative?

  Trading Failure and the Downhill Spiral of Creativity

  The Essence of Creativity: Reframing Problems

  The Skills of Creativity: Switching Modalities

  The Skills of Creativity: Increasing the Productivity of Our Thought

  The Skills of Creativity: Finding Fresh Combinations

  The Skills of Creativity: Thinking by Analogy

  Creativity and Lifestyle

  Creativity in Groups

  Does Brainstorming Work?

  Tapping into Group Creativity Even When You Are Independent

  The Single Greatest Barrier to Creativity

  It All Fits Together

  Chapter 4: Best Process #4: Developing and Integrating Best Practices What Are Best Practices?

  Linking Best Practices into Best Processes

  Steps Toward Becoming a Process-Driven Trader

  How Many Trading Firms Are Truly Process-Driven?

  How Can Individual Traders Be Process Driven?

  Conducting a Process Review of Your Trading Business: Twenty Sets of Questions

  A Few Observations on Process Improvement

  Fifty-Seven Best Practices for Trading Success

  Summary

  Conclusion: From Best Practices to Best Processes

  Postscript

  References

  About the Author

  Index

  End User License Agreement

  Founded in 1807, John Wiley & Sons is the oldest independent publishing company in the United States. With offices in North America, Europe, Australia and Asia, Wiley is globally committed to developing and marketing print and electronic products and services for our customers' professional and personal knowledge and understanding.

  The Wiley Trading series features books by traders who have survived the market's ever changing temperament and have prospered-some by reinventing systems, others by getting back to basics. Whether a novice trader, professional or somewhere in-between, these books will provide the advice and strategies needed to prosper today and well into the future.

  For more on this series, visit our website at www.WileyTrading.com.

  Trading Psychology 2.0

  From Best Practices to Best Processes

  Brett N. Steenbarger, PhD

  Copyright © 2015 by Brett Steenbarger. All rights reserved.

  Published by John Wiley & Sons, Inc., Hoboken, New Jersey.

  Published simultaneously in Canada.

  No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, (978) 750-8400, fax (978) 646-8600, or on the Web at www.copyright.com. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, (201) 748-6011, fax (201) 748-6008, or online at http://www.wiley.com/go/permissions.

  Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials. The advice and strategies contained herein may not be suitable for your situation. You should consult with a professional where appropriate. Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages.

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  Library of Congress Cataloging-in-Publication Data

  Steenbarger, Brett N.

  Trading psychology 2.0 : from best practices to best processes / Brett N Steenbarger, Ph.D.

  pages cm.—(Wiley trading series)

  Includes index.

  ISBN 978-1-118-93681-8 (hardback)—ISBN 978-1-118-93683-2 (ePDF)—

  ISBN 978-1-118-93682-5 (epub)

  1. Stocks—Psychological aspects. 2. Speculation—Psychological aspects.

  3. Investments—Psychological aspects. I. Title.

  HG6041.S762 2015

  332.6401'9—dc23

  2015016663

  Cover Design: Wiley

  Cover Images: Business growth graph © iStock.com/Violka08; Black Chess King and lying

  Pawns on board © iStock.com/Dominik Pabis

  Epigraph

  If you don't have time to do it right, when will you have time to do it over?

  John Wooden

  Preface

  Successful efforts to master markets lead us down paths of self-mastery. This book is one guide to those paths.

  Market participants have traditionally defined self-mastery as discipline—controlling the emotions that all too often distort information processing and trigger impulsive behavior. To be sure, discipline is required for any great undertaking, whether it is pursuing an Olympic medal, a business startup, or a medical breakthrough. But discipline, while necessary for success, is never sufficient. Discipline does not substitute for skill, talent, and insight. Strict, disciplined adherence to mediocre plans can only lock in mediocre results. If it were otherwise, there woul
d be no losing automated trading systems.

  I've followed and traded markets since the late 1970s. During the past decade, I have served as a full-time performance coach at two trading firms—Kingstree Trading in Chicago and Tudor Investment Corp. in Greenwich, Connecticut—and worked with many other trading organizations on a consultative basis. Through the TraderFeed blog and three prior trading books, I've had the honor of interacting with thousands of traders around the world. If there's one thing this whirlwind of experience has taught me, it's that there is far more to market mastery than controlling emotions and impulses. Sustained success requires the cultivation of a host of positive performance elements: creativity, productivity, adaptation to change, and psychological well-being. The good news is that recent research in psychology and related fields has profoundly deepened our understanding of these contributors to human performance. The bad news is that most of us in the money management world, immersed in the day-to-day challenges of keeping up with news flows and market movements, have little opportunity to sift through and apply this knowledge. As a consequence, we tend to work hard, but not smart. From the organization of our daily routines to our reviews of performance, we rarely optimize learning, independent thought, and productivity.

  The unfortunate tendency to substitute quantity of effort for quality ensures that we will face a yawning gap between our real and ideal selves: between who we are and who we're capable of becoming. Trading Psychology 2.0 seeks to bridge that gap by breaking trading success down to four essential processes. In the coming pages, you will learn a simple ABCD:

  A How to dynamically Adapt to changing market conditions

  B How to identify and Build on your distinctive trading strengths

  C How to Cultivate creative processes and generate fresh market perspectives

  D How to Develop best practices that help you sustain productivity and effectiveness in your work routines

  Most of all, this book is about taking best practices—the ingredients of your trading success—and weaving them into best processes. The goal is not to change you but to help you more consistently tap into the drivers of your success.

