BRETT N. STEENBARGER, PHD, is Clinical Associate Professor of Psychiatry and Behavioral Sciences at SUNY Upstate Medical University in Syracuse, New York, and an active trader of the equity index markets. He has published over fifty peer-reviewed journal articles and book chapters on topics related to brief therapy, and is the author of The Psychology of Trading, also published by Wiley. As Director of Trader Development for Kingstree Trading, LLC, in Chicago, Dr. Steenbarger has mentored numerous professional traders and coordinated the training of new traders.

Enhancing Trader Performance

Proven Strategies From the Cutting Edge of Trading PsychologyBy Brett N. Steenbarger

John Wiley & Sons

Copyright © 2006 Brett N. Steenbarger
All right reserved.
ISBN: 978-0-470-03866-6

Chapter One

Where Expertise Begins

The Performance Niche

I’m a big believer in starting with high standards and raising them. We make progress only when we push ourselves to the highest level. -Dan Gable

He was cut from his team in his sophomore year of high school. Any hopes of obtaining a college scholarship were quickly receding. Most aspiring athletes would take their lumps, join a local league or intramural squad, and move on with their lives. Michael Jordan, however, was not like most young athletes. He responded to the cut by practicing day after day. When he felt too tired to continue, he forced himself to recall his cut from the team and drove himself harder. Two years later, he was a McDonald’s All-American and the MVP of the McDonald’s game. The year after that, he hit the game-winning shot for the University of North Carolina in the NCAA finals. By the time his NBA career ended, Jordan had made an astonishing 25 game-winning shots, perhaps none as memorable as the jumper he nailed against Utah on June 14, 1998. With 5.2 seconds left and no one in the house doubting who would take the last shot, he sealed his sixth championship for the Chicago Bulls.

Michael Jordan was an elite performer, one of many we will encounter in this book. Yet Michael Jordan was not always Michael Jordan. His rise from high school reject to college star was dramatic, but not stellar. He never averaged more than 20 points per game during his college career and was selected third in 1984’s NBA draft. All signs pointed to stardom, but not superstardom. Nonetheless, Michael Jordan-along with a small handful of other athletes-stands today as a towering symbol of expert performance.

What makes expert performers tick? How are they different from average performers? Is expertise the result of natural, inborn talent, or can it be cultivated? And, most important of all, what can we learn about trading expertise by studying expert performance in other fields? In this book, we will find common factors that contribute to the success of chess experts, Olympic athletes, world-class performing artists, and successful traders. One of those factors is finding a performance niche: a specific activity that is most likely to capitalize on your talents and interests. Michael Jordan had a niche in basketball; he did not find one in baseball. Dan Gable started his athletic career as an undistinguished swimmer, later to discover his own world-class talent as a wrestler-and then as a wrestling coach. Discovering your trading niche may well make the difference between a hall-of-fame trading career and a disappointing one that never quite makes prime time. Sadly, most traders stumble into their markets and trading styles, never to discover where their opportunities might truly lie.

A TALE OF TWO TRADERS

Al and Mick were two short-term traders at a professional trading firm. Both traded the electronic Standard & Poor’s (S&P) 500 (ES) E-mini futures contract, and both gave me carte blanche to stand by their screens during market hours so that I could help them with their trading.

I began the day watching Al. The market was trading in a narrow range early in the morning after an attempted rally fizzled. The average price from the day before was about three points below the market’s current level, and I had a strong sense (based on my historical studies) that we would take out that average price. Al, Mick, and a handful of other traders had met with me before the trade, and we discussed using the likelihood of the market hitting that level as a potential trade idea. Nevertheless, Al was leaning to the long side. I was skeptical, but decided not to press the point.

As the market ground lower and Al’s position went into the red, he shook his head in recognition of his error. Very soon afterward, however, he stopped himself out of the position and flipped to the short side. He was able to pick up a few ticks before the market reversed on him once again. The choppy action continued through the morning, with a mild downward drift. Al was patient, but not making much money for the day. He took a break at lunchtime and expressed to me his hope that the afternoon trade would pick up. Throughout the morning he maintained his composure and held his own in a difficult trade. He expressed optimism that taking a lunch break and clearing his head would help him focus through the afternoon and take advantage of opportunity. Never once did he lose his composure or his positive attitude.

