Trading Beliefs

Unexpected situations

Part of any trader’s plan should include what to do in emergency situations. If you get a phone call that a loved one has been in a car accident, can you close out your trades quickly? Do you know which ones you would need to close out and which ones can be left open?

Today, I was confronted by a less serious trading obstacle: the power went out at my home. I consider myself lucky because this happened before the market opened and the trading day began. I get a chance to think and write out my plans before I actually have to enact them. Here are the issues I’ve considered for now:

1) Trade from a laptop. My normal trading computer is a laptop, so even if the power goes out, I still have battery power and can keep the computer running to close out positions and place or move stop orders, providing I…

2) Have a second internet connection option. Since the modem and wireless router are powered by the electrical supply in my house, if the power goes down, I lose my internet connection. I presently have one other option for internet connection from my laptop because my internet provider offers local wifi that I can connect to from my home. Switching wifi connections creates a brief interruption in trading, but if a 2-3 minute interruption in power can cause disastrous losses in your account, you are trading too large to begin with.

3) Have a third internet connection option. For me, right now, this is the trading app on my phone. Some people may also use their phone to create a wifi network, but I have not yet chosen to pay for that option. While cumbersome, it would be possible for me to open my account on the phone, and close out or monitor positions from there until the unexpected situation is over.

4) Have a backup trading location. Power outages tend to be localized. Wifi is offered now in many restaurants, coffee shops, and shopping malls. What places near your home offer wifi? How quickly could you get there? What if the power is out there as well? A couple of months ago, we experienced a fairly long power outage that affected not just our neighborhood, but the shopping centers near us as well. I didn’t know where the flashlights were in the house and discovered that we had no candles, so ended up on quite an expedition to find a place that was open where I could get dinner and the proper supplies. How long is your list of potential trading locations? Have you tried trading from there?

5) What’s the minimum set-up you need to trade? I often have several different charts open and potentially several different platforms while I trade. If you are used to looking at charts with a lot of indicators, can you see those same charts from your phone or tablet? If your plan is to simply exit the trades, you may not need to see the charts, but if you are looking to add stop orders to your positions, do you know where you would put them without seeing a chart?

Results

While I was expecting to set up and day trade today, the power outage has driven me to focus on other areas of my trading. I did not need to rush to close positions or enter stop orders because I had not opened any trades yet today. If the power outage had been one hour later, I would have had more trading obstacles to face and might have a little more harried description of what to do when the unexpected arrives.

Other Trading Obstacles

I consider a power outage to be a moderate trading obstacle. A loved one in a car accident would be more severe and would require me to close out all day trades immediately. Less severe surprises might be the crash of a breaking dish (or lamp) that a pet knocks over. What happens if you spill your morning cup of coffee on your desk (or laptop)? As I was preparing to leave the house earlier this week, the doorknob came off into my hand. I had to fix it before I could leave. How would that have changed my trading plan if it had been while I was on the way out of the house to a new trading location?

Every day is full of surprises, large and small. Being a robust trader means not only having a system (or set of systems) that can trade the markets in various conditions and time frames, but knowing what to do when life throws curve balls at your trading. Being a successful trader means knowing how to handle what happens in the market and what happens outside the market.

SMART Goals

One of the the frequently recommended paths to success is to have a SMART goal. To be a SMART goal, it must be Specific, Measurable, Achievable, Realistic, and Time-bound. At some point, I may look at the other letters of the acronym, but today I wish to focus on achievable and the path to achieving progress in any area.

The area of focus for our efforts is fundamental to whether any achievement is even possible. The area we choose must be a skill that we can practice and develop. Physical characteristics such as age and height are not skills, and thus are inappropriate targets for goals. The classic example is a short person wishing to play in the NBA, or middle-aged person attempting to join any of the professional sports teams, even golf. At a certain point, our bodies stop getting taller, and at least at this point, our medical knowledge cannot return to us the youth and vigor of our younger selves. Physical limits pose restrictions on our possible goals.

Trading, however, is a skill. There are no physical requirements to open a trading account beyond signing your name (or typing it) on a few documents. There may be limits to what realistic returns are, but progress is possible in the area of trading because it is a skill. The difficulty arises because trading is not just one skill, but a set of skills, and the deeper you dive into trading, the wider the skill set seems to expand.

Basic Skills

Any area has fundamental disciplines to study before one can be considered a master. I believe the most important skill anyone need to master for any area is that of learning. In his book, Principles: Life and Work, Ray Dalio provides several drawings similar to this one:

I’ve added my own labels, which are my reflections on the multiple presentations of the graph he makes in the book.

