Brett Steenbarger - Psychology Of Trading - Meetup

274 Pages·2006·2.62 MB·English

by  Brett Steenbarger

A Dozen Reflections on Life and Markets

Brett N. Steenbarger, Ph.D.

www.brettsteenbarger.com

I've never seen a trader succeed whose explicit or implicit goal was to not lose. The trader who
trades to not lose is like the person who lives to avoid death: both become spiritual
hypochondriacs.

No union was ever destroyed by a failure of romance. It is the loss of respect, not love, which
ends a relationship.

Love, once present, never dies. It must be killed.

Sometimes we select markets--and trading styles--much as we choose romantic partners: by their
ability to validate our deepest-held images of ourselves. Our choices generally succeed, for
better or for worse.

Many a trader fears boredom more than loss, thereby experiencing the two in sequence.

Goodness of character is measured in loyalty to others; greatness of character is measured in
loyalty to principle.

A measure of the soul: the degree to which the surpassing achievements of others evoke
inspiration rather than envy.

If you listen to the words, you'll understand the brains of the speaker. If you listen to the tone,
you'll understand his heart.

Show me what a man loathes, and I will show you what he cannot accept in himself.

Two traders: one increases size after a loss; the other gets smaller. Both continue to lose.

One encounters losing traders as often as one encounters losing golfers--and for much the same
reason.

The absence of self-acceptance too often masquerades as the desire for self-improvement.

Brett N. Steenbarger, Ph.D. is Director of Trader Development for Kingstree Trading,
LLC in Chicago and Clinical Associate Professor of Psychiatry and Behavioral Sciences
at SUNY Upstate Medical University in Syracuse, NY. He is also an active trader and
writes occasional feature articles on market psychology for a variety of publications.
The author of The Psychology of Trading (Wiley; January, 2003), Dr. Steenbarger has
published over 50 peer-reviewed articles and book chapters on short-term approaches to
behavioral change. His new, co-edited book The Art and Science of Brief Therapy is a
core curricular text in psychiatry training programs. Many of Dr. Steenbarger’s articles
and trading strategies are archived on his website, www.brettsteenbarger.com
A Trader’s Self-Evaluation Checklist

Brett N. Steenbarger, Ph.D.

1) What is the quality of your self-talk while trading? Is it angry and frustrated;
negative and defeated? How much of your self-talk is market strategy focused,
and how much is self-focused? Is your self-talk constructive, and would you want
others to be talking with you that way while you’re trading?

2) What work do you do on yourself and your trading while the market is closed?
Do you actively identify what you’re doing right and wrong in your trading each
day—with specific steps to address both—or does your trading business lack
quality control? Markets are ever changing; how are you changing with them?

3) How would your trading profit/loss profile change if you eliminated a few days
where you lacked proper risk control? Do you have and strictly follow risk
management parameters?

4) Does the size of your positions reflect the opportunity you see in the market, or do
you fail to capitalize on opportunity or try to create opportunities when they’re
not there?

5) Are trading losses often followed by further trading losses? Do you end up losing
money in “revenge trading” just to regain money lost? Do you finish trading
prematurely when you’re up money, failing to exploit a good day?

6) Do you cut winning trades short because, deep inside, you don’t think you’ll be
able to make large profits? Do you become stubborn in positions, turning small
losers into large ones?

7) Is trading making you happy, proud, fulfilled, and content, or does it more often
leave you feeling unhappy, guilty, frustrated, and dissatisfied? Are you having
fun trading even when it’s hard work?

8) Are you making trades because the market is giving you opportunity, or are you
placing trades to fulfill needs—for excitement, self-esteem, recognition, etc.—that
are not being met in the rest of your life?

9) Are you seeking trading success as a part-time trader? Would you be seeking
success as a surgeon, professional basketball player, or musician by pursuing your
work part-time?
10) Can you identify the specific edges you possess over the many other motivated,
interested traders that fail to achieve success in the markets? Do you really have
an edge, and—if so—what are you doing to maintain it?

Brett N. Steenbarger, Ph.D. is Director of Trader Development for Kingstree Trading,
LLC in Chicago and Clinical Associate Professor of Psychiatry and Behavioral Sciences
at SUNY Upstate Medical University in Syracuse, NY. He is also an active trader and
writes occasional feature articles on market psychology for a variety of publications.
The author of The Psychology of Trading (Wiley; January, 2003), Dr. Steenbarger has
published over 50 peer-reviewed articles and book chapters on short-term approaches to
behavioral change. His new, co-edited book The Art and Science of Brief Therapy is a
core curricular text in psychiatry training programs. Many of Dr. Steenbarger’s articles
and trading strategies are archived on his website, www.brettsteenbarger.com
Accepting the Obvious

Brett N. Steenbarger, Ph.D.

www.brettsteenbarger.com

This past week, I received an email with an excellent question that has bedeviled me in my own
work with traders: Why do traders fight breakout, trending moves when they are so obvious?
Time and again, I will see traders refuse to enter a market that is breaking lower because “I don’t
want to sell the lows”. Worse still, traders will hold onto positions against the trend because “It’s
going to come back” or “The market is being manipulated.”

