Two of these people term themselves trading coaches, and one, a trainer of traders. At least one has been featured on CBNC, TheStreet.com and other well-known trading-related venues. All have written trading-related books and numerous articles.
They also have something else in common. They've all presented www.cbot.com webinars that deal with handling emotions when trading.
I can hear you groaning all the way here in my Texas office. You want technique tips in these Trader's Corner articles. You want optimized trading systems. You want the holy grail of trading.
Managing emotions is the holy grail of trading.
Emotions can impact your trading so strongly that Jankovsky asserts that psychology comprises 95-99 percent of your trading success. Dayne likens trading under emotional duress to setting up conditions for a forest fire. Let a Santa Anna wind of emotional upheaval blow through your life and the conditions are set for you to burn through a trade or your entire trading account. Dayne claims that the overwrought mind simply cannot focus on logical solutions in the same way that a rested mind can. Solutions for ameliorating losses just do not occur to the mind operating under the influence of strong emotions. "Pity, wrath, heroism, filled them, but the power of putting two and two together was annihilated" is the way that E.M. Forster explained the damage that strong emotions do to logical thought when writing A PASSAGE TO INDIA.
The three webinar presenters might agree that the first method of controlling emotion is to avoid trading or limit the size of trades when your life is out of kilter. If you're already overwrought when coming to your trading day, you're not going to make the best decisions.
All three agree that traders must realize that some trades are going to result in losses. Jankowsky warns that most trading systems have about as many losing trades as winning ones, with a 52-percent ratio of winning trades to all trades being characteristic of a good system. Chambers wants traders to have a better win/loss ratio than that, saying that traders should concentrate on what he calls "quality" trades, trades that have a 70-85 percent chance of success.
Dayne reminds traders that, even if they have found a system that results in a high degree of success, a string of losing trades is inevitable. She wants traders to realize that when that string does occur, the trader hasn't changed. The system hasn't changed. Market conditions have. Accept it as a fact of business.
Don't look for the perfect trading system. Chambers and Jankowsky both assert that it does not exist. Dayne says that traders need to accept the idea that they'll take home losses. If traders do not fully recognize that they do and must take risks, Chambers says they're engaging in an "account-destroying activity."
Put the work into your trading so that you feel that you are executing those quality trades Chambers mentions. Having confidence in yourself and your system helps you control emotions. How do you start that hard work? You keep a trading journal.
I know. You're groaning again. Honestly, though, how are you going to know that you trade better on Monday than you do on Friday unless you keep a trading journal? I used that example because that's what I once discovered about my own trading, but you might learn that you always lose money on weeks that include an FOMC meeting or that your trades are more successful in opex week if you use back-month options rather than rapidly expiring front-month ones. You might learn that you trade better using a particular vehicle or at a particular time of day.
Both Dayne and Chambers assert that traders must keep trading journals. On his CBOT webinar, Chambers provided examples of the details that should be included. At the start of a day's journal, write a paragraph including relevant background about the markets. I advise including relevant background about your life, too. Write down your approach to the market for that day. Do you believe that any early downdraft is likely to be quickly reversed? If so, write that down. You'd be surprised how often you forget the impressions you formed while calmly studying the markets and jump into a play because you get caught up in the heat of the battle.
Chambers adds that you should note whether your market selection is complete. In other words, do you know whether your intended bullish play should best be executed with the QQQQs or SPX calls? Do you believe that a long-term move is setting up in commodities, and, if so, will you participate by using futures or an ETF? Is your analysis complete?
Are any caveats identified? Perhaps you believe that gold will move a certain direction on a particular market day, but you've learned that Japan's Fukui will also make a statement about the pacing of any interest-rate hikes in Japan. That could impact currency markets, you reason, which could then impact gold. Note this caveat. Perhaps you'll elect to let that trade pass because of the uncertainty of the impact that Fukui's statement could have.
What will be your entry strategy? Have risk-management and exit strategies been developed?
Having those risk-management and exit strategies help manage emotions in a trade, as you might imagine. Chambers warns that when you get into a trade, you already know that three possibilities exist: the market goes your direction, the market goes against your direction, or the market stays flat. Before you get into the trade, you have to know how you'll handle each situation. We options traders know that a market that stays flat for any length of time is equivalent to one that's going against our trade.
Jankovsky expounds on how psychology changes when you've entered a trade. You initiate trades, and then you liquidate those trades. Liquidation psychologies prove much different than initiation psychologies. They prove much more difficult to handle.
