Psychology of Trading Series: Stress

As mentioned previously I've become interested in trader psychology. This is an entirely new field for me, and professionals already blog in this area. I have no credentials to compete, nor do I intend to compete.  However, I believe that discussing some of their ideas can only improve our understanding of how we trade, and thus, improve our results.

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Although no longer an active blog, Dr. Brett's TraderFeed is still my favorite place to find nuggets worth sharing:


What stresses traders out: "When
traders face high levels of emotional stress over time, the result can
be a form of burnout. Overwhelmed by obstacles and challenges, traders
shut down. They stop learning, and they stop taking the actions needed
to move their progress forward."


It's difficult to be trading under stress.  And it's not likely to be a profitable time.  Yet that's when we need to be at our most alert – to defend our assets and be certain that we are not over-trading, trading too much size, or ignoring risk. 

When suffering from burnout, it's easy to get bored and take a 'let's go for it and take my chances' attitude.  When in danger of not performing at your best, it is important to take a break from trading.  You don't have to go on vacation.  Perhaps an afternoon bike ride will be enough to restore your energy.

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Signs of psychological burnout: "Very often, it's
not just the stresses of markets that overload traders; it's also the
stresses that traders can impose upon themselves. It's easy for
achievement-oriented traders to become their own worst enemies when
they're not making money: instead of focusing on constructive
improvements, they beat up on themselves and add self-imposed stress to
trading pressures."

Can you imagine the frustration of someone who is on a losing streak who feels the desperate need to earn a big profit from the next trade?  I hope you are never in that position.  When under stress, if you cannot back off and get away form trading for a short (or longer) time, then it's mandatory to your mental health and future earnings power to cut down on trade size. 

That's the simplest and most direct method for cutting risk and stress when trading.  And when you have less pressure, you are more likely to make good trading decisions.  That's far more important than risking your trading career in an effort to go for one big win.  

Don't undervalue the risk of ruin.  It's difficult for traders to find another stake when they blow out.  When under stress, it's far better to take a break than make a big effort (under even more stress) to recover losses.

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Keep your eye on the ideal: "It is far better to trade less often
and trade exquisitely well than to trade frequently and haphazardly."

There's nothing to disagree with in that statement.

718


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10 Responses to Psychology of Trading Series: Stress

  1. Andy 06/16/2010 at 9:59 AM #

    Mark,
    I’ve been in the trenches over the past month. Unfortunately, my trading experience has been costly. I started trading iron condors late last year and became frustrated that I was losing money or breaking even every month while everyone else was having fun riding the stock market upwards.
    You can probably guess where this story goes… In April, I decided to close all my short positions and loaded up on MAY bull put spreads and additionally sold cash-covered puts (with the subliminal goal of earning all the money I had lost the past several months with one fell swoop). As everyone knows, a few weeks later, the market ‘correction’ occurs, and I reluctantly closed some of my spreads early, but miserably waited until the bitter end for many of my other contracts (I was in shell-shock by that time) to simply expire. Indeed, I lost a lot of money.
    I haven’t given up on trading… and, hopefully, will be able to recoup a good portion of my losses over the next year (or two). In one of your posts a while back, you mention how difficult it is to teach risk management to a new trader, and that most people will go on to learn their lessons from their own experiences.
    Here are a few things that have stuck with me:
    1) If you get to the point where you have to adjust a condor, it’s hard to come out ahead. My condors were simple: close them whenever the index came within 30 points of either leg. One major thing I learned about this: the money you lose from the ‘close’ leg far outweighs the money you gain from the ‘far’ leg. For a while, when the market was moving singularly upwards, I simply tried selling fewer short legs (ie: 4 bull put spreads and 2 bear call spreads) and selling the short leg further out of the money than the long legs. Eventually I just decided to sell the long legs and scrap the short legs.
    2) Sell your spreads for at least 1 dollar. Way out of the money for 25 cents seems nice, but then you have to hold onto your spread to near expiration to make any profit (no one will close that spread for you otherwise for a measly dime). You’ll probably find it much easier to sell a spread for 1.25 and close it for a 1.00 if you’re far from expiration.
    3) For every trade you make, there is another person out there who thinks otherwise (who do you think is buying/selling your spreads?). So, what makes my judgement any better than his? By this reasoning, this should be a ‘zero sum game’. I’ve been pondering that the only reason people generally make money from the stock market is that the influx of new investors outweighs the outflux of retiring investors, thus the market generally floats upwards (like a pyramid scheme). Thus, doesn’t it only make sense for the nonprognosticator to invest long, and never short?

  2. Mark Wolfinger 06/16/2010 at 10:07 AM #

    Andy,
    This a valuable, if lengthy, comment.
    As usual, I have lots to say. Let me see if I can get the response to a reasonable level. Will return as soon as feasible.
    I’m sorry to learn of your troubles.

  3. Mark Wolfinger 06/16/2010 at 10:30 AM #

    This requires a separate post. Reply to be posted Friday. I need time to work on it.
    Thanks much for sharing.

  4. Andy 06/16/2010 at 10:40 AM #

    When going through turbulent times it’s always good to have a friend who understands.
    Thanks, as always.