Let’s get down to basics:

Volume tells you where traders and investors are accepting value at a given point in time. If the
market has been trading within a narrow range and then breaks above that range on high volume,
it means that the market is accepting value at higher levels. If you were attending an auction for
an artwork that you own and large numbers of bidders kept offering higher prices for the painting,
you would conclude that the painting has not yet found its ultimate selling value. You surely
wouldn’t sell your art piece as soon as the first group of bidders starts to aggressively bid!

The market works on similar auction-based principles (see Mind Over Markets, the excellent book
by Jim Dalton and coauthors for a discussion of auction theory in trading and the use of the
Market Profile). Each day, we see an auction for such artworks as the S&P, NASDAQ, bonds,
etc. The dynamic interplay between buyers and sellers determines value for those markets. It is
when we see volume expanding on a directional price move that we realize that the market is out
of balance. It will continue to move in its direction until it can attract sufficient buying or selling
interest to create a new balance.

Not infrequently, I will ask a trader who missed a breakout move what happened to volume during
that period? Very often the response will be “I don’t know”. The trader was so busy focusing on
price—and so busy focusing on their own reactions to the movement—that the auction-based
meaning of the breakout was lost.

I would argue that this is one incontrovertible law of trading: When something important happens
in the market, good traders focus on the market and the meaning of the events. Bad traders
focus on themselves and their frustration over missing the events, how they can make up the
money they lost, etc. Incredibly, I have seen traders miss entire trending days because they were
busy convincing themselves that they had “missed the move” on the initial breakout.

Still, there can be another reason for missing those obvious moves. Let me give three different,
but related, examples of "refusing to accept the obvious":

1) A woman comes to counseling complaining of marital problems. Her husband has been
staying out at night, not spending time with her. He told her he was working late, but she could
not reach him at the office. One time she found someone's belongings in his car--a woman's--
and questioned him. He explained that she had forgotten to take them from the car after he
dropped her off at home following a late day at the office. When the counselor suggested that
perhaps he was having an affair, she expressed anger toward the counselor and insisted that she
just needed to "work on the marriage". Several weeks later, the husband moved out and moved
in with the new woman.

2) A cancer patient has taken a dramatic turn for the worse, and tests confirm massive spread of
the cancer. When the physician raises the issue of hospice care and ways of relieving pain in the
final weeks of life, the family members angrily confront him and insist that he pursue "more
aggressive treatment" so that he could return home and, eventually, get back to work.
Meanwhile, the patient is a virtual skeleton due to weight loss, cannot hold down food, and is
visibly suffering.

3) A victim of abuse in childhood insists that her father was caring and minimizes the pain of her
childhood, despite clear evidence that she was sexually molested, physically beaten, and
frequently humiliated. She insists that she must have done something wrong to upset him, and
will not use the term "abuse" to describe what she went through. She undergoes periods of
depression when, even now, she reaches out to him, only to be rejected.

In all three cases, the difficulty accepting the obvious is the result of a need to believe something
different. It isn't just that the individual is blinded to reality: it's a desire to perceive a different
reality. In most cases where traders fail to act on breakout moves--or worse, get run over by
them--there is a situation where the trader was actively anticipating a different kind of market.
Once this becomes part of their analysis, it becomes their opinion, and their ego gets caught up in
it. The term traders use is that they become "married to their opinion".

What I've found is helpful is the active creation of "what-if" scenarios in the market that can be
mentally rehearsed in a vivid way. If we are range bound, what if we break above the range with
expanded volume? What if the small and midcap sectors break above their range, even as my
market stays range bound? What if we probe the top of the range and volume dries up? Such
what-if scenarios actively prevent the trader from getting caught up in assumptions that become
opinions that become marriage partners. "Plan the trade and trade the plan" is common advice,
but good traders always have a Plan B.

