Category Archives: Trading

Trend following and pivots basics

Introduction

When it comes to trading the markets, we are always inundated with so much of information (I call it as ‘Information constipation’) that we could no longer see the forest but obsessed with just seeing the trees. The process of trading or speculation (as they call it), has morphed into a pseudo-intellectual science and consequentially, traders think that they must strain their brains to profit. Trading, however, is anything but an intellectual exertion. In fact, the more we use our brain in trading, the more likely we are to find ourselves with negative P&L.

I have actively traded my own account for the last 12+ years and let me be honest – the initial few years were marked by lots of trial and error. A good mentor can obviously shorten that learning curve but that is besides the scope of this post. Becoming a consistently successful trader has got nothing to do with education and I can vouch for it. My success in trading has got nothing to do with my postgraduate degree. In fact, my formal schooling did more to hinder my ability to trade than help. Graduate school filled my head with lot of abstractions and theory but did nothing towards advancing my common sense. It caused me to think a lot about the ‘right way’ to trade, and the harder I thought, the farther I was going away from the basics of trading.

Trading is not so fundamentally difficult, but the print/visual media wants us to feel so. They have their own business reasons for it. Trading the markets can offer fantastic opportunities to make money but it is at the same time, the most self-revealing career anyone can ever choose. Now, one may wonder why this rhetoric but think about it. If any of us can structurally identify what the markets are doing currently rather than trying to ‘predict’ what the markets are going to do, job is 75% done. We don’t need to predict as we don’t know ourselves what we would be thinking this time next week. Neither can anyone know what the markets will be doing this time next week. We all trade our own belief systems. Once we identify the underlying structure of markets, suddenly, trading seems not that difficult. This is where ‘structural pivots’ can be of immense help. Pivots can help us identify the path of least resistance. Think of how, in our own life, we follow the path of least resistance. Following that path has led us to read this blogpost this very instant. Just understanding the underlying structure of the markets has served me well in the past decade.

Floor pivots vs structural pivots

Whenever I use the word ‘Pivot’, the listener always gets baffled on what I really mean as we have another set of pivots that is often talked about. This section is to clear that up a bit.

There is something called ‘floor pivots’. Floor pivots has been used for many years by floor traders to come up with a reference point based on the prices from the previous day. It is calculated based on high, low and close of the previous day. And few lines are drawn above the pivots as resistance and few lines below as support. Most of the technical trading platforms can plot these lines automatically.

The formula is as follows:

Pivot = (H + L + C)/3
Resistance level 1 =(2*P) – L
Support level 1 =(2*P) – H
Resistance level 2 = (P – S1) + R1
Support level 2 = P – (R1 – S1)

I personally find these levels not so useful for trading. Some people think that these levels have meaning because so many floor traders, and now screen based traders, watch them, and they become self-fulfilling. That may be true to some degree. On most trading days, there is no beneficial information at any of these levels. Many attempts have been made to change the formula, such as using the current day’s opening price instead of the previous close. There is little improvement with any of these variations, in my opinion.

An interesting experiment is to draw a line randomly on an intraday chart. Just close the eyes and drop a line using a horizontal line tool and place it anywhere on the chart. Then, watch as prices move away from or toward this line. It will hit and reverse on the randomly drawn line about the same percentage of times as it does off the pivot or the support or resistance levels. The randomness of the placement of the line does not necessarily make it useless. A line drawn anywhere on the chart can be a useful point of reference. With a line on the chart, one has a better sense of the market movements. You can more easily gauge the movement, or acceleration towards or away from this line. It is like being in a boat at night, in a fog, with a lighthouse at some distance away. The lighthouse becomes a point of reference, and you can tell whether you are getting closer to or further away from that point of light.

On the other hand, a structural pivot is a price level that stands out on the chart as a high point and surrounded by lower bars, or for downtrends, a low level that stands out and is surrounded by higher bars. For example, in an uptrend, a price level will be reached that attracts selling and shuts off buying, at least momentarily. Prices will usually fall back somewhat, thus leaving a price bar on the chart that has lower highs on either side. This high price bar then becomes an area to test on the next push higher. Traders mark the structural pivots in myriad number of ways and I have found my own way of marking that helps me understand the underlying structure of the markets in a more systematic/structured way (this will be covered in the first session of my upcoming workshop in Bangalore/Chennai). Pivot points on the chart create excellent reference points to interpret the developing market structure. Some traders refer to these pivots as swing points. Those who view the markets in terms of chaos theory would refer to them as fractals. They are all same concept, just with different names. This way of marking structural pivots has been around from early 90’s.

Trend following and structural pivots

Trend determination is obviously important for trend followers, but anyone trading in any style should be aware of the trend in the market they are trading. The overall trend can influence our trading style. The beginning of a trend can be easier to trade than end of a trend in many cases. Therefore, it is important to know what the trend is.

But to complicate matters, there can be many trends at play in the same market, even on the same chart. There are trends within trends. Different period lengths on a moving averages, or indicator input, can signal a different, often confusing and conflicting trend. There can be a counter trend down move on a 30-minute chart, while the daily chart is showing a powerful uptrend, while the monthly chart is showing a sideways trend. When they all line up, it is the most comfortable and reassuring time to take a trade, but if we wait for everything to be in sync, we you would probably trade very little, and often not in a timely manner (this is a common problem with ‘multi timeframe’ analysis’) And often the comfortable and easy trade is the one everyone sees, and it often turns out to be untimely. My thought, after changing my mind on this issue many times over the years, is to keep it simple and just trade off the time frame of the chart you are analyzing.

