Cognitive Flexibility

This post belongs in the series that I refer to as: What Other Bloggers are Saying.

Thanks to Derek for the following (somewhat edited) post on the #1 trait of winning traders.  He begins with an appropriate quote:

“It is not the strongest of the species that survive, nor the most intelligent, but the one most responsive to change.” Charles Darwin

Cognitive rigidity: the tendency to lock into one’s opinion at the exclusion of all new information…Read When Genius Failed: The Rise and Fall of Long-Term Capital Management to get the painful details on how cognitive rigidity brought down those brilliant folks at Long-Term Capital Management.

What separates the [successful] traders, and why they so consistently make money, is the ability to maintain flexibility.. As Joe Donohue said a couple weeks back, successful trading is about changing one’s mind ALL DAY LONG.  

I think the best lesson followers can take from these great traders is not mimicking every pick, but watching someone execute with cognitive flexibility (the topic of a Phil Perlman post).  It is the most valuable of all trading skills; exposing oneself to repeated instances of it can only help to sharpen one’s own development of it.

It's difficult for many of us to recognize the difference between rigidity and the confidence that our methods work very well.  We know that being flexible is likely to bring better results, and that stubbornness is a no-no.  However, it is less trouble to avoid learning new things – and that is not the mindset of a winning trader.


On the other hand, you can be too flexible:

Mike Bellafiore suggests that traders Find the Setups that Fit Your Personality [Again, the words below are edited for brevity.]  Mike offers some examples:

In One Good Trade: Inside the Highly Competitive World of Proprietary Trading (Wiley Trading)  I wrote about Mad Max craved momentum stocks.  Aggressive individuals may enjoy trading momentum set ups.  They should find more of them and must learn which set ups offer excellent risk/reward opportunities and which offer too much risk.

One senior trader loves to measure his trades.  He doesn’t believe in a trade unless he can understand its probability of success.  So this trader should crush the trades he can measure but accept that things don’t always make sense, and adapt in these unique markets.

Another senior trader is ultra laid back.  He likes his plays to develop.  He trades size but prefers the slow movers.  Forcing him to trade momentum makes no sense.  He should focus on his best set ups that match his personality, trade more of them, and work to trade them in size.

One former trader was always the smartest guy in the room.  He loved fading stocks. He was smarter than most in the market thus, faded out-sized moves.  The problem was he faded everything, and was unable to pass on the super strong and weak stocks.  He was unable to understand that his personality was causing him to over fade.

We had traders move to hedge funds because intraday trading was not intellectual enough for them.  This was the right move for their personality.

I like order.  I tend to be able to trade just about any set up but I can struggle with taking on too little risk. 

Also I most enjoy helping others.  And thus, it is best for me to use my talents as a trading teacher than as a trader. [MDW: That's something I can understand]

We are all different.  We must understand our natural disposition and consider how our personality impacts our trading.  We should find plays that match our personality and focus on trading more of them.  We should understand the limitations our natural disposition imposes on our trading and find solutions to improve.

One last note for developing traders.  You must first build a solid foundation.   Learn and experiment with many different set ups. Then you can gravitate towards the plays that fit your personality.

For us, as option traders, there are always situations that make for a more comfortable entry point.  Perhaps our trades do better in volatile or dull markets.  Or we may achieve better results in bullish, rather than bearish markets.  Perhaps high risk plays in small size work better fro some traders than low risk plays in greater size.

Those who maintain accurate trade journals would have such data at their fingertips.  Regardless of how well (or poorly) any of us perform as a trader, if we dig deeply we can probably discover which set ups work best.  That would present a choice:  Sit it out, waiting for better opportunities, or be flexible enough to find an alternative methodology.

So which is it for you?  Can you combine cognitive flexibility with trading the best set ups?


 All options, all the time.



, ,

10 Responses to Cognitive Flexibility

  1. Bob 01/13/2011 at 7:01 AM #

    Greetings Mark,
    Relative to recent posts on opening a trade and implied volatility I was hoping I could fit this in. What is your opinion on my considering an Iron Condor trade in RUT today being at 801.36 with a spread choice of 710/720-880/890. This trade on each side is outside 1 SD and the credit that is quoted would be $2.47.
    D = -0.8 G = -0.09 T = 3.37 V = -21.01
    I feel comfortable to a point with this trade but being a rookie I’m not sure if the value of Vega is a hi/lo or okay value. This is still a paper trade and I value your input that I’m on the right track in my studies.
    Thanx so much for your time.

