It’s interesting that there are quite a few trading blogs out there devoted at least in part to the psychology of trading. Who knew we were all such nut-jobs? I was reading one today and it got me thinking about my mental track record so far.
First off, I’d like to give myself a pat on the back for sticking with the system the vast majority of the time. No matter what the trading system, I’ve done a pretty good job of staying with it and following the rules to the letter. My disciplinary success rate is definitely not 100%, but I feel pretty good about it. And I do suck at some stuff too, which I’ll save for later in the post.
Take for example an ill-fated trade with Weight Watchers International (WTW). A friend of mine had described a swing-trade system that took advantage of mean reversion to catch a bounce. Sometimes it turns into catching a falling knife. Which is what happened on this particular trade.
For this particular trading system, more often than not, the stock rebounds. It rebounds over 60% of the time in out-of-sample backtesting, and the forward-testing looked good too. But there are those other 40% of trades, and sometimes there’s a doozy. This one never turned around while I was in the trade, and finally stopped out with a >12% loss. Ouch!
It’s one thing to look at a chart from the past, and quite another to experience each red bar as it happens. Every day at the closing bell I would look at WTW and say “Really??! Aw c’mon already, turn the other direction!” And of course it did that the day I after I stopped out, at least for a short time.
Every day there was a temptation to get out. But I stuck with it, because I knew that if I quit before the rules said I should, I would invalidate the whole trade. It would then become not a statistic to apply to my overall system health, but some random trade I made for no reason.
The times I abandon a trade is when I don’t have confidence in the underlying system. There have been several times where I’ve either learned something new, or realized I’d made an error in my testing, and invalidated a system I had been trading. Or worse, I was trading a system based on discretionary reasons (i.e. “gut feelings”). Then I start to second-guess everything.
I can stick with a trade very well if I’ve got hard numbers to back it up. But if I doubt those numbers, or didn’t have the hard evidence in the first place, then I’m a wibbling bowl full of nervous jelly.
Some mental techniques I’ve learned along the way so far:
– If you’re trading on an end-of-day basis, don’t constantly watch the market. It will only cause you heartache. There are only two emotions you can realistically feel while a trade is open: mild anxiety or wild panic. So what’s the point in peeking? (I must admit I’m only partially successful at this part.)
– Trust your research. If you’ve properly tested your system with out-of-sample data, then it should continue to work a given percentage of a time. If over time the percentages of wins drops off, it’s time to pause the system until paper-trading shows good results again. But no single trade is going to tell you whether a system is broken (or working).
– Don’t bet the farm. You’ve heard that one before, I know, but it’s true. Losing $1000 hurts more than you imagine it will. Ask yourself “what amount could I stand to lose three times in a row and still continue trading?” Err on the side of small. Heck if your trade goes from a profit to a loss because your position size was small compared to commissions, it’s still a win. Because it’s a) a small loss instead of a big one and b) counts as a win in your live forward-testing. Get rich slowly, instead of getting poor quickly.
– When you exit a trade, don’t look back. Don’t look at what the price did the day after, or even a week after. MAYBE take a look a month or two later, but really, what good will it do? Doesn’t change a thing. If you stuck to your system, then all you can say is “well that one didn’t work out.” And if you didn’t stick with your system, then you’ll just be reminded how foolish you were.
So what do I suck at? Well I hinted at it above. I’m often too quick to try a new system with real money, when perhaps I should let it stew for awhile with paper trading before jumping in. I like inventing things and trying them out, so it’s difficult for me to NOT trade a new and promising system. Fortunately I’ve had enough sense to keep my positions small, so as not to get hosed.
What are some mental tricks/techniques you use to combat the wibbling-jelly feelings that trading the markets can sometimes cause? Leave them in the comments section!