Five Guiding Principles of Trading Psychology

By Brett Steenbarger

I recently participated in an online chat presentation for John Forman where I assembled my ideas into ten basic principles that have guided my thinking about the psychology of traders and the psychology of markets. In the very near future, if my testing continues to be promising, I hope to present a market indicator for swing traders that rests firmly upon these principles. In the interim, here are the five principles that pertain specifically to trading psychology and in future I will also give five principles for trading the markets.

Principle #1: Trading is a performance activity

Like the playing of a concert instrument or the playing of a sport, trading entails the application of knowledge and skills to real time performances and this is the core idea behind my most recent book. Success at trading, as with other performances, depends upon a developmental process in which intensive, structured practice and experience over an extended time yield competence and expertise. Many trading problems are attributable to attempts to succeed at trading prior to undergoing this learning process. My research suggests that professional traders account for well over three-quarters of all share and futures contract volume. It is impossible to sustain success against these professionals without honing one's performance--and by making sure that you don't lose your capital in the learning process. Confidence in one's trading comes from the mastery conferred by one's learning and development, not from psychological exercises or insights.

Principle #2: Success in trading is a function of talents and skills

Trading, in this sense, is no different from chess, Olympic events, or acting. Inborn abilities (talents) and developed competencies (skills) determine one's level of success. From rock bands to ballet dancers and golfers, only a small percentage of participants in any performance activity are good enough to sustain a living from their performances. The key to success is finding a seamless fit between one's talents/skills and the specific opportunities available in a performance field. For traders, this means finding a superior fit between your abilities and the specific markets and strategies you will be trading. Many performance problems are the result of a suboptimal fit between what the trader is good at and how the trader is trading.

Principle #3: The core skill of trading is pattern recognition

Whether the trader is visually inspecting charts or analyzing signals statistically, pattern recognition lies at the heart of trading. The trader is trying to identify shifts in demand and supply in real time and is responding to patterns that are indicative of such shifts. Most of the different approaches to trading--technical and fundamental analysis, cycles, econometrics, quantitative historical analysis, Market Profile--are simply methods for conceptualizing patterns at different time frames. Traders will benefit most from those methods that fit well with their cognitive styles and strengths. A person adept at visual processing, with superior visual memory, might benefit from the use of charts in framing patterns. Someone who is highly analytical might benefit from statistical studies and mechanical signals.

Principle #4: Much pattern recognition is based on implicit learning

Implicit learning occurs when people are repeatedly exposed to complex patterns and eventually internalize those, even though they cannot verbalize the rules underlying those patterns. This is how children learn language and grammar, and it is how we learn to navigate our way through complex social interactions. Implicit learning manifests itself as a "feel" for a performance activity and facilitates a rapidity of pattern recognition that would not be possible through ordinary analysis. Even system developers, who rely upon explicit signals for trading, report that their frequent exposure to data gives them a feel for which variables will be promising and which will not during their testing. Research tells us that implicit learning only occurs after we have undergone thousands of learning trials. This is why trading competence--like competence at other performance activities such as piloting a fighter jet and chess--requires considerable practice and exposure to realistic scenarios. Without such immersive exposure, traders never truly internalize the patterns in their markets and time frames.

Principle #5: Emotional, cognitive, and physical factors disrupt access to patterns we have acquired implicitly

Once a performer has developed skills and moved along the path toward competence and expertise, psychology becomes important in sustaining consistency of performance. Many performance disruptions are caused when shifts in our cognitive, emotional, and/or physical states obscure the felt tendencies and intuitions that lie at the heart of implicit learning. This most commonly occurs as a result of performance anxiety--our fears about the outcome of our performance interfere with the access to the knowledge and skills needed to facilitate that performance. Such performance disruptions also commonly occur when traders trade positions that are too large for their accounts and/or do not maintain sound risk management with their positions. The large P/L swings cause shifts in emotional states that interfere with the (implicit) processing of market data. Cognitive, behavioral, and biofeedback methods can be very useful in teaching traders skills for maintaining the "Yoda state" of calm concentration needed to access implicit knowledge.

The most important question I can ask an aspiring trader is: Are you engaged in a structured training process? Education--simply reading articles in magazines, websites, blogs, and books--is important, but it is not training. Training is the systematic work on oneself to build skills and hone performance. It requires constant feedback about your performance--what is working and what isn't--and it requires a steady process of drilling skills until they become automatic. No amount of talking with a coach or counselor will substitute for the training process: not in trading, not in athletics, and not in the dramatic arts. Training yourself to proficiency is the path to a positive psychology.

The market doesn't show any kind of positive movement based from the chart shown below.

Though a light volume was registered last Friday's trading, but the sentiments reflected on the chart speaks for itself.

The market seems looking for a "motivation" to move upwards.

It breaks out in the open but went back from its original price in the close.

Lack of conviction from the participants.

It is still a trader's market.

The market starts to stabilize as shown from this 5-min. chart.

Finally, the market got its bearing and rises from the ashes.

It's been burning totally for almost two weeks.

Let's see come Monday if it's going to continue after today's short trading schedule, the market will close at 2:00 pm. ET.

Today's trading is a light volume day for traders/investors are on a Holiday retreat.

Only those who sleep and breaths with the market are the participants.

It is a nice breakout from the opening bell today in the market, no noise!

Buying at the open and take your Starbucks coffee from the nearby and exit your position at the close can make you a paycheck for a week?...how's that in trading as compared working for fck*&?'thers...