When I moved over to Mick, however, it was a very different story. Mick also tried to play the market’s upside and found his position underwater. Enraged, he held onto the position past his stop point, only to see his losses expand. My cautionary comment to Mick was “If your morning losses are small enough, you’ll have a fighting shot to make them up in the afternoon.” He eventually did exit the position, but refused to take a break at midday. He reviewed every piece of market data from the morning, replaying his bad decisions. All the while he shifted in his chair, pounded the table, raised his voice, and otherwise expressed his frustration. He became particularly agitated when he reviewed the morning trade on his videorecorder. “I can’t believe I was so stupid,” he fumed. He then proceeded to tell me five things he should have seen in the market to tell him we were going lower. Come hell or high water, he practically shouted, he was going to focus on those five things in the afternoon.

Al and Mick: two very different traders. One of them made a high five-figure sum during the afternoon; the other one struggled to break even all day.

One was an expert trader, the other was struggling.

Al kept himself emotionally balanced, taking liberal time away from the screen after setbacks. He honored his stops religiously and didn’t become irate at losses. He consistently expressed optimism over his development and a love of trading.

Mick was anything but balanced, taking losses almost as personal affronts. He periodically violated his risk management guidelines and could not break from the markets until he had rehashed all his mistakes and fumed over each. At such times, he spoke of the market and himself with equal derision.

Most of the trading psychology books you’d read would give the trading edge to Al, the more disciplined, less emotional performer. But Al, the novice, never did succeed at trading. Mick was-and remains-a multimillion-dollar performer. The experience of working with many Micks and Als-and seeing common wisdom about trading success shot down time and again-convinced me to write this book.

THE CORNERSTONE OF EXPERTISE

No doubt, there’s a bit of the young Michael Jordan in Mick. He doesn’t accept defeat lightly, and he uses losses to drive himself forward. That is characteristic of elite performers, we shall learn, but there’s something even more basic that distinguished Mick from Al. In fact, it’s so basic that K. Anders Ericsson, perhaps the most prolific researcher in the field of performance, considers it the cornerstone of expertise.

Think of the difference between Al and Mick as something that occurs every day, for approximately 250 trading days a year. Both Al and Mick trade frequently enough that they have winning and losing trades each day. Al puts his losses behind him and clears his head, to focus on the upcoming trade. Mick fusses and fumes, but uses the losses to review his trading, figure out the market (and his mistakes), and get his money back.

Over the course of a year, Mick’s reviews ensure that he has easily experienced twice as much market action as Al. Moreover, Mick has systematically reviewed his performance and made constant adjustments. Al, though more relaxed, has little basis for detecting and correcting his errors. Mick, for all his emotionality, has become a learning machine, using losses to improve his trading. Ericsson refers to this as deliberative practice, and it is a hallmark of expert performers. Through guided practice, experts open themselves to feedback and, as a result, become better decision makers.

We often hear the phrase “practice makes perfect,” but performance experts in sports emphasize that it is perfect practice that makes perfect. How practice time is structured makes the difference between a performer with 10 years of experience and one who has a single year of experience repeated 10 times over.

All performers face a chicken-and-egg dilemma: They need confidence and motivation to win, but they need to win to develop such a winning mind-set. This is why rehearsals are so important: They permit repeated experiences of mastery that provide the emotional fuel for formal competition and performance. Mick would not allow himself to take a break until he had reviewed every one of his mistakes and figured out what he had done wrong. Al was much more concerned with keeping a level head. By the time the afternoon began, Al was feeling calm and Mick was feeling confident. Mick had figured things out and knew it. What’s more, he knew that if he just spent enough time in review, he could figure out any market. His emotionality, which so many would consider a trading liability, was the intensity of a competitor. Vince Lombardi once commented that good losers usually lose. So it was with Mick and Al.

Dan Gable was not a good loser. He also knew that practice is the cornerstone of expertise. After a lengthy and exhausting practice, he would order his wrestlers to perform “buddy carries”-hauling other wrestlers up the gymnasium steps. Author Nolan Zavoral tells of Coach Gable’s epic sessions with wrestlers, coaxing them to ride the exercise bike with layers of sweat clothes beneath plastic gear, the sweat pouring from them in buckets once the gear was removed. Every fiber of the wrestlers’ being wanted to get off the bike and get a drink of water, yet they persisted. By the time they reached the tournament, they had faced every physical challenge imaginable. They could dig deep during the exhaustion of a close match in the third period because they had mastered similar physical adversity day after day in practice.