Most of us want indicators to guide us, as indicators are quantifiable. We can lean on them with more confidence. However, the purest and fastest way to determine trend is just through studying the price structure. Price does not lag. Price is not derived from anything. It is current. It might frustrate, but it doesn’t lie.

Workshop

The above chart shows a series of price bars. I took the time frame and market off the chart for this illustration. It really doesn’t matter what time frame is being analyzed. A trend has the same basic structure in all time frames. The red and green horizontal dotted lines are placed at swing points in the price action.

This is the same theory of a market making higher highs and higher lows, although this isn’t always exactly true. Sometimes a pause will form in the price structure and prices temporarily go opposite to the trend with the market making a lower high, but as long as a lower low is not taken out, the uptrend is still intact. On the above chart there is a smooth progression of structural points taken out from the first blue up arrow to the red down arrow on the right. There was only one instance, near the middle of the chart, where there was a slightly lower swing high.

I believe swing points are valid as a breakout strategy because the market views these points as areas to test. If the test fails, the market will test or create a swing point in the opposite direction. If the test is successful, the market will proceed upward, and the old swing point becomes an area of support if the market revisits that neighborhood. The market is constantly testing whether trade is accepting or rejecting price, and these structural points are the reference points for these tests.

Workshop

So, what do we do when the market chops like we see in the above picture? There is a way of avoiding these chops atleast 60% of the time if we mark the large pivots (see it as a high/low of a range) on top of the small pivots and trade only if it goes beyond that range. I have 100% mechanical way of marking it, formed rules around it which can be traded mechanically. Most of the structural pivot traders imbibe an element of discretion in their trading (to avoid chop trades) but that is exactly why, those traders suffer the most w.r.t psychological let-downs of the mind.

I should also mention that another trend following approach that was very popular in the past. It is the channel breakout. It worked in a very narrow window of time when markets trended well. The basis of this approach is to buy the breakout of the high of x number of bars ago, or short the breakout to the downside of the low of x number of bars ago. Often a stop is used with the same breakout method, but with a shorter look back period. One of the originators of this method, who was incredibly successful for a time, has not been able to be profitable with it in recent markets, even after many attempts. I think a more valid approach using breakouts is to trade the structural pivots, rather than a fixed lookback. The pivots are dynamic and reflect the structure of the price action. Fixed lookback periods don’t offer a breakout related to market structure. The market is testing structural points to see if price can be accepted or rejected at these points. The market doesn’t care about testing a price bar that occurred 21 bars ago just because it was 21 bars ago.

This has been a long post but I feel a much needed one as I often get questions on what pivots are and how to make a price action idea 100% mechanical in nature (with unbending set of entry/exit/MM rules). That is exactly what I intend to do in my workshops on August 11, 2018 at Bangalore and August 18, 2018 at Chennai. I will be showing how to identify and mark the pivots, how to mark ranges (mechanically), how to create entry/exit rules for this concept that can be traded mechanically and how it has served me well so far

Happy trading all !!

Price action trading workshop – Topics

Trading Journal

Received few queries on what would be the topics discussed in the 1-day PAT workshop and here is the probable list –

Morning session topics – the trading strategy

1. Why price action based trading?

2. Market structure – Basics

3. Rallies and declines

4. Details of swing pivot high/lows – how to mark them mechanically (to avoid subjectivity)

5. Trends – what constitutes the trend

6. Analyzing trends based on price action swing pivots

7. Positional mechanical strategy with set of mechanical(rule-based) entry/exit rules

8. Intraday strategy with set of mechanical (rule-based) exit/entry rules

9. Trading results of both positional and intraday strategy – How it has made money consistently in the markets

10. Useful price action tips and tricks to extract more juice from the markets

Afternoon session topics – executing the strategy to trade profitably (albeit consistently)

1. What is an ‘edge’ in a system? How to quantify an ‘edge’? Do I really have an edge in my system?

2. How to efficiently backtest a strategy – what to look for and pitfalls?

3. How to evaluate backtesting results to create a money management plan?

4. Money management in trading – how to tailor made money management based on the backtested results?

5. Trading journal and its importance

6. The real holy grail of trading – Execution

7. Part time trading vs Full time trading – Differences and their effect on our P/L

8. Role of psychology in trading – Everybody talks about discipline/patience but how does that relate to trading success.

Pre-requisites

–*None*–

Who can attend

Anyone who wants to learn price action based trading for both positional and intraday trading

Have more questions?

Please email your questions to marketswithmadan@gmail.com or Whatsapp 96770 36689

Trading journal – why should a trader maintain it

Trading Journal

Introduction

Journaling our trades or in rudimentary terms, record-keeping is simply recording the trades with different set of values but it is not as simple as that. Now, I can hear some voices – ‘What is the big deal about journaling my trades? I have the best method in the world which is raking in 10% profits per week and so, I don’t need them” Fair enough. Happy for you!!