Wall Street rebounds after six losing sessions

By Edward Krudy

NEW YORK (Reuters) - Stocks rose on Friday, on course to snap a six-session losing streak, as a buoyant start to the holiday shopping season helped offset fears about the euro zone's debt crisis after another leap in Italian bond yields.

Reinforcing what some see as recent signs of strength in the U.S. economy, shoppers stateside flocked to stores, which opened early to offer a jumpstart to "Black Friday," the traditional beginning to the U.S. holiday shopping season. The S&P Retail index (Chicago Options:^RLX) rose 0.4 percent.

"Anecdotally it seems that Black Friday is off to a positive start," said Todd Salamone, director of research at Schaeffer's Investment Research.

Europe will continue to predominate, he said. "We may have days when the U.S. market separates itself for whatever reason, but everything is about Europe right now."

Yields on Italy's debt approached recent highs that sparked a sell-off in world markets. Italy paid a record 6.5 percent to borrow money over six months on Friday, and its longer-term funding costs soared far above levels seen as sustainable for public finances.

The Dow Jones industrial average (DJI:^DJI) gained 53.32 points, or 0.47 percent, to 11,310.87. The Standard & Poor's 500 Index (SNP:^GSPC) rose 6.47 points, or 0.56 percent, to 1,168.26. The Nasdaq Composite Index (Nasdaq:^IXIC) added 9.50 points, or 0.39 percent, to 2,469.58.

Friday's moves looked to steer indexes away from ending with a second consecutive week of losses. The S&P 500 had lost almost 4 percent this week and given back almost two-thirds of its gains in October, the market's best month in 20 years.

A European Union conference in Strasbourg produced little to ease the markets fears, said Peter Cardillo, chief market economist at Rockwell Global Capital in New York.

"What they agreed to was not bickering in public," he said. "The markets are going to continue to pressure the EU until they come up with a solution that is going to ease the crisis."

For many investors that means the European Central Bank printing euros to buy larger amounts of European bonds and for Germany to accept the issuance of euro bonds. Germany currently opposes both of those options.

U.S. stock markets, closed for the Thanksgiving holiday on Thursday, will end trading on Friday at 1 p.m. The day after Thanksgiving is typically one of the lightest trading volume days of the year.

The market continues to drop as shown on this 5-min. chart from the Globex market.

A big whooping 100 points drop earlier in the holiday trading.

A big sell off!

Fearful European bankers see little to be thankful for

(Reuters) - On Thanksgiving Thursday, people working in Europe's financial sector are struggling to find much to be thankful for.

While the United States turns its back on global gloom for a long holiday weekend, a failed German bond auction has finally brought home to Europeans the realization that nowhere is safe.

"It's as grim as hell. The only good thing is now everyone knows it's as grim as hell," one pale commuter was overheard telling a disheveled-looking colleague on their early-morning Tube ride into London's Canary Wharf financial hub.

Until this week Germany -- Europe's largest economy, with a hard line on austerity -- had been seen as the euro zone's last refuge and a source of comfort for the army of bankers, fund managers and traders caught in Europe's deepest financial crisis since World War Two.

Then came Wednesday's bond auction, in which Berlin found no buyers for almost half of a 6 billion euro 10-year bond offering at a record low 2.0 percent interest rate.

"Yesterday's German bund auction was a clear example that things they thought were on the periphery are now in the core... it's time to do something," said Thomas Becket, chief investment officer at funds firm Psigma Investment Management.

Bond investors have fled, interbank lending is drying up again and questions are being asked about the stability of the region's banking sector: while Americans tuck into turkeys, Europeans are finding life more frightening than festive.

One senior European banker, who declined to be named, said many of his colleagues had been "crisis-deniers" and were given false hope of a rapid return to big bonuses and job security by the significant economic rally in 2009.

"What they are realizing now, and it's even more brutal for them, is that this is in fact the new normal, that the industry is going back to what it was in the early 2000s," the banker said, adding that the recent round of layoffs had cut much deeper than the last, because no bank was hiring.

WORSE THAN LEHMAN?

The quarter following the September 2008 collapse of U.S. investment bank Lehman Brothers has long since served as the benchmark for the lowest ebb of banker morale in living memory, but consensus is quickly shifting.

At a capital markets conference hosted by IFR at the Thomson Reuters' London headquarters on Thursday, bankers and investors exchanged sober greetings like "How are you holding up?" and "are you surviving ok?."

When an attendee expressed surprise at seeing an acquaintance at the event, the fellow delegate drily replied: "It is not like any of us have much to do at the moment."

Depression and stress are sweeping the financial sector, industry sources say, as working weeks gobble up weekends and bankers and traders nervously accept they don't know whether they will still be employed in the New Year.

"You can spend more time on pitching and marketing but sometimes you have to stop and say, 'there is nothing we can do.' And you see people just leave (to go home)," one debt capital markets banker said.

This rock-bottom sentiment can be observed right across the financial sector.

Money men once cynically described as the "Masters of the Universe" are feeling powerless to influence, much less prevent a potential unraveling of Europe's monetary union -- a calamity that would define their generation, possibly even the century.

"You have to think that eventually the penny will drop and they'll have to do something. But...quite sensible people were sitting around in 1914 and saying Europe's not going to tear itself apart over some arch duke being shot by a Serbian fanatic, is it?," said Rob Burgeman, a director at British investment manager Brewin Dolphin.