SFOMAG.COM: Demons of Trading article by Gail Osten

I am taking this opportunity to reproduce the excellent June 2003 piece on trading psychology by Gail Osten on sfomag.com. Ari Kiev, Ruth Barrons Roosevelt, Brett Steenbarger and Adrienne Laris Toghraie participated in the round table discussion... for those of you who are into the psychology of trading, these are all names that you should already aware of...

GO (Gail Osten, SFO Editor): First, thanks to each of you for participating in this roundtable. Each in your own way has something to offer the trader from a psychological point of view. I’m interested to see how your responses may shed light from different angles. To start off, what would you say sets trading apart from any other profession?

AT (Adrienne Toghraie): When most traders first come into trading, they truly do not handle trading as a profession. In other professions, people endure long, arduous educations for making decisions that become embedded for an automatic response for their neurology to handle. Without this training, trading sessions in the beginning are not only an intellectual choice, but an emotional choice. When dealing with losses, a trader goes into the psychological place where he stores all losses. Since human beings avoid losses, a trader who does not operate out of an automatic response will make an emotional choice. Emotional trading builds negative anchors that keep a trader from following good money-making strategies.

GO: It’s been my experience that a lot of traders do indeed seem to jump in without any experience or education at all – particularly after a bull market where they have profited quite well from investments. It makes them feel like they’re already experts. Any other ideas?

AK (Ari Kiev): One thing that differentiates trading from other activities is that you’re constantly being measured. A long-term investor buys stock, holds for a year or two and rides out the fluctuations. A trader who’s taking advantage of short-term moves is very much influenced by the intra-day volatility and, so, he is measuring performance daily. A trader’s performance is constantly judged, recorded and measured. There aren’t too many other activities out there where your performance is measured so closely. In a regular business you can say, “We’ll get our figures quarterly, and we’ll make projections and plans based on how things have been going.” So in regular business, you’re protected from the scorecard ‘til the end of the game or ‘til the end of the quarter.

RR (Ruth Barrons Roosevelt): It’s also different from a regular business because politics don’t help. You can’t charm your way through the markets. Maybe you can persuade people to do things, but your personal magnetism alone will not draw winning trades to you. Second, the everyday things are different. With trading, the future is completely unknown. It’s not like walking into an office every day with a routine. In a day of trading, many more surprises will pop up than in a day in a cubicle. That’s not to say that there aren’t similarities though. I would say that there are at least two similarities between trading and other types of professions. One is that risk taking is rewarded, but it needs to be managed risk. Second is that optimism is rewarded.

BS (Brett Steenbarger): You’re right. There are definitely similarities. In fact, my focus has been on looking at the similarities rather than the differences, trying to identify fields that are similar to trading in several different respects, where they have a high case of activity, a high degree of risk and reward and a high-performance demand. And, so, my search for similar fields has led me to professional sports and elite military services like the special forces. I have been trying to see how they are similar to trading and how people are trained in those fields as a way of getting some insight into how people might be trained to become effective traders.

GO: Interesting. As long as we’re on the topic of similarities, what professions does everyone else think are similar to trading?

AT: A surgeon, a trial lawyer, an athlete, concert performer or any kind of person that performs and has to do it live.

GO: Because of the necessity for spontaneity?

AT: Right, because you have to be continuously on alert. You have to be conscious, while at the same time perform somewhat intuitively. So, you have to be able to go with the flow of your education. You have to be able to go with the flow of what’s coming next, even if you’re not sure of what’s coming next.

GO: Well you certainly don’t know what’s coming next in trading. What do you think, Ari?

 

AK: I agree with Adrienne. Sports, surgery…really, any job where you’ve got a limited amount of time to do something which is very complicated. If you’re a surgeon, for instance, you may be in control of some of the variables, but when you have an elderly patient that has had some systems break down, and you have a limited amount of time to get the procedure done, you can’t always predict how the patient is going to respond.

GO: And it’s very life or death, probably more stressful than trading.

RR: Actually, speaking of life and death...the insurance policies of floor traders, in terms of their health insurance etc., pay premiums just as high as skydivers, deep-sea divers and all the most dangerous professions.

