Here's how great traders develop

Trader Development: Aligning the Head and the Heart

I had the recent pleasure of chairing a panel presentation a couple of days ago at the Futures Industry Association Expo in Chicago on the topic of trader development. My distinguished colleagues, Tom Rice of Goldenberg Hehmeyer & Co. and Doug Hirschhorn of Sperling, LLC, and I drew upon our many combined years of hands-on work with professional traders to identify "best practices" in trader development. If I had to put my finger on an overarching theme of our presentations, it was that the trader development process is one in which traders learn to align their heads and their hearts. First traders know what they should do, but only later does it become part of them and their feel for markets and trading.

Research on the development of expertise indicates that skilled performers first obtain a body of knowledge about their field and only later develop an intuitive feel for its performance. For example, medical students typically spend their first two years studying basic science information, learning about how the body works. Their last two years apply this information at the bedside, as they learn how to integrate this information with data from histories, physicals, and lab tests in generating diagnoses and treatment plans. By the time they graduate from their residency programs, they have had so much contact with configurations of symptoms and diseases in their field that they develop a feel for patients and arrive at correct diagnoses much more rapidly (and often) than they did in medical school.

One way I, as a trader, align head and heart is to supplement my intuitive feel for the market with pattern-based statistical studies that tell me when there is--and isn't--an edge in the market.

For example, on Thursday we saw the S&P 500 make a four-day low early in the trading session and then rally sharply to make (and close at) a multi-day high. I went back to January, 1995 (N = 3994 trading days) and found that such reversals only occurred 19 times in the S&P. My goal was to see what happened within the four days following that reversal. For the sample overall, we had 2206 four-day periods up and 1788 periods down for an average gain of .15%. After the reversals, we had 8 four-day occasions up and 11 down for an average loss of -.46%. Clearly, the reversals, as a group, did not provide a bullish edge. If anything, were more likely to reverse than continue.

Knowing this by itself helps me maintain discipline. Instead of becoming excited about the upside breakout and coloring my market perspective with the most recently occurring event, I can sit back and watch how the market trades. The information acts as a brake to any impulse I might have to jump aboard new highs. If I see continued market strength, I can wait for pullbacks to ride that move. If I don't see that strength, however, I will look for occasions where buyers, whose action is manifested in the NYSE TICK, cannot push the market higher and then fade their optimism.

As my colleagues on the panel illustrated, there are many techniques for helping traders align their heads and hearts. The use of research to guide one's market views is but one of them. The important thing is that traders find for themselves the methods that will further their own development by making what they know what they feel.

Brett N. Steenbarger, Ph.D. is Associate Clinical Professor of Psychiatry and Behavioral Sciences at SUNY Upstate Medical University in Syracuse, NY and author of The Psychology of Trading (Wiley, 2003). As Director of Trader Development for Kingstree Trading, LLC in Chicago, he has mentored numerous professional traders and coordinated a training program for traders. An active trader of the stock indexes, Brett utilizes statistically-based pattern recognition for intraday trading. Brett does not offer commercial services to traders, but maintains an archive of articles and a trading blog at www.brettsteenbarger.com. He is currently writing a book on the topics of trader development and the enhancement of trader performance.