Engaging the Internal Observer

Bad Assed Trader:  I've been reading Brett N Steenbarger's The Psychology of Trading this past week and so much of what he says really hits the mark for me.  But it's one thing to recognise the problem, quite another to devise an effective cure...


He talks about cultivating the Internal Observer within you, that wise person who can be relied upon to be objective rather than rash and who it is possible to engage when you are actually feeling rash.  Research has shown that we have two hemispheres to our brain and that we are often primarily functioning in one or the other.  When trading we are often planning our trade from one hemisphere but then executing it from another, which is why when we look back at some of our trades we say "How could I have done that?  What was I thinking?  I was not in my right mind!" and we are speaking the truth, we really were not operating from our right mind.

Getting in touch with our Internal Observer helps to bring us back into our right mind - the objective and rational one that can see all the information, build a good evidence base for a trade (or against one) without bringing fear or greed into the act.  Engaging our Internal Observer can also help us to stick with a trade when the evidence is still with us, or cut a losing trade when the evidence is against.

I've heard many traders, including my magnificent coach Emmanuel, say that trading well is like being a robot - and I think this is another way of saying that the Internal Observer has taken control and booted the emotional aspect into touch.  This is not to say that emotions are of no use.  As I have said in previous blogs, emotions generate warning signs which are helpful to notice and scrutinise, but they should not guide our actions.  When we get an emotional signal that is the time to engage the Internal Observer and say "What would the wise woman within me think of this situation?  What would she do?".

This helps get the rational brain back into play, looking for objective technical reasons to act.

Here's a lovely story from Brett's book which really demonstrates so well what I have found myself doing a few times and which I am gradually managing to overcome:

"Kurt was overtrading, trying to make opportunities when none were present.  He would experience "seller's remorse" - he castigated himself for a poor trade.  This then emotionally coloured his subsequent trading decisions....Kurt was trading simply to keep his seller's remorse at bay.  By holding onto losing positions or by quickly entering new ones, he didn't have to think about what was going wrong.  This temporarily made him feel better, but it wreaked havoc with his bottom line."

Isn't that so true?  Getting into trades as a way of getting over trades?

I can remember two occasions when I did that repeatedly to the point where it felt like addiction.  What was I addicted to?  I think probably denial!

So what does Dr Steenbarger recommend?  He explains that Kurt was also a successful golfer and "When he made a bad shot - which happens to all golfers - Kurt would focus on the next shot, rather than immerse himself in what had gone wrong with the past shot.  By invoking his golf-challenge state of mind during trading, Kurt was able to treat drawdowns and losing trades the way he handled errant shots on the golf course."

He says: "It is helpful to meditate on past success to cultivate a winning mind-set...people consist of many little I's, many traders running around with different needs and impulses...by focusing on past successes and by placing yourself in the mind-set of another domain in which you are successful you can select the I's that will dictate today's trading."

I have started to invoke my Internal Observer who, I must confess, often chooses to turn to an imaginary Emmanuel sitting on my shoulder to ask for his advice.  I will take the example of a recent winning trade I have on the yen (USD JPY).

Current long trade on USD JPY from Feb 7 2012 (4 hr chart)

I placed the trade at 11.30am on February 7th and it kicked in shortly afterwards (entry marked with yellow arrow).  I set an initial target at about 1% which was near the top of the range in which the currency pair had been bouncing for months.  I took half of one percent off at that point and have been trailing my stop loss behind the daily pivot point and 50 Moving Average on hourly chart ever since (currently at the pink arrow).  I've locked in over 1% profit.

There have been a few moments where I've been tempted to take the profits and run on this trade because on the daily chart there have been some rather over extended bars followed by small reversal bars that can indicate a turn back down.  But on each occasion I've felt tempted to do this I've brought my Internal Observer in by asking "What is the evidence to support such action?" and Emmanuel has appeared (in a virtual sense) and told me to just trail the stop loss to technically safe levels.  He's reminded me "You don't know where price is going to get to."  and "You don't take the trade off, you set the stop loss where if you're stopped out it proves you wrong."

This has made it so much less stressful, just following that advice.  And price has gone up far further than I would have imagined - and of course imagining is not good when you're in a trade because imagining invokes emotions and we don't want to be led by those.

Tilly: Now working as an emotionally charged Stop Loss

Having said that, I did in my last-but-one-blog talk about emotionally charging my rules to help me to stick to them better and this is generally helping me as it's adding weight to them and I feel that if I'm starting to ignore or downplay one of my rules then I'm ignoring a family member and this makes me feel bad.

The Gorgeous Girl trader I referred to in my last blog is also trying out this technique and is emotionally charging her stop loss by making it Tilly, her beautiful cat, because she feels so protective towards her pet.

And looking at Tilly (right)...well who wouldn't want to make sure she never comes to any harm?

And whoever said traders weren't imaginative?

Rogue Traders

Bad Assed Trader:  I've had company for my trading this week with a couple of rogue traders called Diego and Zippy...

Rogue Traders at Work

This hasn't made it easier to get on with analysing January's trades to work out whether it was my strategy, me or the market that had caused a dent in my account.  Especially when the little rascals fell asleep in my lap.  At that point I allowed myself the pleasure of living in the now moment as advocated by my coach Emmanuel and Eckhart Tolle (author of "The Power of Now") and just enjoyed a rare moment of kittens being mega cute, warm, fluffy, soft and gorgeous.