  5. Ted 06/16/2010 at 11:03 AM #

    I did a buy write when market was down. Sold July calls about 15% OTM. Strike has been hit and exceeded.
    Question is this. Do you advocate closing positions when stock hits sold call strike? I think that there may be a bit more wiggle room as call has lower delta than stock and so increase of stock price may gain quicker than short call. Correct?
    So I’m thinking maybe its best to let the stock exceed over the strike a bit and then close out.
    Just curious about your guru opinion.

  6. Don 06/16/2010 at 12:02 PM #

    Mark, a while ago you mentioned on your site academic research that was performed on investor psychology. I viewed the link then and found it very informative, but I can’t find it on the site anywhere, could you point it out again, it is very applicable to today’s post.
    Also, I wanted your opinion on why a trader would prefer to buy a lower priced OTM call then a call that is already ITM and thus needs much less movement to be profitable.
    Example AKS is presently 14.37 with heavy trading in the Sept. 15 call at 1.45 concurrenlty the Sept 10 call is 4.60 this trader would need a breakeven of 16.45 in the first trade versus .40 on the second trade. If they are that bullish, why wouldn’t they trade the 10 Call? Is it a matter of “ok I can buy about 3X’s as many of these at 1.45” so they are thinking that the net at the end of the trade would be about the same?
    Thanks,
    Don

  7. Mark Wolfinger 06/16/2010 at 12:57 PM #

    Ted,
    Nice trade. Congratulations.
    1) No, I do not so advocate. That would require you to pay a large time premium to repurchase the call.
    But, if you are happy with the profit, by all means take that profit. Perhaps the option price is not so high and you may be pleased to get out now.
    2) Yes, an increase in the stock price adds to profits. But, a decline erodes those profits.
    3) I’m not a guru in that I never make market predictions.
    Here is a good alternative for you. You are short a call with a strike of X, and that call was 15% OTM when sold. You can make two trades. This locks in a good profit and allows you to go for more.
    Make both of these trades or neither.
    a) Sell stock
    b) Replace stock with a call that has a strike lower than X. In other words, you will own a call spread. Because X is already in the money, you want to buy the strike that is only $5 lower.
    Be certain you have profit potential. It would be foolish to pay $10 when you can buy the option you are short for $5.50. That would only allow you to make an additional $0.50. Better to exit if there is not enough premium to make this profitable.
    If you require clarification, please ask.
    Thanks for the comment/question

  8. Mark Wolfinger 06/16/2010 at 1:07 PM #

    Don,
    Do you have any idea when my post was made? It’s not so easy to find these links.
    I never prefer to buy such OTM calls. But the reason for dong so is
    a) much less cash required
    b) leverage allows for earning many times the original investment
    c) Hope springs eternal
    Your major problem is thinking in terms of BREAK-EVEN. I wish option traders were forbidden to ever think of that phrase.
    Your assumption is that the options will be held to expiration. When you buy an option, in my opinion, the plan should be to sell as quickly as possible. You buy the option and only two things can happen. Either you get the move you expected, or you decide that you are not going to get that move and that (heaven forbid) you were wrong in your decision to make this trade. When either of those things happen, SELL the option. It is no longer needed.
    You make another bad assumption. For you, the goal (apparently) is ‘to be profitable.’ Then buying ITM options is best. But if the goal is to lose as little as possible, then OTM is better. If the goal is to make a killing when the stock moves to $20, then OTM is better.
    No Don, they do not think the net at the end will be about the same. If they thought that way, they would not buy OTM calls. They are either spending less cash or they are seeking larger rewards. They have a low probability of reaping the reward, but it does happen and people do buy lottery tickets.
    Your mindset is yours and yours alone. Other traders think differently and invest accordingly.
    I don’t advocate buying OTM options to make money. But I do recommend them as insurance. That’s why I sell credit spreads, rather than naked options.
    Regards

  9. Ted 06/16/2010 at 2:40 PM #

    Thnx Mark.
    So real world example. Bought 1000 shares of LVS at $21 and some change, sold July call at $25. Current price is $26.60. 25 call at 2.70, strike below of 24 at $3.40.
    So basically your saying to sell the stock and use proceeds to purchase 10 ITM calls at 24 and hold as spread which could potentially help lock in a little extra profit from the stock?
    Right?

  10. Mark Wolfinger 06/16/2010 at 2:53 PM #

    Ted,
    I did not know there were one-point strikes.
    No I would not buy that call. Your maximum extra gain is only thirty cents. When you add in the extra commissions, it’s not not worth it.
    I have not looked at the option prices, but I suspect this idea is not going to work with this stock.
    If the Jul 25 calls really is ‘only’ $2.70, I’d be inclined to exit the position and take the profit. My suggestion is for stocks with more premium – in other words, with more potential profit remaining.
    Here’s why. Your potential gain from holding is only another $1.100 because that is how much time premium remains in the Jul 25 call.
    If you want to go after part of that $1.10, the Jul 23 call may be reasonable.
    Whichever you choose – nice trade.