GO: The people that are on the trading floor, really?

RR: Yes. So in terms of stress, it’s probably as high as any other. In other professions, while you could lose your job, you’re not going to lose all your money in a given moment. So stress is higher in that sense.

GO: OK. Are there any positive things regarding the kind of profession that trading is?

RR: Oh, it’s exciting. It’s different every day. It can be infinitely rewarding. And it’s so interesting, and every day is a whole new array of events. Because there’s no limit to how much you can make with it, it’s very, very rewarding. Every day is like Christmas! You’ve got these packages under the tree, and you don’t know what’s in there, but you know it could be something wonderful.

GO: That’s a unique comparison. I’ve never thought of trading as being like Christmas. On that positive note, let’s move on. So, we’ve established that trading is a high-stress, high-performance field, but people in other professions experience stress too. Do traders need specialized psychological advice? Couldn’t they go to a regular therapist?

AT: Usually, they can go to a regular therapist, but most therapists are trained to deal with issues over an extended period of time. Traders don’t have that time. They need instant transformation. If the issues are handled over a long period of time, they might not have the money to continue the profession when they finally have the transformation necessary to follow the rules. In addition, most traders would be diagnosed as gamblers and treated as such by therapists. The truth is that to be exceptional at anything you must be obsessive-compulsive. The difference between someone who is a gambler in trading and a professional trader is that a trader is obsessive-compulsive about following rules.

RR: You’re exactly right, and a regular therapist may or may not understand what is involved with trading and could offer the worst ideas. Adding to that, though, I would say a lot of it also depends on the values of the therapist. For example, I was telling a colleague of mine that I had a client who was making $5,000 a day on the floor of the New York Stock Exchange and that he wanted to make $10,000. She replied, “Well, that’s just disgusting.” And I looked at her and said, “Well, that’s why I work with these people, and you don’t.” He made up his mind to make $10,000. I believe that it’s not wrong that if I make money, somebody else will lose. It’s our obligation to be successful. So you could run into a difference in values of the person.

GO: Brett, you’re a psychologist, do traders need specialized psychological advice?

 

BS: Some do. The key here is making a distinction between traders who have pre-existing emotional problems that are seeping into their trading versus traders who are really trading poorly, and that’s creating their emotional problems.

GO: These are clearly two different scenarios.

BS: It’s two different scenarios, and you really have to separate them. There certainly are people who have emotional problems. They may have relationship problems, and the fallout from those interferes with their processing of market information and making decisions in the market. And, yes, a general, competent therapist would be helpful in such a case because the primary problem is an emotional or a relationship problem. But if you have someone who’s under-capitalized and not managing risk properly, then talking to the best therapist in the world will not change their outcome. Instead, they really need very specialized advice from someone who is a competent trader as well as someone who’s capable of providing therapy.

AK: I don’t think that being a good trader’s coach entails being a good trader yourself necessarily. All that’s really needed, I think, is somebody who understands the market, the impact of the market and the suggestibility of people in certain situations. For example, I talked to a client this morning who was running about a billion dollars, and he said, “These things have been tough lately because there are so many hedge funds, and trades are getting crowded.” So all these hedge funds are out there shorting stocks and covering their shorts while he’s trading them. He’s trading against them, hanging in there and not getting taken out, but at the same time he was getting uncomfortable and wanted my guidance. To an extent I understand him, and to the extent that he truly believes his methodology, I could guide him to stay in his shorts by using a contrarian signal – to just stay with it and that in the long run, he’d be rewarded. I’d have to have been here a few times to feel confident about making that recommendation.

GO: I suppose it’s really a matter of the trader’s preference whether or not his coach or therapist is a trader himself. Moving on…many articles and books focus on the discipline trading requires, but don’t you need discipline and training in other professions as much as you do trading? Is there a difference?

RR: You need discipline in all areas of your life. Discipline is doing what needs to be done to get you to where you want to go. Whether you want to or not, whether you feel like it or not. You need discipline to exercise. You need discipline to get up in the morning. You need discipline to go to bed at night. You need discipline to go to work every day. It takes discipline in life to succeed.