They're not mine and they're going home this evening so a week of kitten sitting draws to a close.

But I am pleased to report that I have today done all my analysis despite having this major distraction, so a large glass of wine is definitely in order shortly.

And what was the result?  How much of my difficulty was down to the random action of the market?  I worked out that the market and my strategy together are probably responsible for about 25% of the overall outcome, whereas I am personally responsible for 75% of it.

So I have to accept that I went rather off piste in January. If I had strictly followed my rules I would have been up about 3.6%.  Instead I was down about 7%.  Poo.

But the good news is that whilst I can't do anything about the market and I really don't want to change my strategy after it was so long in the gestation and delivery, I can at least do something about myself.  After all, I am the master of my thoughts and actions.  Or at least I should be.

So this is the task now, to get that grip and just do it.

A good - and rather beautiful - trading buddy of mine has been experiencing similar difficulties recently.  We've been exchanging supportive emails and one of mine gave her a link to what I felt was an excellent video on youtube of Will Smith giving words of wisdom and inspiration and she said the part which inspired her the most was when he was talking about how driven and determined he is.  He likened it to a situation where if he was competing with us on the treadmill then "either you're getting off the treadmill first or I'm going to die".  

This really worked for her and I think she's right, we have to look at sticking to our trading rules with the same dogged and absolute determination.  He also said "I'm gonna lay this brick as perfectly as a brick can be laid and you do that every single day.  And soon you will have a wall." which is the inspirational quote for me and sounds just like my coach Emmanuel.  I need to make sure every trade is executed as perfectly as possible.  End of story.

So am I being hard on myself over this whole situation?  Well I was for a few days when I ended January with this dent after expecting success.  It was tougher than all my previous months when I'd lost.  But then I reminded myself that I only gave birth to my strategy in November/December and am still clarifying the rules for myself.  Quite a few of my losses in January were down to me not really believing in one of my rules about the MACD indicator needing to speak for my trade.

Having done my analysis I know this rule is non negotiable.  I'm not going to beat myself over the head for having a bad month, it wasn't as though I went crazy and blew my account in any way.  I'm still getting to grips with this strategy and when I look back at January it was a month of some turmoil with false signals that I got lured into believing.

Instead I'm going to find the drive and determination I share with Will Smith and do just as he and Emmanuel advise, create each trade as perfectly as that trade can be created.  And let's see what happens.

Trading: Taking the Rough with the Smooth

Bad Assed Trader:  I've been working my way through my January trading to identify my errors and find out exactly what caused my draw down.  As part of that process I thought I'd share one of the losing trades I took.  I've shared winning trades on this blog before but not sure I've done a loser so it's probably about time I did, particularly when one tanks as spectacularly as this Swissy one did on January 23 2012:

Disastrous Swissy Trade!  23 January 2012

I've put three time frames up on this picture.  I've marked on with yellow arrows where I entered the trade so you can see what it looked like on these three time frames.

The one on the right is the daily chart. You'll see why I decided to take a long trade: price was in an uptrend and had retraced back to the 50 Moving Average (the red line).  On January 22 there was a small green bar which could be interpreted as a bounce off the 50MA - a signal that the uptrend was due to recommence.  There was also a "soft" support level there, meaning price had reacted to that level before and changed direction, but not always.

The chart on the bottom left is the 4 hourly chart.  This shows that just before price started to bounce up it hit a red horizontal line - this is the weekly Support 2 pivot line which often represents a good support level.

The top left chart is the hourly chart and you'll see that by the time I took the trade price had started to form an uptrend - or so I thought.  After all, there had been a higher low and I took the trade long when a higher high was made.

This all falls in line with my rules, so how could I have known not to take the trade?  Well, there may have been other indications of which I'm unaware, but in terms of my rules I do need to have the stochastic and MACD indicators suggesting that price is going to go in the direction of my trade.  In this  instance they weren't.

The MACD indicator is shown at the bottom of the daily and 4 hourly charts and the stochastic is at the bottom of the hourly chart and they are all showing price continuing to move down.  I needed to wait for them to start pointing up.

So why didn't I see that the indicators were not with my trade? God only knows!  But this is exactly the sort of thing I have to focus on better if I'm to consistently profit from my trading.

Also, the previous day's bar was a green up bar but it did not show a decisive rejection of the 50MA and was rather high test-ish (a long stalk at the top) which is a bearish indicator. This should have been enough to make me decide not to take the trade.

I was clearly too keen to get into the trade and paid the price.  The important thing is that rather than seeing this as a failure I use it as an opportunity to understand my weaknesses better and find ways to overcome them.

My action point from this lesson has been to assign each of my rules with a personality which comes from someone I know.  For example, one rule is that there has to be a trend of some sort.  I've emotionally charged that rule by making my husband the trend.  If there's no trend then in my head he is telling me not to trade.

Another rule is that there has to be strong support or resistance against which the trend reacts.  I've assigned myself to that rule as it makes sense to me that my husband might react to me being supportive or resistant!  So if I can't find that strong support or resistance then in my head I'm not present so there is no trade to take.

Another rule is that I have to find a safe place to put my stop loss.  I've emotionally charged my stop loss by making it my youngest daughter - the person of whom I am most protective.  If I am to take a trade I have to find a very safe place to protect my baby (ok, she's 16...).

And so it goes on.  I hope that by giving more emotional meaning to my rules I will be less inclined to ignore, overlook or actively discount them.  Let's see how it goes.