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.