Sunday, February 11, 2007

Trading Errors

I just found this blog article about conditioning optimal trader behavior by punishment. Make a trading error and you cut you in your hand. Bit extreme, but even less drastic measures won't work as far as I can see. Sure you can train animals to stop certain behavior by pain. But I think humans are different. Sure it's simple to teach a child to avoid fire, by telling the child to hold it's hand over a burning candle. It's hot and the child from now on will avoid touching a burning candle. But, if something as complex as trading errors are involved, it's different. You make trading errors for a reason. You might not know consciously the reason, but there always is a reason. And punishment won't rid you of your problems in trading, it will make you only stronger, so you will continue to make the errors despite the punishment.

Take a different approach. Brett Steenbarger suggest introducing an external observer in trading. Think of you split in 2 persons and now you as external observer would look over your shoulder while you were trading. Your external adviser would now counsel you how to handle the trade. A very effective concept I have to say, as you can now look objectively at the trade as if it were a third persons trade, see the risks and potential and suggest to yourself to act accordingly.

Take this concept a step further.
After you make a trading error.
Take the time and try to analyze in a discussion between yourself and your external observer what you were thinking in the trade. What the real reasons were, why you made the trading error.

Maybe you will find,

  • that something totally irrelevant to trading caused the trading error. (eg. You had a pressing chore to do, but you could not stop trading)
  • that you are taking to big risks in trading, because the size traded is too big for your account.
  • that you were frustrated missing a clear opportunity and you wanted to get the "missed" money back.

I found that I can not trade against myself. I will just make the same mistakes again and again. With some problems I have to live, but knowing them I can try to avoid the situations, when these demons pop up, some others I have integrated in my trading as money management rules or strict trading rules. EG. If I have to leave the trading desk in 20 minutes, I take no trade. If my family is around I don't trade. If I have to finish a paper I do that first, then I start trading.

I know I haven't listed them all, but I think I have given you an idea how to deal with trading errors effectively. Take them seriously, you make them for a reason. Deal with the reason and the trading error is neutralized or just gone.


Caravaggio said...

Hi Globetrader. Many thanks for your advice. You are the second person to say that self-punishment won’t work, and I am starting to think there is something to this. Reading your post, I think you are very rational, which must be a real boon in trading. Personally, I find the 'external observer' exercise extremely useful in decision making. I also find a variation of this technique helpful: instead of creating an external observer, I project myself forward in time and look back the decisions I am making. I used this technique when I decided to leave my old job.

However, I still find that it's all too easy to get lost in the moment when I am trading, and it is at these times that the gremlins come out. Because I think I am weaker than you on this front, I believe I need to take more drastic action to modify behaviours and kick compulsive habits and other gremlins. I'll take your advice on board and continue to ponder a solution.

Dicky Lee said...