But, for regular traders (who do this for a living), a trading journal is probably the most important tool a trader needs to possess in order to trade the markets profitably. Proper record keeping can tell us what we have been doing right, what needs to improve and help find patterns in our method/behavior.

Maintaining a trading journal might sound unpretentious but even getting started, is an arduous task. First of all, most of the wannabe traders do not journal their trades. There is a strong reason for that behavior. If we keep a journal, then we will be forced to take responsibilities for our actions in trading rather than blaming the market, blaming others (eg: market makers, software glitches, hot social media guru, TV analyst), wife, neighbor’s dog and myriad number of illogical reasons. Records keep us honest and remember, numbers don’t lie !!

Key aspects of a trading journal

It is absolutely astonishing to know the kind of information traders can get from their journals if they include basic statistics about their performance. Trading predispositions that escape normal notice suddenly stand out when summarized statistically. With statistics, we can not only say that a trader made improvement, but can actually measure that improvement and track it over time. Such statistics capture improvements that will eventually show up in the profit/loss statement, but it may not be evident straightaway.

1. Observation about us and markets – It should have observations about us/our trading and about the markets themselves. I have found that trader journals usually are lop-sided toward self-analysis and include little in the way of market observation. When I began as a trader, I printed out daily charts of each day’s action and wrote comments on these, pointing out the patterns that I wanted to watch for in the future. After some time, this identification of pattern became automatic and it became easy to trigger that trade next time.

2. Observations about our best trades must be included – Many traders use the journal as a means of self-criticism or a venting out mechanism, and they only journal when they’re having problems in the market. Additionally, it should also tell our best trades so that we can focus on them more.

3. Journal should outline specific steps for improvement – It is not enough to write ambiguous generalities, such as ‘I need to hold my winners longer’ or ‘I need to be more disciplined’. Identifying specific steps we will take to hold onto winners (proper setting of trailing stops (if any), self-control strategies, etc.) or maintaining discipline (risk management, taking breaks, etc.) makes the journal a game plan for the next day/week/month. Such review is an essential step in the kind of continuous improvement that marks winners across all disciplines.

4. Net points and Average point in losing trade/winning trade (Risk:Reward) – self explanatory metric

5. Number of winning and losing trades

6. Winning ratio – this is one of the most beaten down parameter to lure newcomers into trading workshops/services and many others. This parameter is of no use if we don’t see it along with Average Risk:Average reward. A system with 30% winning ratio and 1:7 RR is much more superior (w.r.t risk adjusted returns) than a system with 75% winning ratio with 1:1.5 RR

7. Number of long and short trades – Some people are so smooth in taking short trades but they have hard time taking longs. This is a real problem for lot of newbies.

8. Time holding losing trades versus winners – It is very hard to make money over time by holding onto losers. Eventually, the size of the losers becomes greater than the winners so that even a trader who has more winning trades than losers can end up in the red.

9. Profit/Loss broken down by long and short trades and in-turn, broken down by market condition. This is particularly useful for discretionary traders. It tells them if they trade ranges better than breakout movements. If a trader’s performance is ominously worse in one mode than another, then it is time to start probing their trading for needed improvements.

10. Drawdown percentage (both average and maximum)– to identify the drawdown and see if it matches with the system’s expectations

11. Tracking emotions before/during and after the trade – Jotting down our emotions when we enter the trade, when the trade starts going in our favor/against us, stop outs and profit tgts(if any)…we will feel very different emotions in each of these stages. Identifying them (being aware) is the first step to understanding it. Over a period of time, the emotion patterns starts to repeat and we can really work on them.

12. It should have ‘entry note’, ‘exit notes’ and ‘what would i do differently’ columns for every trade taken.

13. It should have provision to subtract the commission+other taxes we pay irrespective of winner or loser.

14. Equity curve – nice equity curve graph is a must and a breakdown of monthly/quarterly points/returns in a pivot table

Probable learning out of a trading journal

When we see the metrics, we could see where we can work on (few areas of improvement) –

1. Holding onto losing trades as long or longer than winners – so, jotting down the time in a losing trade/winning trade helps here (Point # 8 of previous topic)

2. Significantly different profitability during morning vs. afternoon trading hours – this is applicable more to intraday traders. Many a times, fatigue can make an intraday trader go below his desired potential.

3. Different profitability during different market conditions, such as trending markets or volatile ones – there are 4 kinds of markets trending volatile, trending non-volatile, rangebound volatile and rangebound non-volatile

4. The tendency to give back the points of many profitable trades in a few large losing ones – this is the biggest sin a trader can make while formulating a system. Small losses/small profits/large profits are all OK but large loss is never OK for various number of reasons.

5. The trades and their distribution/sequence can teach us a very important lesson – not only markets and volatility are cyclical in nature, even returns are cyclical in nature. A stellar year can be followed with a lackluster year and the 3rd year could be an above-average year. This kind of understanding would give us the conviction to stick to the plan every single day.

Final thoughts

More than a tool, journal can be a great friend to a trader – they can remind us of what we’re meant to be doing. They are a way of focusing on process, rather than anchoring our moods and self-esteem to the ups and downs of P/L.

In the end, trading journal can be thought of as an exercise equipment – they only produce results if you work them regularly. So, let us start journaling our trades the right way and at the end of the day, let us be better traders. Atleast, we owe it to ourselves that much !!