This teacher of traders points out that when initiating a trade, traders are usually working under a system that has given them a signal, whether that system is objective or a combination of objective and subjective parameters. Although Chambers feels that the top 10 percent of all traders go into a trade cognizant of those possible three outcomes, both he and Jankovsky believe that traders initiate a trade because that particular trade has a good probability of succeeding. The entry is made, the trade initiated, at a specific point because of specific entry criteria.
That's when the problems with emotions begin. Each point after that is a potential exit or liquidation point, Jankovsky notes. At each moment, a decision must be made. Even if a trader has a specific system, each moment involves making the decision to stick to that system or abandon it. No longer is the system guiding the trade; it's the trader who will accumulate or lose money. Your system told you that it was time to make the entry, Jankovsky notes, but your system doesn't and can't tell you if the trade will be successful.
Your emotions have been engaged. You might have been able to carry on with other business while you were waiting for the entry signal, but once the trade is initiated, you're often glued to the screen, making those moment-by-moment liquidation decisions.
So what do you do in order to handle the emotions, the trading psychology that switches the moment you enter a trade? All three presenters make the same suggestion: set a hard stop. You might be surprised to learn where they suggest setting that stop, however. That hard stop is only a get-me-out-if-the-trade-falls-apart stop, most suggest. It's far enough away that it's there for insurance only, in case something drastic happens or a trader is pulled away from the computer and needs such insurance. However, they all advise that if a trade is going wrong, you act before that insurance kicks in.
When Dayne's clients tell her about some anecdote about how they were stopped and lost money, she asks them why they let the trade get so far that they were stopped before they made the decision to get out. Still, having the stop there in case of a disaster removes some of the emotion from the trade and also prevents a trade from going so wrong that it blows out a trading account, Dayne suggests. Nothing makes trading more emotional than having blown through an account. Jankovsky echoes her words, with the first of his two rules for handling liquidation pressures being that traders should never trade without a stop.
Jankovsky's second rule for handling emotions may be harder to put into effect. He suggests that when the pressure to liquidate mounts, when traders get that gotta-get-out feeling, that they always wait one full bar on the time frame in which they're trading.
The purpose? Jankovsky says that two things could result: traders will lose more than they would have originally lost, or the system will be given time to work as intended. Traders whose primary shortcomings are cutting winning trades too short will benefit. Jankovsky says that the majority of shoulda-woulda-coulda statements he hears are from traders who either cut their profits short or else took a quick loss when waiting one bar longer before succumbing to liquidation pressure might have allowed the trade to work. Waiting would certainly have allowed a little more assessment time.
Annotated 5-Minute Chart of the SPX:
Of course, waiting one bar beyond the point at which liquidation pressure builds up doesn't always work out so felicitously. Of course it doesn't. If markets are sprinting higher or diving lower, moving against your trade, you just may not be able to wait that one extra bar, either.
In summary, grouping the advice of the three coaches produces the following suggestions. Do the hard work first to determine that you're entering quality trades. That hard work includes, always, keeping a trade journal that notes why you entered or plan to enter a trade, what conditions were present in the market and your life, and the outcome of that trade. Recognize that you're taking a risk, even though you've done that hard work, and that risk is that you might lose money on any particular trade and most certainly will lose money occasionally. Be willing enough to lose that you have an exit plan as well as an entry plan. Set a just-in-case hard stop so that you'll be automatically taken out on a market order if prices move swiftly against your trade, but plan on making an exit decision ahead of that stop being hit. Give your trade time to work, perhaps even an entire bar of decision time on the time frame chart you're watching if you follow Jankovsky's suggestion.
If your system formerly produced mostly winning trades but now does not, then market conditions have mostly likely changed. Dayne would advise that you stop trading after a number of losing trades in a row, using your trade journal to reevaluate what has changed. Dayne, as well as the others, however, says that you have to be able to recover from a trading loss, noting that the best traders have figured out ways to do so quickly.
I don't believe it's possible to remove all emotion from trading. I'm not even sure that you should remove all emotion, but traders have to understand the psychology of trading. That understanding lets us know that the psychology changes after a trade is entered, whether traders apply a specific system or a seat-of-their-pants decision-making process.
I hope I haven't misrepresented the statements of these three presenters, but,
if so, the mistakes are mine. If you've recently let a trade blow up or uttered
that "shoulda, woulda, coulda" sentiment, you might be interested in listening
to their presentations. They can be found at
www.cbot.com under the
"Education" tab, with some presentations taking place this year and some in
2006. Happy listening.