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Friday, 7 December 2007

Simplicity and the Trading Brain

Whether they are making or losing money in the market, traders know that trading is first and last a mental game. When your system makes you money, can you stay out of its way so that it can continue to do so? And when your system inevitably suffers drawdowns, can you remain on the sidelines and not act like a belligerent parent at a Little League baseball game?

Richard Dennis, who co-founded the legendary Turtle Trading System with William Eckhardt, once remarked that he believed that he could publish the entire then-secret Turtle Trading methodology in the newspaper and it wouldn't make a difference.

Why? Because most people cannot follow the rules. And this was not because the rules were especially complex. It was because human beings are especially -- and perhaps in some ways, unnecessarily -- complex.

We see the same thing when it comes to other challenges people have, whether it is in dieting and weight loss or quitting smoking. At this point in time, there are few people who do not know how to avoid gaining weight: cut down on the carbs, don't eat late at night, and mix in more lean proteins, fruits and vegetables in your diet.

Yet obesity rates -- at least in the United States -- are as high as they have ever been. So clearly the problem isn't a lack of information, but a lack of will to act on the information that is abundantly available

There is an entire bestiary of psychological demons that traders must combat in order to simply follow the rules, "the recipe" as I recently heard one trader put it. There is fear-driven trading that encourages us to lessen the pain of drawdowns by changing the rules, or by avoiding taking new trades entirely. There is "what the hell" trading where traders figure that they are down so much that there is no alternative other than to load up with as much risk as possible in a Hail Mary effort to catch a break in the final week of the month or the final month of the year.

There is even the "Let it Ride" syndrome of traders who are ahead -- sometimes ahead big -- and figure they can afford to take on additional risk. To these traders, additional gains are a reason to take on additional risk. So they scale their bets -- and their risks -- higher and higher and higher until that risk reaches a point that turns out to be far beyond their ability to endure when those bets prove wrong.

But most of the psychological problems challenging traders, at root, have to do in one way or another with traders being unable to get out of their own way and let their trading systems -- even discretionary systems -- do the work.

One theory about why this is so has to do with the nature of trading. Trading is private, individual, often secretive work. Most of the people in a trader's life -- companions, colleagues, friends and relatives -- have no idea just what their husband/co-worker/sister "the trader" actually does in that office staring at that the screen and all the strange looking lines, colors and numbers. Our behavior as traders has all the essence of an exclusive -- if not elite -- activity. Sure, maybe our real "trading" on a daily basis consists only of checking a few numbers, a few patterns, and typing in a few orders -- maybe an hour a day on average tops. That's including the days when there is simply no trading to be done, no new positions to be taken, no old positions to be exited.

I am deliberately excluding the work of building and testing trading systems in order to make a point about "trading". The fact of the matter is that trading is really a very simple, straightforward activity. Sometimes I think it is this simplicity that trips us up. Surely, we think, there must be "more" to do. Even after all our position-checking and order-making is done, there is often this need to "do" more: more analysis, more ruminating and, worst of all, more trading than is necessary.

Often those who advertise trading systems talk about how easy their systems are to use. "Only fifteen minutes a day!" screams one tout. "Only on hour a week!" shouts another. But our tendency as traders to seek out greater and greater complexity -- even against our best interest -- makes me wonder if the opposite approach would be better: "Try Our Constant Contemplation and Rumination System!" Or "Spend Hours A Day Fretting with Our Easy-to-Ponder Trading Set-ups!"

Whatever inspiration and hard work go into creating trading systems and strategies, it is often the opposite that is required in order to make those systems and strategies actually work. While it is too much to say that trading is "easy," it is very much the case that actual trading need not -- and should not -- be a 24-hour preoccupation. Placing your positions, and hedges as your rules dictate, and then managing your mind as those positions become winners, losers or are exited simply to free up capital for other, better opportunities is simply as complex as your trading ever need be in order to be successful.

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