Trading Q&A – Discipline

Mentoring

Someone asked me a question on ‘how to be disciplined all the time?’ and there was no easy answer. He was disciplined in following his plan most of the times but could not do it 100%. Tried my best to address this typical mindset.

Here is the question (quoting it) and the complete reply-

Question:

“Is/was breaking system/method rules a problem for anyone here? How did you/do you plan to overcome it? It is a problem I struggle with often, I have many days when I dont break rules and suddenly, the gambler in me, the tuktuk in me all get out on a single day and try to destroy my profits. It is not a continuous thing, I do follow rules most days, the gambler and tuktuk guy remain suppressed until one day they rear their ugly heads. Would be great to get some help in overcoming this failure in part, almost feels like a character flaw”

Answer:

We all go through this from time to time. If a trader is disciplined 90 pct of the time and if occasionally there is a lack in trading discipline, the reasons could be multifold —

Probable causes of the problem:

1. Lack of fit between the trader and the trading system

Discipline problems are not due to trading woes. Usually, there is an underlying problem. Just as a problem maintaining the “discipline” of monogamy in a marriage is frequently the result of underlying relationship difficulties, failing to be faithful to one’s trading plans is often a sign of conflict between the trader and those trading plans.

When traders who are normally disciplined find themselves breaking their trading rules, the momentary lack of discipline are a symptom of a lack of fit between who the traders are and what their rules demand. A fine system on paper is unprofitable if it cannot be followed by a trader. A trading method not only needs to be good; it needs to be good for the trader. A trader and a trading system should be like lock and key – it should be a perfect match !!

2. Trader trying to fulfill his short term needs

Sometimes, the lack of discipline involve failing to take trades that are indicated. Other times, the problem is one of overtrading – taking trades that lie outside of one’s rules. If we think of momentary lack of discipline in other areas–cheating on a diet, for example, or procrastinating on work that needs to be completed–we can see that, many times, we act against our longer-term self-interest by becoming caught up in shorter-term needs. If, for example, we cannot tolerate boredom, we might eat to fill the void and break our diet.

Solutions

Problem # 1

Keep a journal and truly investigate each of your small trading discipline slips. Then view those slips as information, not as problems. What do they say about you? Which rules do you find yourself breaking, and what is actually conflicting with those rules?

Now look at your trading successes. What came naturally to you? What rules and plans can be derived from those winning trades? Don’t force yourself into a pre-made set of trading plans (usually derived from somebody else’s plan) but rather, identify what you do when you win and see how you can make *that* into your system. This is one of the primary reasons why ‘copying’ someone’s system never work in the long run.

Problem # 2

When discipline works, it’s often because people have found constructive ways to meet those short-term needs. The smoker who craves a cigarette may chew gum as a substitute oral activity.

The key to sustaining discipline is to identify the specific short-term needs that are occasionally overshadowing trading rules. Once you’ve made that identification, it is easier to then brainstorm constructive ways of addressing those needs. Traders who overtrade, for example, often have problems during quiet market times. Their needs are for stimulation. By creating stimulating activities during the trading day that don’t take them away from their screens, they can avoid using unwanted market activity as their stimulation.

Other times, traders fail to follow their rules because they don’t truly have confidence in their ideas. They front-run their own signals out of anxiety and wait for perfection in setups before they act. Their short-term needs often are for safety and security – they need to believe in what they’re doing. Very often this problem occurs when traders have short-circuited their learning curves. They are putting meaningful capital at risk before they’ve done small real-time trading that is needed to build a successful track record. You believe in your system when you see, in your own experience, that it works over time, across market conditions.

So, keep working on your problems and am sure you will better off gradually!!

Good luck and hope it helps

Trading Q&A Audio/Video 1

Audio/Video response to the tweet posted on April 26th 2018

Here is the A/V link:

Bouncing back slowly but steadily

Mentoring

A trader asked me a question about how to develop the discipline in following his trading plan. Am sure many of us can relate to the questioner’s mindset in ‘trying to recover the losses as quickly as possible’. It is clearly evident that the trader does not believe in bouncing back slowly. He is also well aware of the risks involved in trading stock futures on result days but he could not control the urge to put on a trade.

Here is the question (quoting it) and the complete reply

Question:

“Hello Madan – i know i have to focus on maximizing gain and have to stop weighing losses more than gains. If I look at my losses, have incurred heavy losses in trading stock future and that too on result days. I need to bury this desire to recover what I lost quickly. I find it difficult but would want to know if there is any mental drill to have disciplined approach.

I understand that trading in stock future on result days is very risky, after I enter a trade if it is in my favor it nurture my belief that being undisciplined at times helps u in profit but in the long run I am at loss due to these trades only”

Reply:

First things first – please do not answer these questions but just answer them to yourself.

1. Why are you trading the markets?

2. What is the need to trade on results day (knowing well that the stock can go either way)? If it is not part of the trading plan, why trade that day? For example, i don’t initiate new trades on RBI days. There is always another trade right? I know few traders trade on earnings announcements day but they have hedged strategies.

3. Why are you impatient to make back all the lost money back quickly? Why are we not respecting probabilities, distribution of trades and climbing up steadily?

