The Seven Lessons I’ve Learned

Over the past several years of writing about trading and investing, psychology and self-development, there are a few things that seem to come up over and over. When I started out, I just wanted to share what I found interesting and what I had learned in my career journey. But after some time, as I noticed that I was writing about the same topics over and over, I realized that there were a few core themes that I had learned and that struck me and my readers as the most important ones.

Too often, we put too much emphasis on things that are not very important or that don’t help us in our journey. I wanted to distill a few of the topics and lessons which I think are the most important and beneficial, to help other traders and investors in their development. Just recently, I’ve finished writing a book, Peak Performance Trading and Investing where I explore a lot of these themes in more detail. Consider this blog post an introduction to the seven main points of the book.

1. Good trading is about good decision-making   [please read more about Lesson 1]

What is the key skill that we are practicing when we put on positions and take them off? We are making a decision about what to do. Just like any important decision, we arrive at it by gathering up various inputs, weighing them against our criteria and then making a determination. Moreover, we are doing so under stress, because the markets are always moving and new information is coming in constantly. Also, our decisions involve weighing the potential risks and rewards versus the probability of it working out. It is never a completely black and white situation. There will always be shades of grey.

This is the skill we are trying to cultivate—making good decisions. By thinking this way, we are also detaching ourselves somewhat from money, which is also a massive positive. I know you’re thinking, “But isn’t trading all about making money?”— yes, it is, but the problem is that thinking about money involves our emotions. We get greedy, we get fearful, we think about how we just lost enough money to buy ourselves a house… And all of these can interfere with our making good decisions. We want to make the best decisions possible—from a place where we are calm, collected and resourceful, not buffeted by our emotions.

2. Peak performance is the right lens through which to view our trading experience   [please read more about Lesson 2]

You’ll hear a lot of metaphors to describe trading and investing, like “trading is combat” or “investing is a game”. These are helpful for thinking about the markets overall, but when it comes to getting better, I want to use a different description: trading is about the cultivation of peak performance and expertise. Being excellent in the markets is similar to many other fields like sports or music: we want to thrive even when the pressure is high and the skills demanded are great. Our skill, the thing that we have to excel at under pressure, is making smart risk/reward decisions.

There are several implications for this. The first is that we only achieve mastery after a long, arduous preparation process. Peak performance psychologist Anders Ericsson said that it takes 10,000 of diligent preparation to achieve mastery in a field. Second, we only build up this skill through deliberate practice—exercises that work on building specific skills and correcting weaknesses. As the famous wide receiver Jerry Rice put it, “Today I will do what others won’t, so tomorrow I can accomplish what others can’t”.  Thirdly, we can borrow many of the tools that peak performers employ, such as their attitude, mental practice and regimes for managing stress. If we can think of trading and investing as a profession requiring diligent preparation and the deliberate pursuit of mastery, then we will cultivate an attitude that will lead to peak performance.

3. A process and methodology of your own are what make you a long-term winner [please read more about Lesson 3]

Given the last two points, what do you need to become a long-term winner in the markets? Every successful investor and trader has a methodology that is unique to them—a way of approaching the markets that allows them to get into winning positions and out of losing ones. It is a way of making decisions that helps them to be consistent in their approach to markets and in the decisions that they make. It helps them to filter out the noise and just pay attention to what matters. And this methodology plays to their unique personality and intellectual strengths. Summarizing this, Jack Schwager wrote in Hedge Fund Market Wizards that “Traders must find a methodology that fits their own beliefs and talents. A sound methodology that is successful for one trader can be a poor fit and a losing strategy for another trader”.

Dr. Atul Gawande wrote an amazing book called The Checklist Manifesto, about how to make difficult decisions in the midst of a stressful and constantly shifting environment. He cites the example of operating rooms, where overlooking one simple task like sterilizing an injection point can substantially the risk of infection. The solution is to create a checklist—a list of items to ensure that everything is done right. We should conceive of a methodology the same way—as a checklist of what we want to see and avoid in a potential investment.

4. Process and psychology interact—and you need to understand this to make them both work for you   [please read more about Lesson 4]

To achieve peak performance, we need both our processes and our psychology working for us. The “mental game” matters in any peak performance endeavor, but especially in trading, where we are dealing primarily with decision-making. We need to understand how process and the mental game interact with each other.