  In hindsight, it's not difficult to see that Trading Psychology 2.0 is a natural extension of my previous books. The first of these, The Psychology of Trading, focused on the emotional problems faced by traders and how these mirror common life challenges. It introduced a solution-focused framework to trading: identifying the patterns that underlie our success and becoming more consistent in enacting those. My second book, Enhancing Trader Performance, adopted a developmental view of trading success, emphasizing expertise development as an ongoing process of deliberate practice that matches skills, talents, and challenges. An important implication of that work was that there are many forms of trading, each requiring unique skills and learning processes. I continue to find that many of the emotional problems faced by developing traders are the result of bolting generic learning processes onto very specific performance domains, creating frustration and suboptimal performance. Finally, my most recent text, The Daily Trading Coach, created a cookbook of psychological techniques and approaches to help traders overcome common performance challenges. An overarching theme of that book is that a primary goal of trading psychology is self-coaching. By becoming better self-observers and catching best and worst practices as they occur, we can overcome market noise with enhanced self-determination.

  Trading Psychology 2.0 differs from these books in one key respect: It breaks trading success down into those four ABCD processes and explores research-based ways of maximizing them in our personal and professional lives. The book's aim is to move trading psychology beyond the usual focus on discipline, emotional control, and trading one's plans to the broader context of sustaining peak performance. Most important, the book aims to nudge traders toward what might be called meta-processes: robust routines for changing our routines and adapting trading to ever-changing market conditions.

  It is not enough to find an “edge” in financial markets; as any tech entrepreneur can attest, competitive advantages are perishable commodities. Those who sustain success continually renew themselves, uncovering fresh sources of competitive advantage. That requires processes for assessing and challenging our most basic assumptions and practices. It takes a good trader to create success, a great one to recreate it. Nothing is quite as difficult—and rewarding—as letting go of what once worked, returning to the humble status of student, and arising phoenix-like from performance ashes.

  What makes any performance domain worthy is that none of us will ever completely master it. There is always room for improvement in dance or golf; chess players, brewmasters, woodworkers, and racecar teams can always hone their craft. For that reason, performance activities are the consummate psychological crucible, moving us ever closer to self-mastery. This is particularly the case with trading, where the rules of the game continually evolve. What other field demands the utmost of conviction and risk-taking, but also the greatest of flexibility and prudence? In adapting to change, we embrace change, we become change. We cannot rest on individual best practices; we need best processes that yield ever-improved practice. There will always be a gap between real and ideal: between who we are and who we can become. If this book can be a resource in bridging your gap, it truly will have fulfilled its aim.

  Of course, no performance journey is traveled solo. Life is a team sport and success crucially depends on surrounding yourself with the right teammates. I owe many debts of gratitude to colleagues at Graham Capital, Tudor Investment Corp., Kingstree Trading, and SMB Capital; the ever-resourceful editorial staff at Wiley; Victor Niederhoffer and the Spec Listers; and Howard Lindzon and the supportive crew at Stock Twits. The book wouldn't be possible without the many talented traders who contributed best practices and inspired the case studies. As in my prior books, the names and identities of the traders in those case studies have been changed to preserve privacy, but I want my debt to the many fine people I work with to be as publicly voiced as possible. The greatest debt, however, is to the family that has offered constant love and support through all the not-so-constant financial markets: Debi, Steve, Laura, Devon, and Macrae; their families; and most of all to my wife, Margie. She, not markets, has been the love of my life, and that has kept me sane through many ups and downs in the business. Finally, to the many readers of the TraderFeed blog a hearty thank-you for your support and all you've taught me. I think you'll find many of those lessons in the pages that follow.

  Introduction

  There is a valuable tradition in academic scholarship called the literature review. A literature review is a survey of published research on a given topic, with an eye toward identifying what is known and what remains to be investigated. A good literature review is selective—covering the most important, methodologically sound studies—and it is integrative, highlighting areas of consensus and debate within a research field. Without such efforts, science would generate far more data than understanding. At its best, the literature review is a bridge between observation and explanation. If undertaken properly, it illuminates existing research directions and inspires new ones.

  Although the exercise that inspired this book was a performance review and not a literature review, the aim was similar. I identified approximately a dozen of the very best traders I had worked with intimately over a decade of coaching and asked myself what made them tick. On the surface, they were quite different. Some were daytraders in the electronic futures markets; others were portfolio managers in currency and fixed income markets. A few were highly quantitative; others drew on pattern recognition in a purely discretionary manner. Some were outgoing, some introverted; some were highly emotional and passionate about winning and losing; others were relatively calm, cool performers.

  When I looked at what these traders did, all I found was variety. When I examined how they did what they did, however—the processes underlying their decisions and actions—several common features leaped out at me:

  Adaptability. To a person, the best traders were adaptive and flexible. They were sensitive to market environments and altered their trading to fit changing landscapes. Often, they would quickly alter their risk exposure, sensitive to occasions when market action did and did not confirm their expectations. Even more broadly, they adapted to changing market regimes by learning new skills, broadening their trading universe, and reworking their analytics. What made them successful was not merely that they possessed a trading “edge.” Rather, they had found ways of continually honing and expanding that edge.