4. We are aware that ‘profiting by breaking our system/rules can create havoc in the long run’ but we still take comfort in the fact that we are making profits by not following our plan. So, what thought process is giving us this pleasure?

5. Are our goals oriented towards P/L or oriented towards the process? Why are we so focused on P/L than focusing on the process?

Common observations about an undisciplined trader:

1. More often than not, traders do not trade to make money. Trading is not rocket science. It’s like making biryani – all the raw-materials and perfect ratio/sequence has to come into play. Once we figure that out, making a great biryani is just a process of following the routine. All the major restaurants follow routine in making their special dishes every day.

Most of the traders trade to regulate their emotional state. Once the trader becomes attached to the need to trade and make money quickly —and once his perfectionist voice of “I should have bought there” enters the picture–he is no longer grounded in markets. It’s when those frustrations build over time, becoming self-reinforcing, that traders sway away from their plan/system. What derails traders is that, at some point, we switch perceptual lenses and view the trade through the lens of profit/loss (P/L), not through the lens of probabilities, risks, and rewards.

Mentally rehearsing a mindset everyday (please read psychocybernetics and see how you can implement mental rehearsing in trading. It helped me tremendously) in which it is OK to miss moves–there will always be future opportunity–traders can prevent many of these train wrecks. The practice of taking a break during the trading day, reviewing one’s state of mind, and clearing one’s head is remarkably effective in this regard. Clearly identifying the parameters of one’s trade–the optimal size, a logical way to trail SL, stop loss points that put risk and reward into proper alignment–also ensures that you are controlling your trading, not the reverse.

2. Many traders formulate intentions for their trades and then wonder why they have veered from their trading plan. When we ask them about their trading plan, however, there is nothing written down nor is there anything specific that has been planned. Often, however, we will hear from traders that they’ve violated their discipline. When we ask which rules they’ve violated, they cannot give a definite answer. How can we violate a discipline that isn’t there to begin with? The problem is not that an excess of emotion interfered with their plans and rules. Rather, they were never sufficiently planful and rule-governed to begin with. So, there is no emotion involved (or progress to be made) when there is no plan to follow in the first place.

Essentially, in my opinion, the single greatest way to build discipline is to turn rules and plans into ‘resolutions’. That means that you have to give those rules and plans a life of their own. The more you think of them (mental rehearsing/writing them down in a piece of paper whenever you find time in a day), look forward to them, grade yourself on them and reward yourself for them–the more real they become. You are most likely to abandon rules and plans that haven’t been internalized as resolutions/commitments. This is where ‘mental rehearsing’ would help immensely. It enables us to internalize our plans/goals effectively.

Unfortunately, mere intentions are not strong enough to trap these trading errors. We need the emotional force of resolutions and the reliability of routines. Turning intentions into checklists and checklists into resolutions is a great way to ground yourself into best trading practices.

Last but not the least – being disciplined is a self-fulfilling phenomenon. The more you are disciplined, the more you will see stability in your trading and the more stability in P/L (bottom left to top right angle), the more disciplined we become. And the cycle continues.

Hope it helps. Good luck with your trading !!

Deliberate practice and patience

Mentoring

Few people have emailed me about ‘being impatient’ in executing their trades (both entry and exit) and I have already written a blogpost on patience few weeks ago. Here it is..

Why do we exit prematurely from a trade

Nevertheless, let me put some more thoughts to drive that point home again. As St. Augustine once quoted – “Patience is the companion of wisdom,” and if he lived in our era and had to say it about trading, he could have easily gone on to say that patience is a virtue that should never be disregarded when trading, nor ignored when learning how to trade. Proper patience is essential throughout the life-cycle of any given trade, and is of acute importance when learning and practicing how to trade. Unfortunately, patience is one of the most challenging skills to develop as a trader.

Deliberate practice is the key

In the book ‘Talent Is Overrated’ (I highly recommend this book, if you haven’t read it), Colvin cites research presenting that only through 10,000 hours of practice can world class performance be accomplished. He is not talking about ‘being there’ kind of practice but ‘Deliberate practice’.

Deliberate practice stresses repetition, but also stresses self-awareness and the ability to analyze how we are performing and acclimatizing accordingly. It is a crucial stage in the development of a trader because it is at this time when both good and bad habits are formed. If a new trader is not patient and hurries through the process, because of their over-enthusiasm or need to make money, the chance for developing improper skills is amplified, and the odds are the trader will become overly frustrated and either quit or attempt to accelerate their learning curve even faster.

Now, the question lingers in our mind – why are we impatient? Impatience usually stems from the underlying belief to prove oneself. If we have an underlying belief to “prove our worth”, we may find ourselves hastening through things, eager to accomplish things – in myriad number of ways to prove our worth. The “need to prove oneself” belief may be formed by any number of life experiences, where we may have felt inadequate, incompetent, defenseless, stranded or unappreciated.

Patience is vital to consistent success in trading because it allows us to be selective in our trading decisions. The experienced trader will not be anxious to make a trade, but will patiently wait until a setup with a high probability of success is exhibited. Once in the trade, a patient trader will give the position time to progress and will not get out of the trade too early, but will exit the trade according to a pre-defined/ ‘well thought-out’ plan. And the patient trader will not have to be concerned with over trading as well.

