Honing Your Trading Process - Part Two

The first post in this two-part series took a look at process orientation and why it is important to trading.  By breaking trading into component elements and identifying effective routines for each, traders can remain grounded in best practices that impart a profitable edge.  That mapping of process elements to outcomes is crucial:  devotion to process in the absence of a demonstrated edge can only make randomness routine.  Effective process components are evidence-based.  But how do successful traders develop those components? 

An interesting commonality among the Market Wizards interviewed by Jack Schwager is that they have generally held strong beliefs about how markets behave and what is necessary for trading success.  Their theories are different, but they serve a similar function:  orienting traders or investors to unique opportunity.  Indeed, market theories are the Wizard's attempts to explain how asymmetric opportunities exist within otherwise efficient financial markets.

A good example of an orienting theory are the Principles outlined by Ray Dalio.  As Dalio explains, "...those principles that are most valuable to each of us come from our own encounters with reality and our reflections on those encounters--not from being taught and simply accepting someone else's principles."  

An important implication of Dalio's insight is that principles spring from experience; they do not precede experience.  We discover truth, rather than simply receive it.

This means that elaborating your processes and strengthening them requires observation and testing:  seeing what works and what doesn't; seeking explanations for why something works or doesn't; revising approaches based on observation and testing; etc.

Core principles spring from basic ways that we approach the world.  As a brief therapist, my solution-focused work emerged from a perspective of contextualism:  what we observe is a function of context, not necessarily an intrinsic and enduring state of affairs.  A person can be depressed in one set of life circumstances and happy and fulfilled in another.  Contextualism means that I will not expect the same patterns to show up at work, home, and parties, but may observe regularities within each of those social settings.

In markets, one expression of contextualism is the identification of "regimes":  stable, but transient market periods that often follow identifiable "rules".  Just as I sought to understand the emotional and behavioral patterns of clients as a function of their life context, I naturally understand market behavior as a function of drivers that operate in a given regime.

But what are these "drivers" and how can we objectively determine whether they are uniquely correlated with future price movement?  A great deal of defining and redefining drivers, testing and retesting them, occurs before they can become legitimate elements of process.  Those drivers are discovered, not simply lifted from books or the pronouncements of gurus.  Such discovery starts with the observation of regularities that exist within identified regimes.

Once you have anchored yourself in theory and used your principles to guide discovery, those market understandings become truly your own.  It is much easier to sustain conviction in your trading if your trading is grounded in what you have directly experienced. 

When process begins with first principles, theory becomes quite practical, guiding our encounters with reality.  In an important sense, how we trade is an expression of who we are. 

Further Reading:  Toward a Cognitive Theory of Trader Performance
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