The importance of understanding probabilistic thinking in both our daily lives and in financial decisions.
When beginner traders look for role models in trading, they often think of the big names in hedge fund industry or legendary investors who accumulated billions in their lifetime. Such idolization of great traders or speculators is actually doing more harm than good when it comes to trading. Unlike these legendary figures, normal people usually do not have the same special opportunities nor the right combination of requirements to trade like them. I have the unique opportunities working with many traders myself and witness their transformations from struggling to being successful career traders. I notice that there are little things no one paying attention to that actually recur in their inspirational stories. I like to share these little secrets with you – they are practical solutions to help oneself dealing with the unavoidable ups and downs in making yourself a better trader.
Habitual Mistakes Are Very Costly
Habitual mistakes are mistakes we made in trading that are unforced but you keep repeating them again and again. The most common one is after being stopped out from a trade so quickly the event triggers you to place another trade on, in the same direction right after. Another one we often see is cutting a breakout trade quickly when you do not see the price moving quickly in your favour. Once the act is done enough times, you will continue to make the same mistake again and again even though you may regret that right after or by the time you are reviewing your own trading performance.
Once the habit is formed, you cannot stop the behaviour easily by telling yourself not to do it. It is a very frustrating problem yet so common among traders. These habitual mistakes add up quickly and bad overall performance is often the direct result.
Not Everyone Can Break Their Habits By Will Power
The truth is that human are designed to take advantage of their habits for survival purpose. Thus habit forming is natural and necessary. The problem though is that if you have accumulated many bad trading habits, you will have a very hard time fixing them all.
Habits are formed over months even years and your response to similar events are reinforced every time you repeat the mistake. Hence it is very difficult to break them by sheer will power. It is actually counter productive to do so because the more you fight it, the more powerful the reinforcement will be next time you make the same mistake again.
Some trading mistakes are also closely related to your personalities. You cannot simply change who you are. Forcing so called better trading practice onto yourself will eventually stress you out and break you mentally.
It Is Not Courage That Breaks Bad Trading Habits
What I learned from the success of many traders in breaking their own bad trading habits is that they all fix their problems indirectly. Nope, they did not confront their own demons. They did not use will power to change themselves either. As far as I can conclude from the accounts of their transformations, the key to allow the changes to happen is a change in perspective.
It is no secret that in order to solve a difficult problem you need a change in perspective or at least getting new perspectives about the problem. The interesting thing here is how these traders did it while the others failed to do so. The steps they take is the real secret behind their success.
Here is my summary of the steps they all took to turn things around.
First Step: Stop Trading, Take A Break
Stop trading is the necessary first step because it is a form of acceptance that there is a problem. And the problem is significant enough that you know you need a solution before it is too late.
The main distinction of the ones who turned their trading careers around and those who failed is that the ones who did it actually stopped trading completely with their trading platforms turned off for at least several days. No charts, no monitoring real-time quotes and no watching news on those markets they trade. They actually took a break and did something they don’t usually do – have a trip to somewhere else for those who can afford it, going to nearby park or beach that they never go to, read a book not on trading, pick up dance classes, etc.
The complete halt from trading and trading related matters helped these traders in many ways. Some told me they feel alive again while the others have realizations that the setbacks in trading they experienced is acceptable. Most important of all, they picked themselves up and gathered strength to look for ways to improve their trading. This is the necessary start of perspective change.
Second Step: Reflect In Comfort
Being able to quiet down and reflect is an important routine for traders. The problem, however, is that many traders are glued to their trading station all day. They pretty much conduct majority of their daily activities there from breakfast to dinner. This makes the reflection routine much less effective and to certain degree, the research and development efforts are also likely less productive. Normal people cannot reflect properly in an environment with many distractions. Research cannot be done properly when you cannot think deeply. It is important to find a place that is away from your trading station where you can spend time either alone or talking to someone that you trust to bounce off ideas.
Do not mistaken the place for reflection being all Zen-like environment. From what I learned from these traders who successfully turned around their trading, their choices of reflection spot varies but they all have one. It can be taking a ride on your favourite spot on a very long bus or train route. It can also be in your car parked next to a quiet neighbourhood. The balcony and roof top are common choices. Taking a walk in a scenic trail works for many. The important thing here is that you need a way to allow your mind to settle in an environment where it feels comfortable enough so that it can raise its own voice.
My personal favourite spot is the top of the CN Tower. Sometimes you are not allowed to go up there though because of weather condition. My backup spot has been a bar / coffee shop hidden in an industrial building. Everyone has their own way in finding peace and inspirations.
