Trading journals as trader therapy
A healthy mindset provides the backbone of successful trading. It is easy to identify harmful psychological influences; it is harder to offer a set of objective solutions. How do we reduce the negative influences on a trader's mindset and learn to control emotions?
Conquering psychological issues always requires a degree of self reflection and self criticism. A trader must be able to identify their weaknesses in order to seek solutions.
This lesson will explore some of the already existing solutions, as well as drawing on some of the ideas of esteemed trading psychology author Brett Steenbarger.
Benefits of a trading journal – observe, explain, test and revise
A trading journal is a place to document all trading and market-related activity, including the thought-processes behind each trade. It embodies a scientific approach of "observe, explain, test and revise."
It is the evidence of trading activity that guards against recency bias and warped expectations. The facts and figures in a trading journal cannot be disputed and a trader can look over the recordings without any emotional influences. If a trader becomes disillusioned by a profitable strategy during a drawdown period, consultation of a trading journal and observation of a positive equity curve will help a trader regain confidence.
However, a great trading journal will go one step further to include self-analysis and market observation – what were you considering at the time and what were your thoughts?
A trading journal should incorporate a balance of self-criticism and positive reflection. This means you should highlight the best trades along with unsuccessful ones. This helps to you to see what you did right and what, if anything you can improve.
Perception of great trades
It is easy to forget that unsuccessful trades can be the result of excellent entries, as long as they adhered to the rules of a strategy. It is also easy to forget that winning trades can be the result of sloppy entries that have broken the rules of the system.
A trading journal keeps track of this trading activity and will enable a trader to re-trace their steps to discover if they are really trading within the rules of their strategy or whether their positive trades are the result of luck.
A journal should also highlight concrete steps for self-improvement. A trader should avoid ambiguous solutions such as “hold on to winners longer,” but rather specify the precise setting of profit targets.
Most importantly, a trading journal should contain a list of performance metrics, a set of recorded statistics that will help a trader analyse his trading overall. For example, the number of long and short trades, the number of winning and losing trades, the breakdown of profit and loss, and the risk to reward ratio for each trade.
Different recording techniques
It is worth noting that a trader is not limited to the use of a trading journal. Thought processes do not have to be written – in fact Steenbarger suggests more authentic techniques, such as the use of a voice recorder. By recording the thought processes of a trade out loud and playing them back at a later stage, a trader avoids any bias that can occur when putting them on paper.
A journal can be used for stress inoculation therapy
Performance metrics can provide the basis of ‘stress inoculation therapy,’ which involves the exposure of a person to a previously stressful event, in the hope of preparing them for the next encounter.
By reflecting on losing trades and the emotions associated with it, a trader can be better prepared for a similar scenario in the future.
Imagine that you have recorded a series of trades that include a drawdown period. At the time of making those trades in a live environment, you would have been exposed to emotional stress – even more so if it is your first time experiencing it.
Provided that you have followed the correct procedure in testing to make sure that the strategy is profitable overall, you can trade though the drawdown period. As long as you have recorded all of your trades in a journal, then you can go back a reflect and even relive that period over again.
This means that when you go through a drawdown period again in a live environment, you have experienced what it is like to go through such a phase and trade back to profitability. You have effectively gone some way to training yourself to be less sensitive to the emotional stress of a drawdown period.
So far, you have learned that:
- A healthy mindset in trading is essential for success. A trader must learn to be self critical and identify their own weaknesses.
- The benefits of a trading journal go beyond merely recording data. You should record your thoughts and feelings, as well as documenting the most successful trades and unsuccessful ones.
- A losing trade can still be a great trade, providing that you have stuck to a strategy.
- A trading journal should contain a list of performance metrics in order to measure future performance against.
- A journal can be used for stress inoculation – a technique of re-living stressful periods by going over drawdown periods from a trading journal. That way it is easier to deal with in the future when going through further drawdown periods in a live environment.