Finally, let’s consider the reverse scenario: Traders in a range bound market who convince
themselves at every move that a breakout is at hand. Once again there is a need to believe, but
for a different reason. Too eager for action, bored by the bracketed trade, needing of some P/L
juice, they cannot accept that the market has found value and is staying there. Low volumes
speak as loudly as high ones to those willing to listen. An ES market that trades only a few
hundred contracts per minute is not attracting “other timeframe” participants and will only be
jostled back and forth by “locals”. It is very easy to overtrade these markets by anticipating
breakouts rather than waiting for evidence of their occurrence. The telltale sign of this problem is
the frequent complaint of traders that “this market just won’t trade”. They are busy fighting what
the market is doing rather than following the market’s lead.

Ayn Rand was right: Many problems boil down to evasion once our needs and desires conflict
with reality.

Thanks to Bob Kieffer (www.r7.com) and Bill Duryea (www.marketshaman.com) for
inspiring this article with their excellent observations.

Brett N. Steenbarger, Ph.D. is Director of Trader Development for Kingstree Trading,
LLC in Chicago and Clinical Associate Professor of Psychiatry and Behavioral Sciences
at SUNY Upstate Medical University in Syracuse, NY. He is also an active trader and
writes occasional feature articles on market psychology for a variety of publications.
The author of The Psychology of Trading (Wiley; January, 2003), Dr. Steenbarger has
published over 50 peer-reviewed articles and book chapters on short-term approaches to
behavioral change. His new, co-edited book The Art and Science of Brief Therapy is a
core curricular text in psychiatry training programs. Many of Dr. Steenbarger’s articles
and trading strategies are archived on his website, www.brettsteenbarger.com
Anticipating Market Turns

Brett N. Steenbarger, Ph.D.

www.brettsteenbarger.com

Note: The following is an excerpt from Gail Osten’s interview with Brett Steenbarger in
the March, 2003 issue of Stock, Futures, and Options (SFO) magazine entitled “The
Windmills of Your Mind and the Pathway to Your Trades”. The entire interview can be
accessed at www.sfomag.com.

Gail Osten: …Too often, people give generalities, but they really want to know how
these strategies are put together. At this point, I think your daughter’s fish story might be
appropriate.

Brett Steenbarger: This came out in a posting that I did for Laurel Kenner and Victor
Niederhoffer’s Speculators column, which is on the MSN Money site. They requested
ideas about trading and indicators for trading. My daughter Devon, who was about 10
years old at the time, came up with this idea with me. We were examining stocks in the
basket of 40 issues that I [follow], and she had the idea that some of the stocks were
strong, and some were weak. Some of the stocks were going in one direction, and the
others weren’t. It was her view that the stocks were like schools of fish and that ones that
are strongest are the “lead fish”. So if you want to know what direction the market is
going in, you had to look at the lead fish—in other words, the stocks that were leading.
Since then, it’s turned out to be a helpful, qualitative insight. Sometimes the market will
be going down and down and down, but you’ll notice one or two or three stocks are
refusing to continue to go down, and they’re actually starting to bubble up. Those are the
candidates as lead fish, and it makes sense to follow those stocks. It makes sense to think
about a turn around in the broader market as more of the individual issues follow those
lead fish.
Assessing Intraday Trendiness

Brett N. Steenbarger, Ph.D.

www.brettsteenbarger.com

Each day the Weblog posts a trendiness measure that captures the trending qualities of
the previous day’s trading. The basic logic behind the trendiness measure is that shifts in
a market’s directional persistence precede actual price changes. Prior to outright
declines, markets lose upside momentum and vice versa. The trendiness measure looks
at directional movement over the past day and compares it to the day’s total movement.
The result helps alert us to shifts in the short-term trend. It is also particularly helpful in
identifying non-trending markets.

Below is the Trendiness measure, as posted to the site:

Note that downside trendiness has tended to precede price lows, and upside trendiness
has tended to precede price peaks. Note also during the most recent price period, the
trendiness reading stayed between –2.5 and +2.5 for most of the time, keeping us alerted
to the non-volatile trading environment.

Having found some success with this measure, I decided to construct an intraday version
that might assist with shorter-term trading. The logic behind the Short-Term Trendiness
measure is the same; instead of looking over a past day for trending behavior, it evaluates
a 45 minute lookback period.
Below is a chart of the Short-Term Trendiness measure.

Once again note that the trendiness reading tends to bottom prior to price lows and peak
prior to price highs. In a non-trending environment, the amplitude of the peaks and
valleys in the measure are quite similar; in a trend, we see the trend measure make
distinct peaks (bullish trend) or valleys (bearish trend), with countermoves bringing the
short-term trendiness toward the zero line prior to reversal.

Thus far I have found these trend measures to be more reliable in identifying relative
price extremes than conventional indicators, such as RSI and Stochastics. I will be
investigating applications of the measure to a variety of markets in coming weeks.

