A Strategic Framework for Trading Decisions

One of the more common problems I see is that many traders have difficulty pulling the trigger because they don’t have enough confidence in their ability to make decisions. I was reminded of this phenomena last week when I read the excellent post on decision making in trading from Tadas Viskanta on Abnormal Returns, one of my favorite blogs.

Some highlights:

There is no room for perfectionism in trading.  Trading is a decidedly messy enterprise filled with false starts and missteps.  Traders trying to pick off the top and bottom ticks in the market are going to find themselves frustrated on a consistent basis.  Trying to wrestle perfection from a trading regimen is a false promise.

and this nugget for systems traders:

A few quick notes on these points for traders.  The first point [Don’t try to get it right in one big step.  Just get it going.] is especially relevant to systems traders who spend days/weeks/years trying to perfect a methodology before letting it loose on the markets.  The fact of the matter is that there are no perfect systems, and even good systems need to be adjusted over time.  Trading small may be a good way to overcome this initial anxiety.

The entire post is well worth a read.

Tadas is right. Too great an emphasis on perfection in your decision making can cripple you. You will be wrong. So you are much better off accepting that reality instead of fighting it.

The best way to do this is to make trading decisions within the context of an overall strategy for dealing with the uncertainty of the markets. One that will allow you to quickly make decisions that you know may be wrong. With some strategies, you may even know that you will be wrong most of the time.

In my book Mind of the Turtles, I laid out a general framework for one such strategy for managing decisions under conditions of uncertainty. I call the framework the Seven Rules for Managing Risk:

1. Overcome fear – you must master your fear to trade well
2. Remain flexible – don’t paint your self into a corner by overcommitting emotionally
3. Take reasoned risks – bet smart so you can survive a long series of losses
4. Prepare to be wrong – know what you will do before the market says you are wrong
5. Actively seek reality – don’t look for why you are right, look for why you are wrong
6. Respond quickly to change – don’t wait around when the trade is bad
7. Focus on decisions, not outcomes – good decisions often lead to bad outcomes in trading, it’s part of the game

If you follow all of these rules, then you will find it much easier to avoid the perfectionism in your trading that Tadas describes.

When a given trading decision does not paint you into a strategic corner, you can change course more easily. When you have a flexible plan that avoids too much risk, and you closely monitor your results to change course quickly if reality turns out different than you had hoped, you can make your trading decisions with greater conviction. You know you are not trying to predict the future but rather to follow what the markets indicate is happening right now.

Without a plan that accounts for the imperfection and uncertainty of trading, you won’t be able to trade decisively. With a strategic plan, you can trade with confidence.

As you are more successful, and your plan begins to show results, you’ll be able to make more and better decisions in a shorter period of time by tapping the powers of both sides of the brain.   It is this little-understood leverage of intuition and intuitive decision making that will be one focus of my new book, Trading from Your Gut.

Tagged as: Decisions, Perfectionism, Seven Rules, Trading