HOW PSYCHOLOGY AFFECTS TRADING STRATEGY. A London Academy of Trading Guide by Paddy Osborn BSc (Hons), MSTA, CFTe

Transcription

1 HOW PSYCHOLOGY AFFECTS TRADING STRATEGY A London Academy of Trading Guide by Paddy Osborn BSc (Hons), MSTA, CFTe June 2016

2 HOW OUR BEHAVIOUR MATTERS We are all human and we are taught how to behave in society as we grow up. We learn how to react to certain situations; we may become brave or fearful, aggressive or timid, happy or sad, or a number of other emotions. In the world of trading, it is important to recognise how our emotions and behavioural patterns can sabotage trading performance and we need to understand how our emotional reactions to different events need to change. Today we will examine Performance Anxiety. This is defined as the fear of failure, either due to performing in front of an audience or executing a task under pressure (for example trading).

3 HOW DOES PERFORMANCE ANXIETY AFFECT TRADING? Most trading problems are varieties of Performance Anxiety Performance Anxiety occurs when a performance that is usually automatic becomes the object of excessive scrutiny. This attention to the performance creates an Interference Effect, in which the performance can no longer flow naturally. Such Performance Anxiety frequently interferes with athletic performance, public speaking, trading performance, sexual performance, and test taking. Whenever fears about the outcome of a performance dominate the performance, outcomes are apt to suffer. Performance Anxiety occurs as much during times of market success as during times of market loss It is not at all unusual to find traders who are good at taking (appropriate) losses, but who become fearful when they book a gain and take profits prematurely (i.e., prior to reaching their profit targets). Interference Effects following strings of losses are no more debilitating than Interference Effects from pressure that traders feel when they are making money. Traders usually try to replace negative self-talk with positive self-talk This is a mistake! When traders are immersed in the market and focused on the screen, they should not be engaging in self-talk at all. Perfectionism is the most common source of Performance Anxiety among traders Traders tend to be achievement-oriented and often set lofty goals for themselves. These performance goals contribute to tension when the goals are not met. In general, it makes sense to replace performance goals with process goals. Instead of setting a goal of making, say, 250 a day, a trader should, for example, set a goal of following their trading process (in terms of trade set-up, triggers, execution and trade management). Perfectionism leads to overtrading Overtrading is the most common source of losses among the traders I ve interviewed. Traders overtrade when they feel internal pressures to make money, and these pressures blind the trader to what is happening in the markets at the time. Trading when volatility is low, trading outside one s trading plan or strengths, trading to make up a loss, and trading imprudently large sizes are examples of overtrading. Increased levels of trading size can reignite Performance Anxiety Traders that master performance anxiety at one level of trading size (e.g. profit/loss swings of up to $100) will frequently re-encounter it once they meaningfully increase their size (e.g. profit/loss swings of $500). We generally calibrate our emotions by the dollar amounts we make or lose. This makes a larger trade much more difficult to manage (emotionally) than a smaller trade, even though the setups may be identical. Traders often think they have worse psychological problems than they actually have When performance anxiety patterns have interfered with trading for a period of time, traders often become convinced that they have deep-seated emotional problems that need intensive psychotherapy. Often, the belief that one is damaged that one is emotionally unfit is a larger problem than the performance anxiety itself. This is a very solvable problem. 4 5

4 To be sure, there are other problems unrelated to performance fears that can interfere with trading. The unique thing about Performance Anxiety is that it can afflict highly successful traders every bit as much as rookies. This is because the root of much of the anxiety perfectionism tends to be present in the most achievement-oriented and successful individuals. It is truly a double-edged sword. Somewhere between the extremes of performance pressure and complacent laziness is a happy medium where traders can focus on self-improvement without sabotaging their results. Trading is like dating: You want to keep initial expectations reasonable, enjoy it while it s happening, and learn from it once it s over. 6 7

5 CONSIDER THE FOLLOWING PSYCHOLOGICAL SCENARIOS A B C A student needs to pass an anatomy course final exam in order to successfully complete his first year in medical school. Because his first several exams were on the borderline between pass and fail, the course grade entirely rides on the final. As the time approaches for the big test, the student finds himself increasingly worried about the test particularly when he misses questions from his practice exams. The worry interferes with his sleep, which in turn makes him even more concerned that fatigue will prevent him from doing well. By the time he takes the exam, he is tired and nervous and misses many questions, often by second-guessing right answers. A young woman who has never been particularly uncomfortable in public speaking situations is now asked to give the most important presentation of her career. The result of this presentation could spell the difference between landing a major client for her firm vs. losing the client to a competitor. During the talk, she notices that the audience members from the firm she is wooing don t seem especially attentive. This suddenly raises her anxiety levels and she desperately tries to spice up the presentation. When she loses her place in the talk, she becomes flustered, and finishes the presentation on a hesitant note. A trader has several winning trades in a row and, feeling confident, increases his size to take advantage of his hot streak. The position initially goes in his favour, but quickly reverses when the market pushes lower. Forced to liquidate his position, he realizes he has lost all of the profit from his previous winning trades. He is driven to regain the money and re-enters the market, only to get slammed by a second wave of selling. He now feels like he has entered a cold streak and begins trading hesitantly, with reduced size. By the time the market closes, he is down on the day and the week. He feels like a jerk for becoming overconfident after his gains. No doubt you can detect a pattern in each of these situations. The individual is in a performance situation where he/ she experiences pressure to succeed. The situation has taken on extreme importance in the person s eyes, and now he/she is focused on the results of the performance rather than executing the performance itself. This dual focus - worrying (or focusing) on the outcome of performance while trying to stay immersed in the performance is the common element behind all Performance Anxiety. Such anxiety is the single most common trading problem I have encountered in my interviews with traders. 8 9