Brett N. Steenbarger, Ph.D. is Director of Trader Development for Kingstree Trading,
LLC in Chicago and Clinical Associate Professor of Psychiatry and Behavioral Sciences
at SUNY Upstate Medical University in Syracuse, NY. He is also an active trader and
writes occasional feature articles on market psychology for a variety of publications.
The author of The Psychology of Trading (Wiley; January, 2003), Dr. Steenbarger has
published over 50 peer-reviewed articles and book chapters on short-term approaches to
behavioral change. His new, co-edited book The Art and Science of Brief Therapy is a
core curricular text in psychiatry training programs. Many of Dr. Steenbarger’s articles
and trading strategies are archived on his website, www.brettsteenbarger.com
Becoming the Person You Know You Can Be
Brett N. Steenbarger, Ph.D.
www.brettsteenbarger.com

Note: A version of this article appeared on the Trading Markets site the week of
10/3/05.

This is one of my shortest articles, and it may be one of my most important.
In bodybuilding, there is a principle known as "train-to-failure" (TTF). The idea is that
you lift that amount of weight that permits you at least ten repetitions, but continue the
lifting to the point of failure: the point at which you can no longer sustain the repetitions.
Such a heavy-duty program, as outlined by the late Michael Mentzer, is low force (to
minimize injuries) and high intensity (drawing upon the body's full reserves). This
program also contradicts usual practice, which has athletes lifting every day. Mentzer, a
world class bodybuilder, found that a limited number of repetitions to failure were
sufficient to stimulate muscle growth, as long as there was an adequate period of
recovery following the training stimulus. When first espoused, the idea of doing a
limited number of intense repetitions and then staying out of the gym during the recovery
phase was heretical. Now it is the backbone of many successful approaches to
bodybuilding and strength training.
As Mentzer noted, the idea of TTF is itself a reflection of a principle in exercise
physiology called SAID: Specific Adaptation to Imposed Demands. The body, according
to SAID, will develop along the lines of the demands imposed upon it. If you impose
intensive demands upon a muscle set, that set will develop more than others that have not
been challenged. The opposite of SAID is deconditioning: the absence of demand upon
the musculoskeletal system. Astronauts in space for a considerable period of
weightlessness lose body mass due to deconditioning and, at times, have had to be carried
from their spacecrafts due to a loss of strength. Their bodies adapted to the absence of
demand.
The vast majority of people live their lives the way uninformed athletes train: they take
on too many demands, none of which are sufficiently intense to take them to failure.
Theirs is the equivalent of lifting a twenty-pound barbell for hours on end. They become
tired, but not strong. By the time they get old, they are chronically tired, and then retire
from all demands. For many, retirement is an exercise in mental, physical, and spiritual
deconditioning.
Truly great people live their lives on a TTF basis. They challenge themselves until they
fail, and that provides new challenges. They ultimately succeed, because the challenges
that produce failure also build their adaptive capacity. Their minds and their personalities
exhibit SAID: they adapt to imposed demands.
Now ask yourself: If you trained in the weight room as hard and as smart as you train for
trading success, how strong would you be?
The reality is that few traders train at all, and those that do rarely impose demands on
themselves that require growth and adaptation. The bodybuilder knows that effort is a
friend, a stimulus to development. You push yourself to your limits, and then you adapt
to those imposed demands. In simulated trading--and in the practice that comes from
trading small size--it is not enough to concentrate and focus: you develop the capacity to
operate in "the zone" by testing the limits of your mental stamina. Similarly, don't just
follow your trading ideas; test them until they break. Then you'll be able to figure out
where they are weak and how you can fix them. We cannot know our limits unless we
are willing to venture beyond them.
Mentzer realized that, to become the person you know you can be, you have to do more
than you think you can do. Paradoxically, you will find your greatest freedom, in the
gym and in life, in the imposition of your most stringent demands.
Bio:
Brett Steenbarger, Ph.D. first corresponded with the late Mike Mentzer in April, 2000
(see the "Testimonials" section of Mike's site). Brett is Associate Clinical Professor of
Psychiatry and Behavioral Sciences at SUNY Upstate Medical University in Syracuse,
NY and author of The Psychology of Trading (Wiley, 2003). As Director of Trader
Development for Kingstree Trading, LLC in Chicago, he has mentored numerous
professional traders and coordinated a training program for traders. An active trader of
the stock indexes, Brett utilizes statistically-based pattern recognition for intraday
trading. Brett does not offer commercial services to traders, but maintains an archive of
articles and a trading blog at www.brettsteenbarger.com.