  2. Mark Wolfinger 01/13/2011 at 8:05 AM #

    Greetings Bob,
    You don’t say which month, but with the credit of $2.47, it must be March expiration.
    Here’s the bottom line; This is practice and this is where you can learn things about iron condors. Make the trade.
    This spread suits me and my comfort zone In fact, I opened one yesterday that was a bit worse (same $2.45 credit, but I sold the 870/880C spread). Thus yours is better – if you can indeed get those prices.
    As to whether the greeks are ‘okay’ or not depends 100% on you. There is no ‘best.’ There is no ‘good enough’ because what is good for me may not suit you. I understand that you don’t have a way to make this judgment right now. That’s why you are asking and why I suggest keeping track of these numbers in a trade plan or journal. Don’t forget to include the value for RVX so you can see IV level for your underlying.
    As you accumulate some experience, you will be able to decide if you have too much vega (for example).
    Bob – the one thing that’s going to be true for these iron condors is that they are going to be quite vega negative. If IV pops, the trade will not look pretty. If it holds or declines, it will look good. That really is the bottom line.
    Here is my suggestion: If you ‘feel’ that vega is too high in this low-volatility environment (I don’t), trade fewer spreads than ‘normal’ trade (for example do 6-8 instead of 10).
    Do trade 10-lots in the PAPER-TRADING account, even though you would probably not do as many with real cash. Why? So that adjustments can be made. It’s difficult to adjust a 1- or 2-lot position.
    You are on the right track. But do remember that picking the specific trade is always going to remain an art and not an exact science.

  3. derek 01/13/2011 at 8:21 AM #

    thanks for the mention, Mark…for most of us, “all day long” is a little hyperbole but we all must seek our own levels of flexibility. rigid in principles, flexible in analysis makes sense to me

  4. Dan 01/13/2011 at 8:43 AM #

    Mark, I decided to buy a VIX June 25 Call. The reason I bought the June was because I figured the time value is greater and would leave a fair bit of room for correction.
    After I bought the option I realised VIX options aren’t going to work like normal options, because they are a 30 day forward looking index from expiration date and they are European. So even if we see a big spike in the next couple of months the June options may not move much at all, unlikely but possible.
    I just wanted to ask whether you have traded VIX options or know how to best trade it, I assume looking at shorter time frame is preferable? The option is currently down 10% last week from last week due to the rally that we are seeing at the moment, would it be wise selling a put on the VIX to hedge against any further upside?

  5. Mark Wolfinger 01/13/2011 at 9:07 AM #

    It does make sense.
    Finding the right way to trade to encompass these ideas – that’s the difficult part.

  6. Mark Wolfinger 01/13/2011 at 9:16 AM #

    It’s not that unlikely. We have seen VIX spikes with little attention being paid to that by VIX options.
    There is no substitute for knowing what you are trading – and VIX options are options on futures contracts, not the VIX index. Yes – Europeans makes it an even worse product for the individual trader.
    I have never traded any VIX options.
    A HEDGE is a position that partially offsets the gain or loss from another investment. Selling a put never hedges a long call. They are both bullish bets.
    I can tell you this: The hedged trade must be made with the same Jun VIX options – or it will not be a good hedge. A different VIX expiration VIX date tells you that a different futures contracts is the underlying. To hedge, you prefer to use the same underlying asset.
    Read the blog (VIX and More) of Bill Luby – he’s my VIX expert.

  7. Robert 01/13/2011 at 4:05 PM #

    I have maybe naive question, is it possible to make adjustments to already open positions, that might be ‘in danger’ of losing money, using stocks (or indexes if applicable) instead of options? From “The rookie’s guide to options” I know that it is possible to create ‘synthetic’ positions and sometimes makes sense to trade them. One of the examples would be a put spread where short side is ATM (or very little out), probably too late but at this point the put should be bought back, instead one might short the stock and buy a call to protect from a big upside move.
    Could you please explain what are pros and cons of such adjustments.

  8. Mark Wolfinger 01/13/2011 at 4:42 PM #

    Not at all naive.
    Any trade that reduces risk and leaves you with a comfortable position is a satisfactory adjustment.
    Adjusting with stock is worthy of a more complete discussion. More detailed reply tomorrow

  9. Mike C. 01/13/2011 at 7:14 PM #

    Wow, I’m excited to have found your blog! What patience across the whole spectrum of questions from rudimentary to sophisticated. I’ve subscribed to the RSS and very much looking forward to keeping up with what you have to say.
    So your post today touches on something I’ve been mulling over recently. Is there any reason for retail traders to use firm systems at all? If the rules are laid out ahead of time, why risk letting your emotions screw it up; why not just have a computer do it for you?
    And if the answer is, “Don’t. Just let a computer do it,” then what are successful retail traders doing? Is it just an art? Honing the intuition?
    Thanks a million.

  10. Mark Wolfinger 01/13/2011 at 8:29 PM #

    Mike C,
    Note: RSS feed does not include access to questions/answers. You’ll have to come to the site to see them.
    Thanks so much. These Q/A take more time that I can spare. So far, I’ve replied to every one received.
    I have no interaction with any retail traders, except through this blog. Thus, to be honest, I have no idea what successful retail traders do. I assume they are disciplined, watch their trade size and don’t take too much risk.
    Computers do make trades for professional market makers. They are designed to find trades that neutralize risk (offsetting their MM trades).
    But I don’t see how a computer can trade a ‘retail strategy’ – covered calls, iron condors, naked buys or sells…I must confess I know zippo about any type of trading systems.
    However, it’s almost impossible to be a winning trader if emotions ‘screw it up.’ If a trader cannot trade without his/her emotions somewhat controlled, I believe that person would be better suited as an investor who uses options, but who makes as few trades as possible.
    Emotions just get in the way of making rational decisions.