Creating the ‘patient identity’

Many of us have the problem of not waiting patiently for the setup to unfold. So, we basically muscle into the trade, see it collapse (or recover after our exit) and wonder what just happened. It is basically our survival instincts overriding rational mind to create a thought process incapable of trading effectively. Research unequivocally shows that our brain is not equipped to deal with uncertainty (the basic essence of trading).

Many a times, traders take the wrong approach of using will power to become a patient trader but come out empty-handed. One can talk to himself (self-talk) that ‘I am a patient trader..I am a patient trader’ but the same mistakes seem to crop up in frequent intervals. One can also put sticky-notes on the screen but ultimately one will become a patient trader only when they experience it themselves. Usually, it means that we practice/cultivate patience in our non-trading life as well. Forcibly putting ourselves in situations that require a person to exhibit patience. One can start a garden (will teach you lot of patience), teach physics (or some other subject) to their kids, babysit a toddler (lot of patience is required) or tutor a special child (great cause too).

By doing the activities that require patience, we create that ‘patient identity’ within ourselves and that will nicely manifest in the market. We will never be organized/disciplined in trading if we are not disciplined (one common example is lack of discipline in working out – if we are not disciplined in life-enhancing activity like hitting the gym, then trading will be no exception) in our daily lives. Everything in life, approached properly, is an opportunity to exercise the capacities we most require in our trading. I always say to my fellow traders that ‘becoming a better trader is a path to becoming a better person’

Final thoughts

As someone said – “People who do the common things in this life uncommonly well will command the attention of the world”. Trading is not rocket science – it is more of an art. It is the pint-size things we do well when trading and learning how to trade, that make the difference between success and failure. Novice traders must always be prepared to put in the practice needed if they want to achieve proficiency, and experienced traders must continue to exercise their skills if they want to achieve greatness. And that ‘elusive’ patience might be the missing link.

Hope this post resonates with some of your experience/thoughts and if it does, I would like to hear it !!

Trading psychology Part two

Psychology

This is in continuation with the previous post on psychology and subconscious mind. There were some interesting messages in twitter after I posted the first blogpost on psychology. Here is the link to the previous post.

Trading psychology and the role of subconscious mind

In this blogpost, I would like to highlight the similarities between trading and other common psychological issues/observations. To make the concept richer, I will give it a try again on the same topic with a different flavor.

Trading and Sports

We all understand that to trade the markets, we need to learn how to trade. That is the baseline. If we believe that trading is a skill based competitive endeavor, then it follows that psychology may have a part.

Like any sporting endeavor, psychology can’t make up for us being crap in the first place. So, no point getting a sports psychologist to attend our first golf lesson. On the other hand, let’s say we have a 15 yard put on the 18th hole this shot and if we putt it right, we win the tournament (plus a cool 10 crores prize money). Fluff the shot and share 2nd place with five other folks. As we line up for that shot, our visits to a sports psychologist could make or break us.

Think about it – this is an easy shot we took a million times. But now there is so much riding on it, can we just saunter up to the ball and pop it in the hole? Or will we be deliberate, think things through too much, not rely on just letting our body do its thing in taking the shot (use of muscle memory). In short – will we f*** it up?

With any skill, our performance can degrade under pressure. We need skill before this will show up in my opinion but anyone that has played a sport competitively will know that feeling of pressure that mounts as the outcome becomes more important. This is our mind/psychology in full play.

Trading and primitive fight/flight response

When we trade the markets, lot of traders feel that that markets are there to prey on them. In fact, market does nothing to affect us individually but our brains are primordially built to handle adversarial situations. Hence, we do things like making “revenge trades”, which is treating the market like a contest between people. That is equivalent to curve fitting data so that it fits our trading idea, but we are fitting the market onto how our behavior and natural responses are designed to interact with people and predators.

Evolution has effectively given us a dumb brain and a smart brain. The smart brain runs the show unless a threat is present and then the dumb brain takes over, because the dumb brain is faster at making simple decisions. This avoids people taking a long time to arrive at a conclusive decision (whether to fight or flight) only to find that it is too late and they are in the jaws of a predator. This can create a problem in trading as our natural responses can be inappropriate and the way we view/assess information changes when the dumb brain takes over.

When we practice trading in a non-stressful situation (read it as ‘demo trading’), we evaluate our success based on how our smart brain handles the situation. Under stress, in real trading, we may find that we fail to notice things that are obvious when we look at the same information after the stress has passed. This is why demo trading is so deceiving.

Trading and owning up for our actions

Some people like to say psychology has no place. We are either a skilled trader or we aren’t. Maybe that is true if we are an Android or computer, but as a human, we have emotions. Our mind plays tricks on us. If we don’t believe that to be true, then we need to do some more research on how memories work with the human brain and it would be wise if we do some research on why wall street employs trading psychologists for millions of dollars to train hedge fund managers.

When we put all these things together, “the psychology of trading”, we come up with a collective of reasons that can explain away why we held on to that losing trade, even though our trading plan said to get rid of it. This is both a good and a bad thing.

For most, it is a good thing when we finally realize that our poor trading performance is a direct result of our own actions. Too many traders never get this far. They blame the market, indicators, vendors, platforms, data feeds, family, neighbor’s dog, phone calls and myriad number of reasons. But never themselves – Zero accountability.

