Michael Martin, trader and blogger over at MartinKronicle.com has a new book out from FT Press, The Inner Voice of Trading: Eliminate the Noise, and Profit from the Strategies That Are Right For You.* The book focuses on coming to terms with the emotions that surround trading. Martin notes, correctly, that “..the act of trading is 20% intellectual and 80% psychological.” It is therefore important that traders come to trade a system that matches their personality. Martin writes: “Incompatibility between trader and system is the single greatest reason most traders don’t succeed, regardless of trading style.” The bottom line is that traders need to be comfortable with themselves and the systems they trade in order to find success. We hope you enjoy this exclusive excerpt.
*We received a preview copy of the book from the publisher.
The following excerpt is printed with permission from The Inner Voice of Trading: Eliminate the Noise, and Profit from the Strategies That Are Right for You by Michael Martin, 2011.
Like many traders, I became very interested in trading professionally after I read Jack D. Schwager’s book Market Wizards, a collection of interviews that he’d conducted with many successful traders and money managers at the time, such as Jim Rogers, Paul Tudor Jones, and Michael Marcus.
Luckily for me, I was able to get to know and study with many of the traders interviewed. A few of them, such as Ed Seykota, became mentors and friends who had a profound impact on my psychological outlook while trading.
A lot of traders love the Seykota chapter in Market Wizards and can quote what might be his most famous line: “Win or lose, everyone gets what they want from the market.” To this day, that line hits failing and mediocre traders right in their most vulnerable spot: If a trader is losing consistently, it is by design—it is the trader’s goal. For Seykota and his students, intentions equal results.
However, I think that the most revealing thought in the chapter was another of Seykota’s quotes: “The goal for the trader is to develop a system with which he is compatible”— that is, a harmony between a trader’s emotional constitution and trading technique. In this case, a system is a set of rules for trading: what to buy, how much of it to own, when to get in, and when to get out, either to take a loss or to collect profits. These rules are intellectual in nature—at least, that’s how they look from the outside.
Lurking below the surface are the emotional buttons they push when the trader employs them. The intellectual aspect of trading rules is what most aspiring traders reach for while learning the craft because they’ve had that approach ingrained in them since kindergarten.
Unfortunately, most aspiring traders find out far too late that the act of trading is 20% intellectual and 80% psychological. I hope to change that with my book.
When Seykota was being interviewed, he was not speaking about rules “that [the trader] can understand intellectually or technically”—he wasn’t offering a “how to trade” proposition. He instead referred to rules “with which [the trader] is compatible,” an emotional and self-awareness proposition. Compatibility equals harmony.
Incompatibility between trader and system is the single greatest reason most traders don’t succeed, regardless of trading style. They have no emotional connection to their trading rules and methodology. They know trading rules from a technical and intellectual standpoint, but not from a psychological or self-awareness one.
Not all of this is their fault, though: Our educational system generally is not concerned with how its students feel about anything—there’s no room for it. This rote, mechanical model sets up the trader for failure before he knows that he wants to be a trader.
Admittedly, it can be challenging to know who to turn to for this type of awakening. In unfortunate cases, the trader is not self-aware but continues to seek the answers. Ironically, these answers to successful trading are found within the trader’s own mind.
Trading rules are provocative and evocative, pushing and pulling a trader emotionally. “Should I get in at this price?” “Should I buy some of this stock?” “Should I get out here and take a loss, or should I wait for it to come back?” For me, these are not intellectual questions—they are emotional. What the trader is feeling at the time evokes the question. Think about what the trader is conveying emotionally, because it’s rarely about the money.
Question: “Should I get in at this price? Is now a good time to buy?”
Emotional translation: “I have no idea what I’m doing, but I’m going to do it anyway.”
Question: “Should I buy some of this stock?”
Emotional translation: “I want in on the action. Just tell me what to do, and I’ll do it— but make it quick. Having so much cash is painful.”
According to Jason Zweig, WSJ columnist and author of “Your Money & Your Brain,” having the potential for gains is more addictive than earning the gains themselves.
Question: “Should I take the loss now, or wait for it to come back?”
Emotional translation: “What will everyone think? I have an MBA, and all my self-esteem is invested in how smart I think I am. I am not willing to risk this. This is who I am. If I wait, I’m technically not wrong. I can defer my incorrectness and maintain my self-esteem today.”