GO: Is there more discipline that’s necessary as a trader?
RR: Well, if you don’t have enough discipline, you’ll slip much faster. It’ll take longer in an ordinary job for a lack of discipline to show up. It could happen in a day if you’re a trader.

AK: I would add to that, that trading successfully, trading to win, trading in the zone, mastering the markets – all those kinds of things – require the ability to act counter-intuitively, which means when you’re losing, the natural inclination is to hold on, to go into denial, to hope that things turn around…you stay attached to your original analysis because you believe it. Now, sometimes you want to stay in a losing position if you’ve done the work and it’s an opportunity to really multiply the potential for profit, but the natural inclination for most people is to hold on to losers.

GO: So, in other words, it does require a lot of discipline.

AK: You have to practice, practice, practice, until you get comfortable doing the uncomfortable, like letting go of losing trades.

GO: Not being able to let go of losers seems to be a very common weakness among traders. How can traders assess their own work? How can they identify their strengths and weaknesses, such as not being able to let go of losers?

BS: Well, one of the things I believe to be extremely helpful in that regard is that at the end of the year, I do an audit of each and every one of my trades.

 

GO: On each and every trade?

BS: On each and every trade, and I do hundreds in a year. I literally write out each trade by hand and when I placed it and how many shares, contracts, whatever, and whether I was long or short and what my profit or loss was, trades that made the most and least money. I see what I was doing right and wrong and formulate one or two big goals. For instance, this past year, a relative handful of my trades were accounting for the majority of my profits. Fortunately, I was profitable on the year. So, I looked particularly at where those trades were coming from, and they were occasions where I was able to catch the sweet spot of a move where the short-term trend and the more intermediate-term trend were aligned. And I realized I could be trading less frequently and really limiting myself to those good-trending opportunities, and I still could be making just as much money. So, part of my goal this year is to trade more selectively, to be more rule-governed in my trading, based on trend readings.

AK: It’s interesting that you say that because sometimes I’m able to get people to keep a diary, to keep real track of where they got in, where they got out, what they were feeling at the time they were getting out and then how much further the stock ran, how much did they leave on the table and how much did they give up because they were too anxious. Then they begin to identify those feelings. I have some people, who’ve become good at it, to even time how long their discomfort with certain trades would last. Once they knew how long it lasted, they had a better handle of the situation. Each time, the discomfort doesn’t happen as much, and then the next time it happens even less. And then pretty soon, a trader can get comfortable with separating feelings from what the trade is.

GO: And that’s exactly what traders need to be able to do. I think generally having a solid trading plan in place also enables a trader to separate feelings from the trade or avoid giving into emotion, wouldn’t you say?

AT: Well, I can’t speak for everyone else, but, yes, traders need a business plan and part of it is like a regular business plan that you would put together if you were a shop owner, let’s say. You’d have to have all of the information, the financial information and all of the information that you need for a business. Now, beyond that, a trader needs a methodology spelled out in a set of rules, even if those rules are intuitive. Going beyond that, they need contingency planning – everything that can go wrong and everything that can go right and seeing themselves with the best possible outcome, so that they can prepare themselves for any kind of situation. If you do not prepare for contingencies, you’re like most traders in that once the flow of the markets change, you panic, and you create a lot of losses and negative anchors. This is one of the reasons a trader has to do a periodic review. The periodic review, by the way, is not every time you get huge draw-down trades. A periodic review should be done every three to four months when you can go back and look at your trading.

BS: I would say, it’s not the plan, it’s being “planful” that helps a lot. The term I’ve used – and it fits for me better as a trader and as a psychologist – is being rule-governed, that you have certain rules that you follow. Every little wiggle in the futures is not going to throw you for a loop or have you asking questions because you have a rule. The rule tells you when you get in it. The rule tells you when to get out. The rule tells you how much capital you’re going to allocate to the trade. You have all of these rules that make it more automatic.

RR: But sometimes they have those things planned out, and they violate the plan. They second-guess the plan in the excitement. Traders have to have confidence in their strategy, confidence that it will most likely work. They have to have confidence in the probability, because probabilities are all that they have, but probabilities ARE enough.