Improvement is generally shown as a line moving up and to the right. Time goes forward along the x-axis, and our progress up and down is plotted on the y-axis. An ideal equity curve just keeps moving up and to the right with no draw downs along the way. What I like about Dalio’s drawing is instead of a dip, there is a loop that occurs before progress can continue. This breaks the time axis metaphor, but I think it is more accurate for what we need to do to get out of those dips.

Problems

The first stumbling block on our road to success we will generically call a problem. Problems take many different shapes and forms, and will continue to accompany our journey throughout life. If we don’t find solutions, then we will simply spiral downward:

While problems seem like they take us off our path to achievement, I will assert that they are what enables us to achieve. Problems highlight areas that we have not mastered yet. They help us refine our knowledge and encourage us to acquire new skills that will take us to the next level.

How can you measure progress if you never hit any obstacles? Even most funds have some sort of benchmark to compare their performance against. (That’s the point of the Specific and Measurable part of SMART goals.) I am smart, and many things have come easily to me, but in the end, even that is a problem because I don’t know what (if anything) I’ve managed to achieve if I have nothing to compare my skills against. If no one else posted trade results or investment returns, I can only measure myself against my own yardstick (which may or may not be one yard long).

To grow, we must encounter problems. Our success is contingent upon finding the correct diagnosis and implementing a solution.

Diagnosis

Before we get to a solution, we have to identify what the problem is. Changing a light bulb when the power went out won’t get us any light back in the room. Problems arise because we have encountered an unknown. Identifying that unknown is the key to finding a solution. Sometimes the unknowns are outside of our control (for example: the death or resignation of a CEO, a product recall, or a power or internet outage). The best we can do is to make sure we have a plan that gives us a path forward and enables us to live to trade another day.

Sometimes, the problems are interior. Our beliefs may be staging their own battle. Which is more important, honoring our stop or cashing a winner? Entering a new trade or not losing money? External problems are usually easy to diagnose. Internal problems may be more difficult to correctly solve. Because we are facing the unknown, we may need to try several different solutions before we find the best one for the problem. There may also be side effects caused by the solution that provoke other problems. As a concrete external example: moving a table so that we don’t bump into it while walking through the living room might seem like a good idea until we sit down in our favorite chair and no longer have a place to put our coffee.

Diagnosis is also an area where it can be helpful to have other people involved. Teachers and mentors can point towards possible solutions or give us information that we need in order to move on to the next level. Most often, our problems are not unique. Other people have been there and done that. Colleagues and friends can share their answers or the information that they have found helpful in solving problems. Even if the problem is an internal one, it’s quite useful to seek out others to help in the diagnosis and solution stages.

Solutions

After encountering a problem, correctly diagnosing it, it’s time to implement the solution. If the solution is not a one-time-fix-it-and-it’s-done solution, then an accountability partner might be useful. A teacher or mentor might also guide in the implementation of the solution. The first solution also may not solve the problem. It’s entirely possible to spin around the loop several times before progress up and to the right resumes. Like a roller coaster, the downward drop can give us energy to move back up. When we find the right solution, we often have more enthusiasm and drive to continue our journey. Having conquered a problem, we have new confidence to move up to the next level. This is the real joy of solutions.

The Path to Achievement

Growth in any area requires that we master the loop of problem-diagnosis-solution. Whether the skill we wish to master is trading, playing piano, or a new language. We take steps forward until we encounter a problem, some task or situation that we have have not encountered before. We must then identify the roadblock and find a way around it before we can continue on the path to achievement and mastery. If the solution we choose is not adequate, we may encounter the problem again, but this only means that a new and better solution is waiting to be found.

There are many different skills required to master trading. At the foundation though, I believe is the ability and willingness to move through the cycle outlined above. Only by looking for progress, identifying the areas for growth and implementing new information can a skill be mastered. This is the record of my journey as a trader, my reflections, observations, and an account of my actions as I walk the path to becoming the best trader I can.

Starting first with the trade report for 21 May 2018. I framed no trades for possible entry today, though two positions did hit their stop losses: SKT and STZ.

Both initially moved in my favor, so I moved the stop closer to the entry, but they eventually moved against me, so were closed out today for losses. Total result for the two trades: -.86R

This leaves the swing portfolio with 18 positions showing +4.69R.
Long: AA(2), CAT, CBOE, CSCO, DIS, EWI(2), GILD, HD, IR, KR, MSFT, PFE, SLB, WYNN(2), XME.
Short: none.

