KEEP A PSYCHOLOGICAL JOURNAL
When I first began trading, I kept a journal in the form of multiple annotated charts. I looked for every major turning point in the stock market and then investigated the patterns of indicators and price/volume patterns that could have alerted me to the changes in trend. After a while, I found that certain patterns recurred. It was out of those early observations that I learned to rely on patterns of confirmation and disconfirmation among such measures as the number of stocks making new highs versus lows, the NYSE TICK, and the various stock sectors. Later, as I gained new tools, such as Market Delta, I added to those patterns. For me, the journal was a tool for pattern recognition. Only after an extended time of recognizing patterns on charts, could I begin to see them unfold in real time. It was also only after an extended period of real-time observation that I felt sufficiently confident to actually place trades based on those patterns.
When we keep a psychological journal, the learning principles are not so different. At first, the journal is simply a tool for recognizing our own patterns as traders. These include:
Behavioral patternsTendencies to act in particular ways in given situations.
Emotional patternsTendencies to enter particular moods or states in reaction to particular events.
Cognitive patternsTendencies to enter into specific thinking patterns or frames of mind in the face of personal or market-related situations.
Many of our trading patterns are amalgamations of the three patterns: in response to our immediate environment, we tend to think, feel, and act a certain way. Sometimes these characteristic patterns work against our best interests. They lead us to make rash decisions and/or interfere with our best market analysis and planning. It is in such situations that we look to a journal (and other psychological exercises) to help us change our patterns of distress.
For more on keeping trading journals
But why do such patterns exist? Why would a person repeat an unfulfilling pattern of thought and behavior again and again, even when she is aware of the consequences? Sometimes traders are so frustrated with their repeated, negative patterns that they swear that they are sabotaging their own success. This pejorative labeling of the problem, however, doesnt help the situation. It only serves to blame the frustrated trader, magnifying frustrations.
As I stressed in my Psychology of Trading book, maladaptive patterns generally begin as adaptations to challenging situations. We learned particular ways of coping with difficult events and those, at first, may work for us. As a result, these patterns become overlearned: they are internalized as habit patterns.
A good example is the tendency to blame oneself when there are conflicts with others. A child in a home fraught with arguing and fighting might adapt to the situation best by blaming himself for problems rather than risk conflict by blaming others. Later in life, with that pattern ingrained, even normal conflicts may trigger self-blame and depressed mood. Such a person, for example, might spend more time and energy beating up on himself after a losing day than learning from his losses.
When we repeat patterns in trading that consistently lose us money or opportunity, the odds are good that we are replaying coping strategies from an earlier phase of life: one that helped us in a prior situation but which weve long since outgrown. The task, then, is to unlearn these patternsand that is where the psychological journal becomes useful.
Just as I used the trading journal to become keenly aware of market patterns, our psychological journal can alert us to the repetitive patterns of thinking, feeling, and acting that interfere with sound decision-making. Such a journal, like the annotated charts that I mentioned, begins with observation: we want to review our trading day and notice all of the patterns that affected our trading. The initial goal is not to change those patterns. Rather, we simply want to become better at recognizing the patterns, so that well eventually learn to identify their appearance in real time.
The psychological journal is a tool for developing your internal observer: learning to recognize what youre doing, when youre doing it.
A favorite journal format that I use divides a normal piece of paper into three columns. The first column describes the specific situation in the markets. The second column summarizes the thoughts, feelings, and/or actions taken in response to the situation. The third column highlights the consequences of the particular cognitive, emotional, or action patterns.
The first two columns help us recognize the situational triggers for our patterns. This makes us more sensitive to their appearance over time. The third column emphasizes in our mind the negative consequences to our patterns. Those negative consequences could include emotional distress, losing money on a trade, or failure to take advantage of an opportunity. When we clearly link maladaptive patterns to negative consequences, we develop and sustain the motivation to change those patterns. That third column should spell out in detail the costs of the recurring pattern: how, specifically, the pattern interferes with your happiness and trading success. The clearer you are about the pattern and its occurrence and the more strongly you feel about the costs it imposes on you, the more likely youll be to catch the pattern in real time and be motivated to interrupt and change it. For now, however, your goal should be to identify your repetitive patterns and their consequencesnot to try to change those patterns all at once. You cannot change something if youre not aware of it. The psychological journal is a powerful tool for building that awareness and understanding what is generating your distress. Keep the journal for 30 consecutive days to help you see just about every variation of your most common patterns. It will also begin the process of turning self-observation into a habit patterna positive pattern that can aid you in your personal life and in your trading.
Begin your psychological journal by tracking your individual trades and focusing on those situations in which your mindset took you out of proper execution or management of those trade ideas. In other words, these will be instances in which you failed to follow your trading rules, not ones in which you followed the rules and just happened to be wrong on your ideas. Replay these trades in your mindor, better yet, consider videotaping your trading and observing those trades directlyand then jot down what set you off (Column A); what was going through your mind (Column B); and how it affected your trading (Column C). Zero in on how much money that trigger situation cost you. With practice, youll build your internal observer and start noticing these situations as they are occurring. That will give you an opportunity to create a different ending to the script.