Another problem is that a lot of people will have so many indicators to tell them what to do that they get lost, and they’ve got so much stuff on their screen they can’t even see the prices. So they can’t make decisions. Sometimes the strategies that are the simplest are the wisest.

GO: So what should be in every trader’s plan? What would you tell people who came to see you?

RR: You need to have a strategy for entering the market and a strategy for exiting with profit and with a loss. And you need to have something that tells you what the trend is, whether it’s up or down or flat.

GO: In addition to a plan, having a coach at your side may help take some of the trader’s bias out as well. Having said that, how does a trader/investor determine if she could seek personal coaching, or maybe just when he/she really needs to be her own therapist?

RR: Well, first of all, you can’t be your own therapist because you’re too subjective. You’re in the middle of it, and sometimes you need somebody outside yourself to perceive what you’re doing and to help you hold you to your commitments. It’s just like nobody would go into the Olympics without a coach. They just wouldn’t dream of it. You might have a physical coach and a psychological coach. Why shouldn’t we, when we’re in the biggest game of all time, have a coach?

BS: Well, I think any kind of good coaching or counseling is directed toward helping people become their own therapist. That’s my goal in working with everyone, and I tell clients that. I tell them I want you to put me out of business. And so you’re teaching people skills that they can utilize on their own. And typically that takes a certain form, so that you’ll first describe the skill to the person. You’ll then model it for them, show them how it’s used. You’ll then have them try the skill out in front of you, so that you can see that they know how to do it, and then you’ll assign it as homework and then you’ll have them do it on their own. And that way, they learn, they see, they can ask questions and they develop that skill on their own, and they don’t need to use you.

RR: I would agree with that. As a coach or therapist, you’re not building a trader’s dependence on yourself. You’re building that person to be strong, to operate without you, but a trader can’t necessarily start out being his own therapist.

AK: And traders definitely benefit from coaching. I would liken it to…why does an actor need a director? You know the actor knows how to act, but the director helps the actor to transcend his limiting notions about his own identity, about his own ability and so on. A coach can do the same for a trader.

 

GO: At what point in their trading/investing journey do you typically see traders/investors, personally? What types of situations typically bring them to you?

RR: There are several. One would be that they’ve spent years designing a system to trade and now they can’t “pull the trigger” on the system. That’s one. Another would be that they’re losing money over trading or not getting out of losses, and they come to a forced awareness that they need help. They’ll come to me then.

GO: Those are the most typical problems that you see?

RR: Yes. Or maybe they work for a bank and they’ll ask the bank to send them to me and they will.

GO: Ok. So, you do both individuals and individuals trading for institutions. Interesting. You work with institutional traders as well, Ari.

AK: Right. I work with a number of hedge funds, and I work with individuals within these hedge funds.

GO: Because you’re there to help them anyway, in the context of the hedge fund, what are the most typical problems that you try to help them through?

AK: I think the biggest problem is getting people to size their positions, and I try to do that typically by getting them to set some goals. One is to really develop a methodology where there is a consistent kind of track record of performance. Somebody can have more winning days, but they don’t make as much money on their winning days as they do on their losing days, which means they’re holding on to their losers and not getting out.

GO: That’s very typical, isn’t it?

AK: Yes, so I would use these kinds of parameters. How much can you make this year? Given what you know, given that you have some control of sizing, given that you have so much capital, maybe you can make X dollars this year. OK. Say you have Y dollars of capital, so the next thing would be to get them to say, “To make X dollars a year means to make Z dollars a day. And to make Z dollars a day, how many positions do I need? How big should they be? How long should I hold them? How much work do I have to do to give myself the confidence to be able to buy those kinds of things.” So, managing loss and developing that discipline, building a kind of methodology, finding a group of financial instruments that you really can do the work on. It’s not just automatic.

GO: But to be able to ingrain a skill, to make it automatic, doesn’t that take a certain type of personality? Are there certain types of personalities that make better traders than others? Or are there certain personalities that should probably avoid trading altogether?

