An entire industry has grown around traders’ struggles with behavioral biases and emotional stress under the umbrella of trading psychology. Being aware of one’s own shortcomings is definitely important for many situations in life beyond such shallow objectives like performance on the job or making money trading.
You can read this summary of cognitive errors and behavioral biases by the CFA Institute for more information. If you want to know everything about the neurobiology of stress, I strongly recommend this article by Rongjun Yu, which includes a fantastic summary of findings from dozens of papers on the effects of acute and chronic stress on decision making. It’s academic in nature but definitely worth the read before googling the nearest trading shrink.
But since this site is build for feeding traders’ intuition by understanding the other players and rules of the game first, let’s focus on what we can do fix our decision-making troubles without throwing intuition out with the bath water.
For starters, one of the most effective ways to take emotions out of trading is to automate certain decision-making processes.
How much automation do I need?
We can differentiate the trader types by the degree of their level of automation. They fall into one of the following three categories:
Discretionary traders rely on their intuition to make trading decisions. There’s much debate on how long it takes to bring trader intuition to a level where heuristics and subconscious automatisms actually work in the trader’s favor. The range is from watching a few hours of broker webinars to 10,000 hours of screen-time in a prop-nanny environment. But this article is about automating external trading processes, so let’s leave my opinion on this debate for another blog post.
Hybrid traders use an automated process for either signal generation or trade management.
One example for idea generation could be entering a position based on a technical indicator, volume data, or other price-related information. Then the trader would manually handle the exit with a mental stop or take profit based on observing order flow, for example.
On the other hand, the trader could enter a trade manually based on intuition and have an algorithm manage the exit. The simplest form of such an exit algorithm would be the common OCO order type which simultaneously places a profit-taking limit order and a stop-loss order. This is a set-it-and-forget-it approach where, as the name implies, once one of the orders is filled the other one is canceled.
It’s up to the trader to decide on which side of the equation he or she can add value to the trading process:
- If you have trouble pulling the trigger and often miss out on trade entries, then automating the first part would make sense. Opportunities can be fleeting so a speedy algorithm could assist you here. Furthermore, you can easily filter out false positives given the current market context.
- If you have a hard time adhering to stops and/or take profits too early, then automating position management could improve your trading results and lower your stress levels at the same time. Your neighbor, spouse, kids, dog, friends and P/L will thank you for that. Your favorite bartender may see you less often drowning your sorrows though.
The Sierra Chart Spreadsheet Trading feature (see Image 1) makes it easy to calculate values from chart data using Excel-style formulas and then use the values from these cells to create buy or sell signals. No programming skills needed.
Fully Automated Traders
Full automation means taking a full-robot approach for both trade entry and exit.
The obvious benefits include consistency and measurability. We are are removing the fickle human factor after all. It’s also easier to trade multiple markets simultaneously this way and better on your eyes than watching every tick of oil price formation.
Drawbacks include that fully automated trading systems are rather inflexible and often perform poorly in changing market environments. In essence they need to be constantly monitored and turned on and off by a human to avoid massive drawdowns. So much for the combo of full automation and sipping piña coladas on the beach all day.
Automated trading definitely helps overcoming stress-induced decision biases. It comes at a cost of leaving human creativity and intuition out of the decision-making process. A hybrid approach may be the best choice for balancing the pros and cons of trade automation.
There are many trading platforms out there offering features for automated trading without programming skills. Using the spreadsheet trading study in Sierra Chart, it is even enough to know basic Excel functions for building a customized trading algorithm to facilitate the human trader. Check out the video above to see how easy it is to build automated strategies in Sierra Chart.
Remember that it may take longer to become a zen master of trading than you can stay solvent (or sane). So until you reach the perfect state of emotional neutrality and equanimity, you should consider automating your biggest weaknesses along with building a solid foundation. Feed your trader intuition with an objective understanding of market microstructure so that it isn’t in conflict with your observations all the time.