When we finally realize that it was our own actions that caused us to mismanage a trade,that is progress. When we realize that it was our own actions which made as a ‘failure’ trader, that’s real progress as well. But why did we do it? We know we did it, but why?? I call this the psychology of trading. Why do we as humans want to be right? Why is it our memories fault us, convincing us of something in order for us to be right, when in reality we were wrong? This is a really important point to ponder.

Trading and stress/emotions

Am sure many of aware of backtesting a trading idea. But here is the question. When we all can see ourselves as multi-crorepatis in backtesting/demo trading, what happens in real trading? The moment that real capital is put at risk in trading, everything changes. Trading goes from a scholarly exercise where loss is theoretical/on-paper/not personal to a primordial experience where potential loss deranges the rational mind and primeval emotional responses take charge of the trading mind. After experiencing real losses, the emotional brain even starts anticipating potential losses (rather than gains) and hijacks the trading mind (and consequently, disabling it to take decisive actions) If one has dealt with fear of entering a trade or fear of pulling the trigger on a perfectly good set-up, he has experienced the incomprehensible power the emotions have over sane thought.

Others are primed for over trading when their desire to experience the feeling of winning big (and to feel that drop of dopamine creating euphoria in the brain – lot of research has been done on how the brain gets addicted to gambling) transforming the coherent trading mind into the gambler’s mind. All these inexplicable behavior during real trading can be termed as ‘trading psychology’ too.

Unless we have won the genetics lottery (to get to be in nirvana stage from age 2), the brain/mind we have brought to trading is simply not equipped to produce success in trading. It was not built to deal with uncertainty.

Final thoughts

In stock markets, riches are made in a matter of weeks and lost in a matter of minutes. This pattern recur itself as each new generation of traders hit the market. Most of us have been raised hearing (through our kith/kin or media) that rich people are immoral/unethical and downright dirty. Once we grew up and become a trader, whenever we reach that mental threshold in trading and we start feeling rich, our subconscious mind will start to help us to adjust that behavior. It pretty much helps us to push the button when we shouldn’t and so on. It is about that much-hyped (pun intended) self-image we carry inside of us. The outer world is mirroring back that to us. If we feel bad one day, our trades are going to be bad as well. This is so relevant to ‘discretionary traders’. Why? Simply because we’re actually not trading the markets really, we are trading ourselves. So, it is prudent for any trader to keep the mind and body sharp, in that aspect.

We can exercise our body (to keep both mind and body healthier) but only if we believe that mind is important in trading, we can exercise the mind as well.

Happy trading!!

Trading psychology and the role of subconscious mind

Psychology

How many times have we heard this word ‘psychology’ getting associated with trading profession? Innumerable times. To the uninitiated, it seems to be an over-rated (probably abused) word. I will make an attempt to give a different perspective about psychology’s part in trading as there are lot of literature that talks about cliched topics like ‘handling fear/greed and discipline issues’. We will not focus on those items in this blogpost.

To all the readers reading this post, have you ever faced any of the following issues?

1. Not taking a trade in your plan because you did not think it would work (after a couple of losses in a row)?
2. Taking a trade immediately after a loss that is not in your plan? And then after another loss, another trade not in your plan?
3. Chasing a price move because you are afraid it is going to run without you only to see it reverse after you jump in?
4. Averaging into a losing position because you just believe you are right and price will come back to where you bought?
5. Moving your stop further away from your original stop to give the trade more room or moving to breakeven too early?
6. Continuous counter trend trades because you feel price has moved too far and you expect a reversal?
7. Refusal to close out a losing trade and holding it until later in the day or the next day taking a bigger loss than your original stop?

If you haven’t had any of these issues, please stop reading this blogpost further – you are either a master/legendary trader or have never traded before!! Chances are if we have had several of these happen to us, we either have no trading plan or should not be trading or our mindset around trading needs some work. We can call it psychology, call it mindset, call it mental discipline, or whatever suits our fancy.

The difference between unsuccessful traders, net profitable traders, and big money making traders is smaller than we think. It usually boils down to a small but perceptible edge, and while it can be related to poor money management, inadequate funds, or a bad methodology, it is usually an internal factor – a lack of discipline, emotional control, patience, and especially an improper attitude about losing and risk. Mind you, all these factors collectively called as ‘trading psychology’. So, it does not matter what we call it, but the intrinsic difficulties are real and they reflect in our trading P&L.

But to understand this phenomenon more deeply, we need to understand how mind works and how it relates to trading profession. Let’s start by dividing the mind into three divisions – inner subconscious mind, the subconscious mind and the conscious mind. We’re not going to talk about the inner subconscious mind (its primary function is to run our organs automatically) and the conscious mind (as our emotions are not relevant to them). Our focus will be on the ‘sub-conscious mind’. On a daily basis, we spend about 1-5% in the conscious mind. The rest is spent in the subconscious mind. The conscious mind perceives about 40 bits of information per second and on the contrary, the subconscious mind about 20 million bits of information/second. As they say -“Your brain (subconscious mind) sees even when you don’t”. And it’s never dormant. In fact, it has been awake and recording since the time we were a fetus.