Reflections

Because I hadn’t framed any trades, and I wasn’t sure there would be any that closed, I intended to write today about my belief that it is ok not to trade. I’m not sure it is a solid belief yet, but rather one I am still working on adding to my belief system.

What this means to me:

As an individual investor, I have no mandate to have my money in the market. I can be in cash, bonds, stocks, futures, currencies, any number of investment vehicles completely at my discretion. There is no prospectus indicating I must always be invested, preventing me from going short, or keeping me from using leverage. There are other beliefs or parts of me that are definitely interested in being in the market, and I certainly know that if I am going to generate any returns from trading, I must make trades. Even so, making trades does not mean I need to do so every day. I can wait for the setups and conditions that I believe will give me an edge.

What this belief gets me into:

It can make it easier to ignore market movements and neglect the daily tasks of trading. It allows me to pick trades that fit the edges I have developed. It could permit me to cherry pick from the trades my systems generate. It provides a sense of ease and loosens the grip on a belief that I need to be in the market.

What this belief gets me out of:

It can keep me out of the market. It can keep me from taking what could be some of the best trades available. It reduces my anxiety around trading and needing to generate results now.

Limitations of this belief:

Taken to the extreme, this would keep me from generating my desired results and achieving financial freedom through trading. It can encourage a less rigorous application of trading practices.

Utility of this belief:

This belief gives me more freedom with y pursuit of trading, lowering my stress, and enables me to focus on process rather than dollar results.

Conclusions:

There are other parts of me that are still not convinced of the absolute truth of this idea. I will need to do some parts exploration to identify and negotiate the difference of viewpoints between the parts interested in being in the market and the drive to succeed and become a successful trader. More will follow as the negotiations are conducted or other parts step into the foreground.

Belief:

I am smart.

What this means to me:

This is not meant to be an egotistical post, but is a time to dive deeper into a point that Denise Shull made in Market Mind Games. When presenting her idea of fractal behavior, she says,

Since I have been consulting on Wall Street, I have yet to find someone who habitually fights trends that doesn’t ultimately reveal a very clear and specific reason that arises out of their personal and family history. The easiest ones are traders who can notice that they want to prove they are smart.

Knowing that one of the behaviors that can cause me problems is fighting a trend, this paragraph just leapt off the page at me when I read it.

As a child, I was tested and classified as a special education student. Not because of any difficulties, but because I qualified as gifted and talented. In 2nd grade I finished our math textbook a month or more before school ended. In 3rd grade, I went to the 4th grade classroom for reading. Eventually, I was accepted into a magnet school and surrounded by other “smart” people. We were very competitive, or at least some of us were. My weak spot was English, but in math, science, and even German, I was one of if not the top student in the class.

Both my parents were teachers, and my mother taught the lowest of the special education students that attended school. While never admonished for a “bad” grades or rewarded for “good” grades, I believe there was both encouragement and an unspoken expectation that since I could do much better than my mother’s students, I should do my best and earn the highest grades I could.

What this belief gets me into:

Being smart generally means I catch on to concepts quickly.
Trying to appear smart and educated.
A desire to improve myself.
A desire to present myself as a better trader than others.
It supports a competitive side of me that likes to win.
Connecting the dots of different ideas.
Relying on my intellect rather than being in touch with my emotions and feelings.

What this belief gets me out of:

Studying and preparing. I wish I still had the little sign I was given in elementary school that said “Genius is the ability to avoid hard work.”
Diving deeply into a task.
Giving proper weight and attention to my emotions and feelings.

Limitations of this belief:

It encourages me to present the best possible side of my trading. Being smart has meant getting in as close to the bottom as possible and out as close to the top if possible. After all, what could be smarter than selling at the absolute top or buying the bottom?

It has been closely connected to my trading results. My expectation has been that a smart trader makes trades that make money. Losses only appear smart if they keep me from losing a larger some of money. Relating being smart to monetary results instead of following trading rules is a real challenge. (There’s another belief that I am a creative person and don’t like rules hiding in there as well.)

If I understand a task intellectually very quickly, I may miss some of the important nuances and/or the impact it might have on my emotions.

Utility of this belief:

Believing I am smart encourages me to continue to grow and learn. I will fix mistakes and tackle new obstacles, always seeking to do better than my colleagues or my previous performance.

