Exposing Ideas to the Envelope of Serendipity

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Monday, April 13, 2009

LESSON 27: Build Emotional Resilience

After catching up reading the comments on the Tim's slopeofhope blog since Friday's market close, I coincidentally was reading the following in Dr. Brett's new book "The Daily Trading Coach". I believe there are many who posted over the weekend who will find the following text of great value:

"Three traders place the exact same trades; all of them lose money. 
  • The first trader becomes discouraged, curses the market, and give up for the day. 
  • The second trader reacts with frustration, vows to get his money back, trades more aggressively, and loses a bundle on the day. 
  • The third trader pulls back, reassesses her strategy, waits for a clear area of the opportunity, and places a good trade that brings her even on the day.
What is the difference among these traders? The research literature in psychology refers to it as resilience: the ability to maintain high levels of functioning even in the face of significant stresses. A resilient person, for example, can lose his job, but still function will at home and implement an effective strategy for finding new work. The individual who lacks resilience is thrown for a loop by the lost job. This interferes with the other areas of life and makes it difficult to find new opportunity.

A key reason why many people lack resilience is that they take negative events personally. Some portion of their self-worth is connected to their individual life outcomes. When events go well, they feel good. When they encounter roadblocks, they become discouraged, doubtful, and frustrated. Instead of dealing directly and constructively with the blocks, they react to the emotions triggered by their peronalizing of events."

he continues:

"I recently researched a new pattern that I wanted to trade and saw an opportunity in early morning trading. I vacillated between placing a small-sized trade and one more normal in size. I thought about the trade  going against me and realized that I didn't really want to lose money on a relatively untested idea. With the smaller trade, I didn't care about the implications of the profitablity of the trade for my portfolio. A larger trade cound dent my week's performance, and that would have been frustrating to me. SO I placed the small trade, observed the pattern in real time, made a small profit, and started the process of integrating the pattern in my usual trading.

In selecting trade size, I was letting my psycological resilience dicatate my risk taking. When I traded to my resilience level, I kept myself in a favorable state regardless of the trade's outcoume. "How will I feel if I'm stopped out?" dicated my trading size. To be sure, this can be taken to an unhealthy, risk-averse extreme. We can take so little risk on trades that we severely diminish potential returns. The key is to know yourself and especially the limits of your resilience. Occationally I'll fantasize about placing an uber trade on a promising idea and taking a mammoth profit. I realize, however, that such a trade can overwhelm my resilience. As soon as the position went against me - even in normal, expectable adverse excursion -  I would be stressing about the dollars lost. Undoubtedly the would prevent me from managing the trade effectively.

Successful traders learn to build their resilience over time and adapt to stresses that at one time might have been overshelming. That small trade I recently placed would have qualified as a large trade back in the late 1970s when I placed my first trades. Now it is emotionally inconsequential. Experience builds adaptation: we can generally handle familiar situations with a high degree of resilience.

The most effective way to build emotional resilience is to undergo repeated, normal drawdowns and see -  in your own experience - that you can overcome those."

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