PRESSING : WHEN YOU TRY TOO HARD TO MAKE MONEY
Traders call it pressing: forcing trades in an attempt to make money. Sometimes it takes the form of trading too large; other times traders press by trading too often. The hallmark of pressing is trying to make things happen. This is 180 degrees from a mindset in which you trade selectively, when odds are with you. In the latter frame of mind, you let the market come to you and wait for your opportunity. In the mindset of pressing, you want things to happen and you want it now.
The irony of pressing is that it is often the most successful traders those who are competitive and driven to succeedthat fall victim. They so hate losing that theyll do anything to winincluding trading poorly!
Trading is a bit like flying a fighter plane or playing chess: it requires highly controlled aggression. In trading, the control element comes from knowing when markets present opportunity and when they dont. One of the best ways of instilling this control is to trade with rules. These may be rules related to position sizing, stop-loss levels, when to enter markets and when to stay out, trading with trends, etc. When rules are repeated and followed over time, they are internalized and become mechanisms of self-control. We can observe this process among children. They so often hear rules about respect for elders or cleanliness that (eventually!) those behaviors become automatic.
The right trading behaviors start as rules and evolve into habits.
These automatic behaviors are important because they dont require effort and a dedication of mental resources. If we have to make ourselves follow rules each time we confront situations, we will be taxedand our full attention will not be on those situations. One of the great strengths of the human mind is its ability to automatize rules, so that mental and physical resources can be fully devoted to challenges at hand. This enables us to face those challenges under self-control (i.e., under rule governance). So how do we make our trading rules automatic? The answer is to turn them into habit patterns. At one time in our lives, brush your teeth in the morning might have been a rule that our parents had to impress on us. With repetition, it became habit; most of us need no reminder of the rule or special motivation to follow the rule. This is the kind of automaticity we aim for in trading: where our rules become so much a part of us that they require no special attention or effort.
When were pressing to make money, the need to put on trades overwhelms our rule governance. Pressing normally occurs in situations in which were frustrated with our performance. Perhaps weve lost money, missed out on opportunities, or are just going through a period of flat equity curve. The frustration leads us to try to create opportunities rather
than respond to those presented by markets.
In our dance with markets, we want the market to lead. When we attempt to lead the marketwhen we try to anticipate what may happen instead of identify what is happeningwere most likely to be out of step with the next price movements. When we are pressing, we are trying to lead the markets, and that has the potential to turn normal losses and flat periods into veritable slumps.
So how do we make trading rules automatic? As with the tooth brushing, it is through repetition. By repeating your rules many times, in many ways, you gradually internalize them and turn them into habits. You will still experience the normal stresses of marketsno one can repeal risk and uncertaintybut you will be so grounded in your decision-making that you cannot fall prey to distress.
When you coach yourself, you can create opportunities for repetition before and during the trading day. This is a several step process:
1. Make a list of your most important trading rules. These rules
should include, at minimum, your rules for risk management; taking breaks after large or multiple trading losses; entering at defined signal points; and preparing for the market day. You cant expect to internalize trading rules if you havent first made them explicit. 2. Create a routine before trading begins to review the rules. Mental rehearsals are powerful vehicles for creating repetition. Every one of your trading rules can be captured as a visualized scenario that you walk yourself through mentally while you keep yourself calm and focused. You actually visualize yourself in different trading situations reminding yourself of rules and following those rules. The more extended and detailed the visualizations, the more likely it is that youll internalize them as realistic experience.
The more you think about rules and rehearse them, the more they become part of you. Repetition creates internalization.
3. Create a break in your trading day to review your rule following. Midday break, when markets tend to slow down, is a perfect time to clear out your head, assess your trading to that point, and remind yourself of what you need to do in the afternoon. By turning your list of rules into a checklist, you can simply check yes or no for each rule depending on whether you followed it during the morning. If you did not follow a particular rule, you jot down that rule on a separate piece of paper, tape it to the monitor, and make it an explicit focus for the afternoon trade.
4. Use the rules at the end of the day as a report card. An end-ofday review will tell you how well you performed in your preparation for trading, your entries, your risk management, and your exiting of positions. Each rule should receive an A, B, C, D, or F grade. Anything less than a B is a candidate to become an explicit goal for the next days trading. In this way, the rules you most need to work on are assured of getting the most attention.
This approach undercuts the tendency to press during periods of frustration by helping you catch yourself in the act of deviating from rules. As a result, frustration is unlikely to escalate into ever-greater violations of sound trading principles. When you cement your rules through repetition, however, you also serve as your own trading coach by preventing frustration from affecting trading in the first place. After all, we can start our day on a frustrating note (perhaps we oversleep), but that wont lead us to shatter our rule-habits of morning personal hygiene. Behavior patterns, once overlearned, stick with us regardless of our emotional state. That is true self-control.
Good self-coaching is the ability to correct trading problems. Great self-coaching is to develop routines to prevent problems from occurring in the first place. Youll see the results in your moodand in the dramatic reduction of large losing trades, days, and weeks.
Dont work at internalizing too many rules at one time. Start with the most important rules that will keep you in the game: entry rules (getting good prices); position-sizing rules (limiting risk per position); and exit rules (setting clear profit targets and stop-loss levels). These three, along with the basic rationale for your trade, can be written down or talked aloud as a trade plan that becomes your guide for trading under control instead of pressing.