Conclusions:

There is definitely a utility to being smart. The catch is in how it tries to manifest itself. Trying to be a smart trader by only having winning trades is actually not very smart. Being a trader who develops a clear system and follows clear trading rules is a smart trader. Keeping those ideas from getting confused is the real task here. In the trading context, a losing trade doesn’t make me dumb. It can make me smarter if I choose to see it as paying for information about the market.

Not all trades are winners, and no one can pick even most of the tops or bottoms. Lacking those skills, I can still be smart by trading a system that fits me and my personality.

Trying to do anything else is actually pretty stupid.

In Market Mind Games, Denise Shull makes the observation that emotions and feelings share characteristics with fractals. What happens in one context may repeat itself elsewhere and in a smaller or larger variation. Having been exposed to Ken Long’s regression line fractal framework for trading, I’m certainly used to thinking of a fractal nature of the market. Van Tharp’s says that “people do not trade the markets; they trade their beliefs about the markets.” My a-ha came when Denise Shull connected these two ideas to demonstrate that traders have fractal behaviors, especially as it pertains to feelings and emotions.

Denise Shull starts with research that demonstrates that actions require feelings. No action takes place without some sort of feeling or emotion connected to it. For trading to be a psychological game, the psychologies driving the market must come from the traders. I’ve known and understood for a long time that my feelings and emotions influence my trading results. What I don’t think I appreciated until Shull pointed it out was how there is a much deeper crossover between my behavior as a trader and my behavior in other areas. Here are some of my own fractal behaviors that I spotted as I came to understand her point.

I am a musician, and my main area of interest in music is improvisation. I create music as I go. There may be a chosen theme, structure, or intention, but my primary goals are to create a competent, coherent, colorful, and convincing piece. I’m not looking for perfection and am certainly not stuck with following a written score. In trading, I recognize this as my reluctance and difficulty to write out a formal trading plan with hard rules for entry and exit.

Here’s another example of my resistance to formal rules. As an undergraduate, it was possible to take Music Theory 4 before Music Theory 3. The two classes covered different material, so while they had a normal sequence, it was possible to take them in either order. Because the best professors were teaching them in the same semester, I wanted to take them both at the same time. It made sense to me, but the Theory department wouldn’t allow it. Rules prevented me from doing what I wanted.

Someone shared the following on a Facebook post, and I resonated so much with it that I now have it posted on my refrigerator:

When I started to look for it, it became easy to see how my improvisation mindset manifests in not only a resistance to rules in music, but in many other areas of my life. Including trading.

Having gleaned this insight from Denise Shull, I’ll be watching and looking for other behaviors from my daily and professional life that might influence my trading.

Belief:

Indicators summarize price action.

What this means to me:

Prices change over time. Indicators collect the price data over time, perform some mathematical functions with that data, and provide a new number that attempts to describe the price action.

What this belief gets me into:

Learning about indicators.
Collecting data.
Exploring which indicators fit my beliefs about the markets.
Building systems using indicators.
Relying on indicators instead of being in the now.
Having more criteria to follow for an entry or exit.
Being confused by conflicting indicators.
Considering how the indicator influences or reflects the psychology of the market.

What this belief gets me out of:

Making decisions by gut feel.
Taking total responsibility for my actions. (e.g. The indicator said go long.)
I don’t have to look just at price.
Looking at previous price action.

Limitations of this belief:

Price action can change faster than an indicator can adapt. Using indicators requires understanding not only what the indicator does but what it tries to say about the price action and the market psychology. Indicators can offer conflicting viewpoints.

Utility of this belief:

This seems to be a useful belief for the further study of indicators. It is simple, clear, and promotes further learning.

Conclusions:

Indicators are a tool for the trading tool box. They need to be studied, understood, and tested to determine how they fit my trading beliefs and style. Some will be useful for the work I wish to do, others will not. Trying to use too many tools at once will make the job harder. Selecting the proper tools and using them properly will make the job easier.

Belief:

Options increase leverage.

What this means to me:

Options are a trading tool that allow me to put fewer dollars on the table to make a trade.

What this belief gets me into:

This enable me to hold more positions that trading stocks alone.
I need to understand options and their pricing.
I have to make sure the option is liquid enough to trade.
I have to subscribe to more market data.
It is easier to put on large positions.
I could have positions that are too large.
Options activate my excitement part.
Satisfying or keeping my excitement part in check.
Examining why I need leverage.

What this belief gets me out of:

Having to only trade stocks.
It reduces the limitations of my capital.

Limitations of this belief:

This belief seems to be more of a fact.