When we seek mastery in any area, we have to build the requisite skills until they become automatic. This means that we focus on practicing them and judge ourselves on how well we are sticking to our process. Once we have a methodology, then a large part of our performance is determined by how well we stick to it.

A lot of trading psychology problems arise due to not having or not sticking to a methodology. For instance, if we take a position without any real justification, then we will be much more prone to close it in a panic—but that’s not a trading psychology issue. The problem is that you don’t have a process or you are choosing not to follow it.

On the other hand, you could have a well-defined process but still have issues. For instance, you could lose your cool if the markets get too volatile. You could be scared of success—it happens more often than you think. Or you could see a position set up perfectly according to your checklist criteria but fail to pull the trigger. SMB has a great blog post about this entitled “Trading is All Psychology”. As the title suggests, these episodes have some underlying psychological causes which can be identified and addressed. To take your trading to the highest level, you will need to have both parts of the equation sorted.

5. Your path to true mastery will require extensive reviewing and tweaking [please read more about Lesson 5]

All peak performers and experts constantly monitor their own performance and look for flaws to correct or ways to get better. They are always making a host of adjustments in real time testing out a variety of ideas, techniques and solutions.

In the markets, we should be reviewing extensively our own performance. The raw ingredients for review are our statistics—the trades that we have done and how they have performed; the basic statistics like win rate, the amount won or loss per trade, and the market environments where we perform best or worse. We should have much more than that for reviewing. By keeping an extensive journal, we can keep track of our thoughts on the markets, different positions that we have on and ones that we are looking at. We can also include an examination of our moods and psychological states, to see how they impact our performance. The more raw ingredients, the better.

Tweaking means making a series of small, incremental corrections or changes. We can identify what we are doing wrong, so we take steps to do something right. We have goals, so we think of the next step to get closer to reaching them. For instance, if you trade 10 setups and notice after extensive review that one is a consistent dog, then you would just stop using it. If you notice that you are selling out of winning positions too soon, then you would find a way to hold them longer. If you want to increase your profits by 50%, then you would gradually up your position size. These are the small tweaks that can add up to a huge cumulative difference.

6. You need to understand the role of luck and skill [please read more about Lesson 6]

There is still an element of luck or randomness in the markets. You can research a trade extensively and be absolutely convinced that it will work—but still end up losing money on it. No matter what you do, you won’t be right on 100% of your trades. What does this mean for traders?

As Michael Mauboussin writes in a white paper for Credit Suisse, “Where there is luck, focus on the process”. You can’t control the outcome, because it is subject to some randomness—but you can control the input, which is the process. You want to have a process that allows for the element of randomness but which is still robust and which you can adhere to.

If it’s helpful, think about the distinction between a well thought-out trade that happens to lose money versus one that makes money. The first is a losing trade, while the second position is a winner, because it makes money.  That is just talking about the outcome. But they are both good trades, in the sense that they were put on with careful consideration. Contrast that with a trade that is a winner—i.e. it made money– but was basically an impulsive decision and thus a bad trade. By focusing on the process over the outcome, we should be trying to make a series of good trades and avoiding bad trades like the plague. Over time, the results will take care of themselves.

7. You can influence the mental game to your advantage, using a variety of techniques from fields like sports psychology and therapy [please read more about Lesson 7]

Peak performers play the mental game just as well as they execute their normal skill. By borrowing tools from these peak performers, we can up our own mental game and achieve the best performance possible. The mental game is so important that Olympians and other top athletes make extensive use of sports psychologists and mental coaching. These tools that they use are well documented and quite easy to port over to the world of markets.

The most obvious of these is mental practice. In an important study, Dr. Richardson showed that visualizing free throws helped athletes to improve performance as much as the actual act of shooting free throws. This works because when we visualize, we are reinforcing the same neural pathways that we would use in the activity itself.

Managing our mental state is just as important. We can use tools like meditation or mindfulness training to manage our emotional states – to stay even-keeled. Moreover, we can learn to access the peak performance state at will, so that we are making decisions from the Flow state – the feeling of being “in the zone”.

Together, these are the most important points that I’ve learned and wanted to share with the world. As my books approaches its release date, I will be writing blog posts going into more detail on each point. Stay tuned for the next installments.

No relevant positions

By Bruce Bower | E-mail: Bruce [at] howoftrading.com

Blog: www.howoftrading.com | Twitter: @HowOfTrading