Aside from not making reflection outside of the trading environment, one common theme with those who could not turn around their trading performance is that the reflection results they arrive at are often redirected towards external factors as oppose to what they can do to improve the situation. For example, when I pointed out the problem could be the way how they place their stops, the conclusion they would come up with is that they need a better entry instead. The environment trapped them to think in the perspective of fight for survival as oppose to the more logical, problem solving self.
Mentor intervention is very useful with this step as I have seen some young firm traders really reach out for help from the experienced ones. That willingness to change make them much more open to constructive suggestions. The results are often quite good with visible improvements. Even if you have a good mentor telling you what is wrong with your trading, reflection is still a necessary process for you to incorporate the ideas from your mentor into solutions to solve your own problems.
Third Step: Rearrange Your Environment
The bad trading habits are triggered because your mind thinks that it is dealing with a similar situation where certain measures must be taken to protect or comfort yourself. This little trick of rearranging your environment is used by at least two third of the traders who turned their trading careers around. From my understanding, many of them did not do it consciously to break their habitual behaviour but more a result from their reflection that they need to do things differently so that they would perform better.
Some examples of environment change include moving the desk from one corner in the room to another, changing the arrangement of the monitors, completely rearrange the positions of the chart windows, changing the coloring of the price bars, changing to a different model of mouse and this one is a bit blizzard – switching the chair to an exercise ball so that he will no longer fall asleep during trading hours.
By making your trading environment as unfamiliar as possible, it is easier to forge new better habits to replace the old ones.
Fourth Step: Observe With New Approach
In my opinion, this step is the most critical one in ditching the bad trading habits. Those traders who take the time to go through this step are the ones who get the most out of their attempts to improve their trading. By observe and practice with their new approach, they get the chance to keep the new approach for good.
Some traders who successfully went through the first three steps in finding a new perspective to trade, often stumble here as they rush through the process. They see results they like and jumped quickly into full size trading at once as they think they got it this time. However, the more important goal of stopping yourself from making habitual mistakes has not been fulfilled. Hence, when they faced adverse situations, their bad habits find a way to resurface again.
This is the classic problem many traders describe as their aha moment for which they have a short term performance boost and then when their bad habits sneak back into their trading, they do not recognize that and blame the market for changing again. This cyclical performance erosion can be broken if the bad habits are kicked out for good. It is a matter of patience and understanding that you need to hardwire the new better trading habits into yourself first before putting yourself up for the challenge.
You can think of kicking the bad trading habits is as difficult as getting very young kids to stop sucking their thumbs. Rarely can you do it by just explaining the consequence to the kids. Instead, intervention of various kinds are more effective because the change of one’s habitual behaviour is much more easily accomplished by someone else who knows what works. The problem with trading, however, is that most of the time a voice of reason, another person who can relate to the situation, does not exist to point out the bad trading habits. The usual time traders realize they have to deal with their problems is after significant losses incurred which is probably the worst time for anyone to think straight.
That’s why intervention helps. By taking the necessary time to look at yourself from a fresh perspective, better ideas will come up. A more objective reflection will allow the hidden problems to surface. This gives the trader a way to make necessary changes to engage in trading. The changes can be good. It can also be bad. But if the trader do not seek to improve, they will fail.
Even a great mentor cannot force you to fix your bad trading habits overnight. If you can take the first step and put a halt to your trading before it is too late, you have a chance to deal with it. The intervention process outlined above is what sets apart the traders who turned around their trading careers from those who have not. Using this strategy is likely the next best thing we can do to solve the bad trading habit problem.
By explaining the logical and psychological aspect of the problem, I hope to make it easier for many traders to help themselves to cleanse their own bad trading habits for good. The most important thing to remember is not changing who you are but focus on ways to make trading work for you in a perspective that you are comfortable with. Yes, this could mean a less stellar trading career comparing to those people who have the superior character traits that best suited for trading but it also means a profitable trading career with excellent growth path due to the scalability nature of trading.
It is also why it helps if one has a good mentor or coach in trading or any competitive field. Their job is not to teach you what to do. The teaching part is just for the building of a good foundation. The more important purpose is that you are observed and provided with feedback from an objective perspective. Bad trading habits will have much lower chance in taking shape. Your mentor or coach can also help you kick the existing bad habits you already have.
More little secrets will be posted as I summarize the interesting discoveries from my correspondence with other traders.
Second part of the series is already available.
Daniel Kahneman is a psychologist who pretty much founded the behavioral economics discipline. In other words, his work proves the prevailing economic theories pretty much all useless garbage. In this talk he explains the fundamental difference between you and the one you remember. The understanding and acceptance of this difference is useful in shaping oneself into a better trader.