Utility of this belief:

This is certainly more useful than options are dangerous or options are risky. There does not seem to be any emotional charge with this belief.

Conclusions:

The real issues to examine here are why use options and why use leverage? What do those items represent for me? Options are a leveraged trading instrument. How I use options and leverage are the real issues to be examined.

Belief:

Options can be used to limit risk.

What this means to me:

Options are a tool and can be used to change or create different risks for trades.

What this belief gets me into:

Studying options.
Learning about option markets and pricing of options.
Learning about the different price characteristics of options.
Looking for ways to limit my risk.
Looking for complex solutions to simple problems.
Determining (some of) my risks when I put on a trade.

What this belief gets me out of:

Accepting all the risk for a trade.
Complexity can create knowledge or vision gaps, so using options may keep me from understanding the larger vision of a trade and how it might turn out.
Taking full responsibility for a trade (The option has me covered.)
Options are not available for all markets, so this could keep me out of markets without them.

Limitations of this belief:

Not all risks are covered by options. Options introduce another level of complexity to the market and trading systems.

Utility of this belief:

Knowing about options can create new trading systems, positions sizing strategies, and offer protection from gaps.

Conclusions:

Options are a two-edged sword: they offer advantages and solutions to certain trading issues while also introducing complexity and greater knowledge requirements. The complexity creates more opportunities for mistakes but also may create more trade opportunities. Limiting risk is a useful application of options, however the realm of options raises many more issues to explore and clarify.

Belief:

Some stocks move smoothly. Others gap frequently.

What this means to me:

Price action for different stocks shows different characteristics of movement.

What this belief gets me into:

Noticing the frequency and size of gaps in price movement.
Developing ways to measure and track changes in the characteristics of stock price moves.
Measuring and tracking opening gaps.
Developing trading systems that take advantage of stocks that gap.
Developing trading systems that take advantage of stocks that move smoothly.
Developing trading systems that avoid stocks that gap.
Developing trading systems that avoid stocks that move smoothly.
Believing that stock selection can impact trade returns.
Considering a belief that gaps are areas of support or resistance.
Considering a belief that gaps tend to get filled.
How does movement style relate to trend and/or volatility?

What this belief gets me out of:

Trades skipped or missed if a stock doesn’t meet the gap or smoothness qualification.
Observing that a stock that gaps frequently can keep me out of stocks that might blow past my stop.
Choosing to trade smooth stocks would keep me out of stocks that gap.
Choosing to trade gaps would keep me out of stocks that move smoothly.
All stocks move in the same way.

Limitations of this belief:

How does this belief get measured? Are those measurements accurate? How sensitive is a trading system to this belief?

Utility of this belief:

This belief provides a snapshot of how prices move and can be useful in developing both trade ideas and market selection criteria for a trading system. It urges me to be more observant of the market and develop nuances to my trading systems that could be very useful.

Conclusions:

While broad in scope, this observation about price movement will allow me to generate more refined ideas about how to trade. I expect other beliefs to flow from this foundation.

Belief:

Choosing the right stock is not a trading system.

What this means to me:

There are many requirements for a trading system. Stock selection is only one of them.

What this belief gets me into:

A trading system requires rules for entry, exit (for profit and loss), position sizing, and choosing a market.
Whatever the market, I will need rules for the other parts of a trading system.
If I have those other rules, does the stock even matter?
Choosing a stock is still part the system.
How do I choose a stock?
What do I need to know about the fundamentals of the business behind the stock?
What sort of price action do I look for in a stock?

What this belief gets me out of:

Claiming the result was from the stock, not the system or me.
It could get me out of paying attention to important news about a stock:
e.g. If the stock isn’t important, do I need to know about an upcoming merger?
Even having a system could keep me from looking at how I execute it.

Limitations of this belief:

Any belief that focuses only on the stock or the system and neglects the psychology of the person carrying out the trades or constructing the system is incomplete. Beliefs expressed in the negative leave open a wide territory for positive associations. If choosing a stock is not a trading system, what does it mean to choose the right stock? What does it mean to have a trading system?

Utility of this belief:

As with the previous post on choosing a stock, this is an incomplete statement. It points towards a truth that there are more criteria to success than choosing a stock, but otherwise is not very informative.

Conclusions:

This is a belief in need to further refinement. An uncarved block of potential, not to simply be discarded, but rather chiseled and cut until clarity emerges. Some of that clarity comes when statements are equivalency comparisons rather than negative exclusions.