AT: One is the opposite of the other. Entrepreneurial people – and that means self-starters, motivators, risk-takers. People who are not only analytical, but who are creative as well. Most people think that to have the analytical skills is to be a great trader, but I found that to be a really great trader you also have to be creative and synergistically combine the right brain with the left brain. Emotionally self-confident, optimistic, self-disciplined—that’s how I would describe a good trader.

GO: What about smart?

AT: There are different kinds of smart. There is emotional smart. There is street-wise smart. There is wisdom. There is intellectually smart. I find that intellectually smart very often gets in the way of being a great trader. People that are street-smart, wise and intuitive are more likely to be better traders.

GO: Are there certain types of personalities that make better traders than others?

BS: Absolutely. That was some of the questionnaire research that I was doing a while back with Linda Raschke while we were looking at traits and coping styles. The successful traders were high in a trait called “conscientiousness,” meaning they were very dependable, very reliable. The successful traders had coping styles that were more problem-based. When something went wrong in trading, they would say, “OK, what can I do about this trade?” The traders who were having problems were high in a trait called “neuroticism,” which is a tendency toward negative emotional experiences, like anxiety and depression. And when the unsuccessful traders were having a problem with trading, they would get emotional and they’d say, “What’s wrong with me?” and “Nothing ever works.”

GO: So there are certain personalities that probably should avoid trading altogether?

BS: I think so. No one ever wants to hear that, of course.

RR: I don’t think so. If they want to trade, we’ve got to find a way for them. They come to me to find a way, and so I’ll find a way, with their personality, to do it. But basically, good traders are optimistic. They are optimists who can apply discipline on top of their optimism. Good traders are risk takers. They’re people that are comfortable with uncertainty. They’re adventurous. They’re able to think quickly and make decisions. Act. They’re able to act. They’re willing to admit when they’re wrong, and they don’t have a fear of being wrong.

 

GO: Do you ever turn anyone away?

RR: No, I don’t, because they’ve come to me and said, “Help me.” I’ve had some really difficult clients, and I’ve been able to get them trading.

GO: Well, for those people who really want to trade, but need help, how do they find a good coach or therapist? How would you define a trader’s coach or therapist?

AT: First of all, recommendation is the best. Credibility, evidence of work and accomplishments, speeches, articles, books. Ask for testimonials or ask for people to call. A good coach takes an investment in your life, someone who makes a long-term commitment to you – not just there for you right in the beginning, but at each new level of success. And the good coach makes a trader as independent as possible as soon as possible. That’s really important. In a typical psychology class, you’re really taught to keep a client coming. A coach gets the best results when a client trusts and follows the advice the coach gives, so it can’t only be a one-way street. There has to be a bond between the coach and the trader to get the best results.

BS: A good coach or therapist is part expert, part teacher. I think if you don’t have experience and expertise in the skill domain, you’re going to be limited in what you impart. I don’t think a person could be a good basketball coach if they had never played basketball. That being said, just knowing a lot about something or having done it oneself doesn’t necessarily mean you’ll be effective in imparting it to others. In fact just recently, there were all of the problems with Michael Jordan and the Washington Wizards; he is no longer with the team because they felt that he wasn’t effective in imparting his abilities to others. He’s clearly one of the greatest ever to play the game and, yet, he didn’t seem to be able to mentor all of the young ones to reach his level. You have to have both.

AK: I think a good traders’ coach is somebody that understands the trading process, that understands the challenge, the dilemma that traders face as regards the realm of uncertainty in a disciplined way…the balance between the willingness to take risk against the need to preserve capital. That creates a certain amount of inner tension and frustration, and you have to be able to deal with that. You need somebody that’s interested in working with people who are in a game that lends itself to high performance. Not everybody likes to do that because you’re talking to people who are—if they’re successful—able to do things that are beyond what most “ordinary mortals” could do. So, these guys are, as a result of their willingness to play in the game, like sports stars. You have to be able to work with them and help them and not put a value judgment on their lifestyle or the fact that they’re making such an inordinate amount of money. And yet, do it without feeling envy or jealousy, which isn’t necessarily the easiest thing.

GO: I’d like to switch gears here. There are probably more investors than traders, so I want to address the investors out there with this question. What do you do differently for traders and investors? Is there a difference?