Traders are human beings first, so it follows that everything we do is part of our overall tendency to seek pleasure and avoid pain. Both are omnipresent for traders and investors alike. In each of these hypothetical questions, clearly more is being conveyed than the “how to” part of trading. Frankly, the “how to” is the easy part. When the self-awareness part betrays the “how to” part because traders don’t have the skill to feel emotions and understand what they are saying, only trouble can come from it. If you get into this situation, along with all the colorful emotional knots you’ll feel in your body, you’ll have a black-and-white version in your profit and loss statement.
A trader doesn’t need another person to ask these questions, nor to answer them. For traders who lack harmony between technique and self-awareness, the voice they hear comes from the most antagonistic person in their life: “You should have become a doctor! I told you that this trading nonsense is legalized gambling.”
However, once they achieve a harmony between technical rules and self-awareness, they discover an inner calm and a sense of confidence. When this occurs, they hold conversations with what I call their inner voice. This is the one voice that the “market wizards” developed and learned to listen to exclusively.
The heart and soul of The Inner Voice of Trading examines trading decisions from an emotional standpoint and helps you gain insight into your behavior. In the process, you will evolve from listening to the cacophony of conformist and conventional wisdom, to speaking with and listening to your inner voice. The journey involves getting to know yourself and increasing your level of self-awareness. How much you learn about yourself is limited only by which feelings you are not willing to feel.
Some traders look for stocks and trading ideas to hotwire their portfolios because they see trading as a process of singling out tomorrow’s headlines before they make the news.
A magazine could publish just one issue per year with the headline “Keep Your Losses to a Minimum of –10% of Your Net Capital.” They would go a great distance in defeating financial illiteracy, but financial literacy is not their business. They’re in the business of selling magazines and keeping ad rates high.
When you develop your inner voice, you can see things more clearly and laugh like I do when I see headlines such as “CMGI Is the Berkshire Hathaway of the Internet” or “10 Stocks the Pros Are Buying Now.” With or without funny magazine covers, trading is a process that focuses on keeping losses small. Focus on that process, not the outcome.
If you want to get a head start on developing your inner voice, start writing down in a journal all the feelings that surface for you when reading this book or in your trading. You need to keep a journal because you have to be hyper vigilant about your behavior. How do you feel you are challenged intellectually? How do you feel when someone (like me) challenges something that you’ve held close for ages? You will learn about yourself with this exercise, and it will benefit your trading.
Timothy Ferriss, author of The 4-Hour Body, has kept a journal of every workout he’s done since the age of 18. He’s in his thirties now. What you measure, you can improve. You can use a computer for a lot of trading, but you cannot delegate all your behavior to a computer. You need insight about yourself to develop your inner voice. If you haven’t begun to trade yet, that’s even better. Self-knowledge and self-awareness are your most important assets as a trader, more than any technical ability. You’ll have an enormous edge on the competition if you focus on developing your self-awareness and then your inner voice.
Little trader in your head: “But Michael, I’m dying to start trading right now. I don’t have any time for keeping a journal—I’m going to miss out on all these great trades. Plus, I want to be able to call myself a trader.”
No one cares if you become a trader. Become a trader for yourself, not to seek attention from other people. You’ve heard about the moth and the flame, right? Settle down and go read Outliers, by Malcolm Gladwell.
If you’re just beginning your career, you’re just starting to log the first of the 10,000 hours that Gladwell says you’ll need to become an expert, so you’re in no hurry. You can write in your journal, “What are my feelings when I have to be patient?”
Teach me what it feels like to be you when you have to be patient. Get to know these feelings, because they are likely to resurface in other areas of your life. One of the most important things I learned from Seykota is that the feelings you don’t want have as much power over you in your trading as the ones you do want. The feelings you’re avoiding might be dying to become your allies.
You will go to great lengths to avoid certain feelings as much as you will want to “go toward the light” to feel the ones you think you want. Make sure that light is not a bug zapper.
If you become a professional trader, you will work hard for the rest of your life. What have you had to work hard for? How have you developed character? For traders, the most important work each day is preparation for the next day. This occurs somewhere between 5 PM and 10 PM each night.
How do you feel about missing the Sunday night football game of the week, 60 Minutes, and Monday Night Football? You can always come back to your Fantasy Football league in a few years. Has missing Dancing with the Stars gotten you down? Explain to me that feeling.
That feeling is in the way of you working toward your goal of becoming a trader. Write those feelings in your journal, because they are part of your emotional system and they will absolutely play out in how you trade, and how you manage risk.
Top professional traders do not seek validation from their trades. They don’t need advice from others, and they enjoy a personal discipline that very few have.
They marry their technical knowledge with their feelings, and the resulting inner voice is their greatest asset and ally. The Inner Voice of Trading attempts to shed light on how successful traders have come to this insight and what they had to do to obtain it.