Practice is the cornerstone of expertise because it multiplies experience. It provides us with far more experience than we could ever gain during formal performance or competition. Gable’s wrestlers executed and escaped many more moves than their competitors, thanks to the rigors of practice. Mick reviewed market after market when he was down money; Al did not. Guess who was prepared and confident the next time a similar frustrating market condition presented itself.

One of the expert traders we’ll be meeting in this book is Scott Pulcini, a trader of S&P E-minis at a proprietary firm in Chicago-Kingstree Trading, LLC. I met Scott when I joined Kingstree as director of trader development, and I’ve been honored to be part of his professional development ever since. What initially impressed me about Scott was not the fact that he had made $10 million the year prior to my arrival. It was that he sat in front of the screen until the very close of the market every single day following every order that came and went from the order book. Note that I am not saying he followed every price tick; that went without saying. He tracked every order that traded and every one that did not. Every day. And, as markets changed, he followed that with a review of the day’s trading on videotape.

How many years’ worth of market data has Scott seen in his relatively few years of trading? How many years’ worth of experience is lost by traders during their periods of emotional outbursts, breaks from the screen, and days off?

When I first came to Kingstree, I was impressed with its game room and well-stocked kitchen. I also was struck by who haunted those facilities and who, like Scott, didn’t.

Slowly, it dawned on me: I never saw the really good traders hanging out. They were always in front of their screens. They were Mick, not Al.

LEARNING LOOPS: THE ENGINE OF PERFORMANCE

The first thing we notice about deliberative practice is that it invariably takes place apart from formal competition or performance. Think of the practices of a basketball team or a theater company. The goal of practice is to rehearse skills that will be utilized when the game buzzer sounds or when the curtain rises. Performers receive feedback about their actions during practice, so that they can make appropriate adjustments prior to actual performance events.

In relatively solitary performance activities, such as chess, performers obtain feedback on their own. They record their chess moves and then replay games, observing how different lines of play might have ended. They also spend countless hours studying the games of chess grandmasters. During such study they don’t just read the moves, but actually replay games themselves so that they can anticipate the moves of experts. When the student’s moves differ from those of the expert, the student can follow the expert’s reasoning and see why the move is superior.

Most team performance activities rely on coaches or mentors to structure the development process. Basketball coaches watch the practice sessions of their teams and frequently interrupt the action to work on a player’s movement or to coordinate teamwork. Similarly, a director will listen to actors deliver their lines and intervene when the intonation or action does not capture the playwright’s meaning. Immediacy and accuracy of feedback is essential to the learning process.

The essence of deliberative practice is what I call the learning loop. A learning loop is an attempted performance, followed by specific feedback about the success/failure of the performance, followed by renewed efforts that incorporate the feedback (see Exhibit 1.1). Mick created a learning loop when he used his losing trades to review his trading, identify where he went wrong, and then make adjustments upon his return to the screen. Chess champions enter a learning loop each time they make errors during a practice game and force themselves to replay the game with other lines of attack. During team practices, basketball, football, wrestling, and swimming coaches initiate learning loops for their athletes. In no small measure, basic training in the military is a series of learning loops fueled by feedback from drill instructors.

Wendy Whelan is a prima ballerina for the New York City Ballet, considered by many to be the best in the United States. As described by Chip Brown in an intriguing article for the New York Times Magazine, Whelan describes the process that brought her from being a dance student with scoliosis to being among the world’s elite: “I used to watch tapes if I wasn’t sure of the image I was giving off, or if I needed to learn steps. When I dance, I can’t see what I’m doing, I can only feel it….” This is similar to active trading: When we’re immersed in markets, we can’t see what we’re doing. We feel market action, but we can’t see ourselves. The prima ballerinas of the world take conscious steps to stand outside themselves and watch their performances, correct mistakes, and jump-start a learning process. Think of Nolan Ryan watching tapes of batters, figuring out who will hit the high fastball and who will sit on a curve. Consider serious weight lifters and ask yourself why they always train in rooms with mirrored walls.

All of this seems straightforward. We observe learning loops in classrooms, recital halls, and gymnasiums. Wherever we encounter expertise, we find evidence of learning through deliberative practice.

Then why is such practice so rarely found among traders?

(Continues…)

Excerpted from Enhancing Trader Performanceby Brett N. Steenbarger Copyright © 2006 by Brett N. Steenbarger. Excerpted by permission.
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