Subconscious mind and the way it works

Subconscious mind can be divided into 3 subsections –

1. The Memory Mind – It has recorded all our memories, all events, and actions, everything that ever happened in our life since the time we were a fetus. Think of it as a video camera with five senses. All of our memories (from brain’s inception) are there and they are present constantly in every moment of your life.

2. The Emotional Mind – It’s the part that contains all of our emotions. Whenever we act, react on an emotional basis, the subconscious mind is involved. Have you ever thought of that situation when we reacted so silly, and we asked ourselves later, why in the whole world did we react like that, or why did we say that? It’s because of the emotive information that’s stored in our subconscious mind. Remember, that conscious mind has no role here – analytical part of the brain (part of conscious mind) cannot even start processing the information yet.

3. The Protective Mind – It has the role of protecting us against what it perceives as dangerous.

How subconscious mind is built

The basis for sub-conscious mind is created from day zero of our life till the age of about 7. That’s because, our brain waves, in that period are in a kind of hypnotic state. They move very slowly, and our whole subconscious is very much completely open. During these years, we lack the critical factor –the analytical and rational mind. And that means that every little thing that’s put there (not that it stays there) creates the fundamentals of our character, and our outcomes in life.

Subconscious mind and need for security

We understood how the mind is built but who’s putting in the information? Well, most of it comes from our parents or the people who raise us up. They are the ones in charge of our lives. One of our primate need is the ‘need for security‘. As I have a 8 months old baby now, I can give an example w.r.t to a baby. Normally, when a baby starts crying, it is taken up by the mother, it continues to cry. The mother checks the diaper, changes it. The baby keeps on crying. The last step – the one that always works – is to bring the baby to the bosom and feed it with breast milk (or stick a bottle with milk in its mouth if one is not breastfeeding). That’s when the baby finally stops crying.

What’s actually happening? The need for security is fulfilled. Being brought up to the bosom, the baby feels the warmth/care from the mother and the need for security is fulfilled. The only problem, is that it creates an association. The brain creates that association to food. In other words, when I get food, then I’m secure. We grow up, and every time, we had a stressed day or we feel depressed, we find ourselves putting something in your mouth. If we start to abuse food, we give birth to obesity. But, remember it has to do with the need of fulfilling ones security. Other quick examples are classical as well. Just think of how many parents out there telling their children, things like “you’re not worthy”, “you can’t do that”, “you’re bad”, “you’ll never be able to” and so on and so forth. So, it is prudent for a parent to watch what they are really telling their kids as that information is shaping up our kid’s future (more so, when they are in their young/blossoming years).

The real us, is our subconscious mind, because we’re spending there about 95% of our daily lives. The subconscious mind is this device ‘playing on’ the program we got and it is put there by our parents and by society.

Subconscious mind and trading

Ok great!! But, what does all this has to do with trading then? Have you guys ever heard of, fear of success? We do want to make money, we love money, we love trading but we’re still losing money. What we’re experiencing here is a conflict between the conscious mind and the subconscious mind. Remember, who the real you is! We’re actually the sum of all our programming. Funny thing right? So, being the sum of all our programs and given the fact that subconscious mind has the role of protecting us – Bingo, we got a great recipe!! It doesn’t allow us to make money. Because somewhere in the program, we’ve got a bad experience that has a negative charge and it keeps holding us back from getting hurt again.

See this innocuous looking statement – “In order to earn money, you have to work hard”. It has probably been put there, somewhere between the age of 0-7. Unfortunately, our parents became parents without getting any instruction manual on how to raise kids and we have the social construction as well in the picture. Nothing against the parents here but just wanted to put the facts across. Our parents inadvertently created ‘reward and punishment’ mechanism. They punish us when we’re not following their instruction and reward us when we do as we’re told. The kind of reward we get is, acceptance. When we get that acceptance, we then fulfill one of our basic needs – the need for security.

This creates a dogged association here –”In order to earn money, we have to work hard” which in turn equalizes to ‘safety’. We grow up, and start to work, and eventually we find out that, working hard equals earning money. And the safety need is fulfilled. Now, fast forward few years and you enter the arena of trading. We get into situations that can make us money easily, without having to work hard. BANG – That’s when we blow it!!

Dealing with the core issue

It is very difficult to buy this concept. I understand that. Personally, it took me a while before I finally had the courage to face it, and to understand that, it doesn’t matter how I take it or perceive it, by my conscious mind. The subconscious plays the lead here. And no matter how much I refused to accept that, it wasn’t that way. Any amount of self-talk and affirmations were not helping here and the subconscious mind just snickered back at me by decreasing my account. This was of course a very basic example but am sure you get the drift. There are various ways of overcoming this obstacle – NLP (Neuro-linguistics programming), Hypnosis and many more. I do not want to dwell in to those vast topics in this blogpost but I hope I have enabled the readers to think in that direction.

Bottom line, discounting psychology is the same as discounting your mental health. Psychology doesn’t mean seeing a shrink. It means being aware of your mind and its behaviors. Surely, we are not going to try and make an argument that mental health is unimportant. Skill is composed of more things than just physical prowess. There is also mental aptitude. And in order to exercise our mind, we must at least accept that psychology (and the subconscious mind) is not a “prank”.

Happy trading all !!