6 HOW CAN TRADERS REDUCE THEIR LEVEL OF PERFORMANCE ANXIETY? 1 Focus on process goals when trading, rather than actual profits and losses Traders like to set goals for themselves, yet often as not monetary goals end up creating unnecessary pressures. More effective goals are ones that focus on the process of trading, such as limiting losses with stops or holding trades until a trailing stop is hit. A nice mind-set is, If I just trade the right way, the profits will come. This takes much off the pressure of the performance. 2 Tackle risk incrementally Risk places a psychological magnifying glass on situations and greatly increases the opportunities for performance pressure. Traders who try to radically increase their size quickly find that the trade that worked out with 1 contract may not work with 10, because of pressures to (too) quickly limit losses or take profits. A gradual ramping up of size is far more effective than an impulsive leap for which one is emotionally unprepared. 3 Step away from the screen Any self-talk during periods of performance anxiety actually interferes with the accurate processing of market data, because the part of the brain responsible for perceiving and acting upon market patterns is not being activated. It is far better to step away from the screen and refocus on what the market is giving you than to act blindly on one s fears and compound an already-difficult situation

7 4 Use mental rehearsals to make threatening situations familiar This is perhaps the single most effective technique for reducing and eliminating performance fears. By using guided imagery to repeatedly face threatening situations and mentally rehearse how one would like to respond, one can eliminate much of the stress when those situations actually occur. The goal is to face the performance so often that the coping response becomes automatic, like a habit pattern. 6 Perform a mental checklist before trading Eliminating perfectionist expectations at the start of the trading day can go a long way towards reducing performance pressures. Any time the word should enters one s thinking about trading, it s time to step back. Shoulds include internal demands to make a certain amount of money, to trade with a particular frequency, to make back money that has been lost, to not leave money on the table, etc. Because performance anxiety is often fuelled by excessive self-demands, setting and affirming reasonable trading goals through the trading day can go a long way toward reducing performance pressures. 5 Anchor mental rehearsals to distinctive mind states By learning to place oneself in a state of unusual calm and focus, and then by repeatedly rehearsing coping strategies for threatening situations, a trader can create a link between the mental state and the coping response. When there is a stressful performance situation, all the trader needs to do is invoke the rehearsed mental state and the coping behaviours that have been over-learned will come to the fore. For instance, if you continually mentally rehearse a strategy for holding onto winning trades while sustaining a calm focus, recreating the calm focus during the next winning trade will make it easier to summon the self-talk and behaviour associated with holding the position. 7 Get a life! When something in life becomes all-important, the pressures that accompany performance increase exponentially. Traders who trade for a living and who have little else going on in their lives are especially vulnerable to performance anxiety. If trading is your whole world and trading isn t working, it s going to feel like your world is collapsing. By placing one s self-esteem eggs in a number of different baskets (e.g. sports, hobbies, relationships, etc.), traders can mitigate the inevitable drawdowns and cold periods will would otherwise disrupt their self-confidence

8 Most traders who are convinced that they have deeply-rooted psychological problems or addictive trading patterns are actually caught in a vicious cycle of perfectionist self-demands, increasing performance pressure, mounting anxiety, disrupted performance, and renewed self-demands to compensate for their failures. After a while, traders caught in such a cycle begin to doubt whether they will ever succeed. By addressing their problems at the source the expectations that generate performance pressure traders can often turn themselves around in a surprisingly short period of time

9 WHO WE ARE The London Academy of Trading (LAT) provides accredited, vocational programmes with a focus on fundamental and technical analysis, trading psychology and risk management. LAT attracts focused and ambitious students who are looking to become the next generation of financial markets traders. We are a privately owned educator within the financial industry based in the City s financial district. We teach through a combination of theoretical and practical sessions, with continued guidance available both in house and online. We provide the financial market knowledge and trading skills to enable individuals to develop their career or to supplement their main source of income. Working in partnership with a number of financial companies enables us to provide cutting edge technology and up-to-the-minute news and data. Our faculty is comprised of experienced traders and analysts from a range of companies including HSBC, Merrill Lynch, Credit Suisse and Bloomberg. Whether you prefer to study on-line, on the Academy trading floor, or via a blended combination of both, we can provide the flexibility for you to fit your studies around your existing commitments. CONTACT US ADDRESS Sceptre Court 5 th floor 40 Tower Hill London EC3N 4DX United Kingdom TELEPHONE +44 (0) info@lat.london