BS: I think it’s a completely different thing. They’re not even related in my book psychologically because in investing you are making longer-term decisions and it’s a very conscious, deliberate, analytical process. In trading, very, very often, you’re making short-term decisions in very active markets, and you’re relying on skills that you have honed over time and that you’re executing relatively automatically. The shorter the time frame of your holding a position, the more automatic your skills have to be. You don’t have time to engage in elaborate analyses.

RR: Yes, but it shouldn’t be too much different, it’s just a different time frame. That’s where people in the stock market got robbed. If they had had more of a trading mentality, they would have gotten out or gone short. But they didn’t. So we really don’t want to think of investment as just staying put. With any good investment, you have to see if it’s still a good investment. You need to reassess it. Investing is just a slower-term trading, and I think if you look at it that way, and reassess all the time, you would be much better.

AT: Psychologically, a trader and investor go through the same process, but those who make quicker decisions are more likely to have more emotional issues to deal with. For both, I start out with an assessment.

GO: In other words, we have some very different ideas out there about what it means to be an investor and a trader. It’s definitely something to consider for anyone who is seeking a trading/investing coach. This is always something I love to ask because I think it is exceedingly helpful for traders – if there were three pieces of advice you could offer the new trader, what would they be?

AT: First, to have a good education in trading. And while there’s a lot of stuff out there, there’s a lot of people teaching and everything, you really need to self-educate. Just read, read, read, read and read. And then have a plan, a business plan which includes rules for entering and exiting a trade. And follow those rules, and if you can’t follow those rules, then hire a coach.

 

GO: OK. Ruth?

RR: Find out what works. Verify that it works. Do it.

GO: Those three things.

RR: It’s pretty simple.

GO: Brett?

BS: First of all, if your goal is to become proficient, that takes, like in any field, a number of years of concentrated practice. In trading, start with a very small account and very small positions, so that you can survive your learning curve. And, then, as you gain success, as you gain experience, you can always add to your size.

The second thing is that, if a newcomer’s going to be a full-time, very active trader, he must be adequately capitalized. If he’s under-capitalized, he’s subjecting himself to very high potential draw downs. So when a trader is under-capitalized, he goes through more emotional swings because the draw downs are affecting a greater percentage of his total equity. So, being well capitalized is also a psychological strategy.

GO: I don’t think most people would have considered being well-capitalized as a good psychological approach to trading. And your third piece of advice?

BS: My number three piece of advice: Find a mentor. Find someone who you can emulate and learn from that person. That was certainly true when I learned how to do therapy. I could pick up things from their style and synthesize those into my own style. And I think it’s the same with traders.

GO: Ari?

AK: First, keep your losses down. Be willing to face the facts, tell the truth, admit to being wrong, and get out to preserve your capital. Don’t get attached to your ideas to the point that you are losing money.

Second, as you build up a cushion, begin to size your positions commensurate with your level of conviction in your ideas and consistent with your profit targets. This is tougher than it appears, and most people tend to be too conservative and cautious and miss opportunities. Be willing to be guided by your objectives and do the work necessary to justify your conviction.

Third, review what you have done, be flexible, keep course correcting and improving your performance and adjusting to the new and changing demands of the marketplace. Successful trading requires attention and intention and commitment.

GO: Brett, there is one other thing that you said to me that I’d like to add as refers to how trading, or working on it, can be of benefit generally. One more time, because I think it’s a good way to end this piece.

BS: When done properly, I think that working on trading is a way of working on yourself. As you work on the trading, it forces you to deal with pressure in certain ways, and it improves you as a person. And as you improve yourself as a person, and work on your ability to handle risk and work on those analytical abilities, it helps the trading as well. So, in the best of all worlds, you get a certain synergy going, your trading is improving and you’re improving. That makes it a noble pursuit.

GO: Excellent comments from you all today. Thanks again for your insights.

 

Excellent post candleman.

The pschological aspect of trading is what I have been working on most for myself.

It's really a 'zen' thing. That's why I chose my trade name.

Linda Raschke is my personal hero for that reason. She is the most disciplined trader I have met. She Just Does It, over and over and over again.

Discipline. Zen. Different words for the same thing.

 

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