How you cope with stress predicts profitability

In "The Psychology of Trading," Dr. Brett Steenbarger describes a study he conducted with a group of 64 active traders. He discovered that the way traders coped with stress predicted profitability. He measured personality traits and the ways these traders coped with stress. Some traders were problem-focused copers in that they managed stress by developing specific plans for coping with stress. For example, they tried to find information to help them develop a specific plan to alleviate stress. They focused on their ongoing experience and methodically took a step-by-step approach to overcome stress. Less successful traders spent all their energy experiencing and trying to control unpleasant emotions. They denied that stressors were a problem instead of devoting their effort to finding solutions. In addition, they believed that the world should conform to their expectations rather than accept stressful events at face value. Their shortsighted focus on coping with unpleasant emotions clearly distracted them from trading the markets skillfully. Dr. Steenbarger's findings suggest that they tended to abandon their trading plans and traded less profitably than traders who were problem solvers.

I agree with Dr. Steenbarger's conclusions.

In my mentoring of new traders, I find the stress Dr. Steenbarger refers to also results in a trader moving from one trading system or method to the next. This quickly degrades into a behavior pattern of looking for the "Holy Grail", the perfect trading system that will save them from the stress and pain experienced when a system fails them, a trade goes wrong and money is lost.

One step traders can take to overcome this trap is to learn to think in terms of probabilities. Long term probability deals with the mathematical effect of time when using a system. Over time a reasonable system will produce a favorable result. Short term probability deals with the random nature of individual trades placed during a trading session. Can any of us actually predict the size of the next trade that will cross the tape ? You have to be able to cope (emotionally) with that inherent uncertainty.

Also, how does the trader react to an individual loss, does he or she take it personally ? react emotionally ? get angry, or sad, or depressed ? Does the person tend to hesitate on the next trade after a loss ? Or can he or she simply step up and take the next trade ? Some of the best advice I learned is to plan for the trade to fail before you enter it. The winning trade will tend to take care of itself, it's how we handle the losing trades that is most important in the long run.

A trader must be realistic. No trading system is perfect. In our research we find systems tend to have streaks, or runs of wins and losses. I think this is because each system has an ideal market condition in which it works best. When the system encounters it's ideal condition, it has a run of good luck. Conversely when the system hits a challenging environment, it has a run of bad luck. This is the way the market works most of the time, and the system is reflecting this reality. If your system works best in a trendy market environment, guess what happens to it when the market becomes directionless and range bound ? Do you have a plan for how you will handle or manage the next losing streak in your trading system ?

These are some of the real world causes of the stressors Dr Steenbarger refers to.

Thanks for that insightful addition pt_emini.

The ability to distance yourself from the trading results is the key I think. Somehow you need to put an abstraction layer or buffer between yourself and the outcome of each trade. I talked to a trader who tried the following method to achieve this:

He was on the first floor of his house and his wife on the third floor. The had an intercom connecting the two floors and he would call out trades but would never know if his wife had taken the trade for him or how many contracts she'd traded. (He was trying to focus on the market action and allow his wife to do the trade and money management under strict rules.)

Problem was, he said, that he kept on running upstairs to check to see if she had a position on and couldn't bear the thought of not knowing if he had a position on or how much of it was left on. So in the end he said that it was a failure and he had to return to his old ways of putting on the trades and managing them himself - for the sake of their marriage.

You mentioned:

quote:

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...If your system works best in a trendy market environment, guess what happens to it when the market becomes directionless and range bound? ...

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...from a technical point of view and talking an aside from the psychology of this topic I think that day traders need to have two or more sets of indicators or styles of trading and they should use the appropriate one for the day type. I believe that more profits are available if we focus more of our time on identifying what the day type is going to be OR is developing into in order to select our weapons to fight the battle for that day.