The Danger Zone

Hey guys. As you're probably aware by now,  I have a strong affinity to the psychological side of trading and I think it's far more important than anything else. Far more. I've hit most areas of trader psychology in the archived posts on this blog, but there's one in particular I want to go over today, one that I've come to realize is more important than them all.

I'm going to refer to it as "The Danger Zone." There are multiple levels to this puzzle on both a macro and micro scale in terms of intraday & bigger picture time frames, which I'll map out for you in a minute and then talk about why they're so important.

The Danger Zone is a foe you're going to meet time and time again on a daily basis, so get familiar with it. It's the critical point in any particular trade (micro), or period of time in your trading (macro), where a build up of emotions and stress are going to tempt you to give in to irrational or unjustified action in an effort to alleviate the frustration. Traders are typically and notoriously impulsive individuals, so when faced with a tough decision when our minds are in the danger zone, we usually make the wrong move. Where we say "Oh just a few more ticks, maybe it'll reverse. Just a few more minutes. Just one more add. Omg it has to pull back. Wtf. Omg it just washed, there has to be a bounce coming." We've all been there more times than we care to count.

I have a favorite saying that I use often and I think remains the most absolute truth in all of trading:

"99% of trading success is just learning how to stay out of trouble."

What that saying basically boils down to is that you need to become intimately familiar with the Danger Zone and a master at controlling it. Today I want to talk about a few specific examples of identifying what the danger zone is and why we fall prey to it so often. Here's a live look at the sequence of events that unfolds when we get put in a tight spot during a trade:

We go completely brain dead. We blackout in terms of ability to think rationally & logically, and we turn into pathetic piles of piggy primordial soup. You know the feeling. I touch on one example in a past blog here by saying this. 

We'll call this "Well I'm already fucked, whats a little more fuckery at this point, maybe I'll get a miracle bailout and it'll work" mode. This HAS to stop. This is an extreme delusion of reality and one of the most dangerous possible thoughts you could ever have. If you find yourself in this mode, you absolutely have to act. I don't care how painful or how difficult it is, you have to stop the trade. It's not an option. Live. To fight. Another. Day.

Trading is all about making the difficult decisions, right? We trade volatility, and there are some known characteristics of trading volatile names. For the most part, the best time to short a volatile stock is when it's going absolutely nuts and nobody wants to touch it with a 10 foot pole out of fear. Likewise - the best time to buy a stock is when it's getting absolutely destroyed and nobody wants to touch it with a 10 foot pole. Well it's the same concept on the emotional side. If you get caught on a trade and are sitting there squirming in your chair thinking "holy shit this is awful, I can't stop out right now that'd be terrible" - that's the time you MUST stop out. Have to. Take your 10 foot pole out, hit yourself over the head with it to knock the stupid out of you, and do the right thing. If you can train yourself to make the tough calls, you're going to like the ensuing results in your trading progress that follows. Capital preservation is paramount to all else in the game of trading. Get on board with that, or you won't be around much longer. One of my good friends and trading partners said it best: 

"Stopping out where I think I should, and being wrong, is a lot easier to live with than not stopping where I think I should, and being right. "

It's really all that matters, so that's what I'm trying to say here. When you are getting that awful feeling of knowing you're in the danger zone, and you would rather do anything in the world than stop out & eat a loss - stop out and eat the fucking loss.  Once you're seasoned and are trading with "expendable capital" we'll call it - (as in if you blow a trade up it's not the end of the world, you have more) - then there's other options of strategically fighting and swimming upstream in certain situations, but that's likely not you yet. If you're building, you have to follow the rules without deviation. Have to. Get with that, or go find something else to do, trading isn't for you. 

That pretty much covers the micro side of the idea, but there is a marco version of the Danger Zone as well. There will be periods along your journey, perhaps lasting a couple weeks or months even, where you just aren't going to make money. Which is fine, it's not the first time it's going to happen and it won't be the last either, you can't really control how much you make. There is one thing however you can control, and that's how much you lose. Because that's really what trading is right - its a repetitious sequence of decision making based on past experiences, probability and pattern recognition - trying to put yourself in a high probability situation to succeed in the trade.

You can't control how much you make, and you can't force the market to pay you. You can however, force the market to stop taking your money - by stopping out. The most crucial aspect of the "slow" periods in your journey and when you're in the danger zone, is that you're effectively controlling the draw downs.  Everyone goes through these periods, trading is an extremely streaky game.

The Danger Zone aspect enters the scenario here by way of frustration. We get impatient and annoyed that we're not making money, so we start to go hunting even harder for ideas. If our ideal setup isn't there or isn't currently working, we go try to find something else. Something we're less familiar with, and it usually ends up getting us in trouble, right. We lower our standards in trade ideas, we settle for sub par entries simply for the sake of being involved thinking "maybe this will be the one to get the ball rolling again." Although this may feel proactive and like you are taking action to get out of your slump, you are actually, ironically enough, doing the exact opposite. 

There are a slew of other issues that come in this macro Danger Zone too. We start to doubt ourselves. We look at trades and say "well I can't do anything right, maybe I should do the opposite of what I think", then you go even further and say well maybe I should do the opposite of the opposite of what I think?? You laugh, but you'd be surprised just how bad people twist themselves into knots like that and have conversations with the trading devil in their head, it happens more than you think. I've had some pretty wild discussions with struggling traders and you wouldn't believe some of the stuff that comes out of their mouths. So all of these negative thoughts culminate into exacerbating the Danger Zone effect - and here-in lies the problem every trader runs into. Once the self doubt creeps in and losses begin to mount, it becomes a very slippery slope. We work extremely hard and take the stairs up, and then bam before we even know what happened, we've taken the elevator back down to Square 1. 

So. What do you do about it?

Unfortunately, there is no easy fix here. However, if you are struggling, I can almost guarantee this is why. You are trying to force things to happen, when that is just not a viable option in this game. So after a loss, or when you're feeling frustrated, you need to be able to internalize that and stay strong, saying "Ok. I've hit a roadblock here. Let's take a step back and look under the hood." Focus on why it happened, not how you're going to find a trade to fix it. You can't sweep the root cause under the rug, or it's just going to happen over and over again.

Write down what went wrong, and start a "Can't Do" list. A list of things you can't do if you want to be successful. Everybody wants to know what to do, but by compiling a list of things you can't do, you're actually creating the list you want, checking off one bad habit at a time. Trading is a process of trial and error experimentation and elimination of flaws along the way. No two people go about this in the same way, so if anyone tells you they have all the answers to your problems, I can assure you they do not. Only you do. This isn't a team game, it's a you vs. yourself game, and you'll only succeed if you learn how to beat yourself - the flawed you.

That needs to be Priority #1. Getting angry and showing up again the next day, doing no due diligence on the problem, hoping "today's the day" you hit that big trade to fix all the damage you've done - that needs to go completely out the window.

Alright. I'm not going to rant about this, I think you get the point - the take home message is this. If things aren't going the way you want them to - you have to think outside the box. Trading more will not fix your trading problems. It's likely a you problem, and you have to start there. So if you don't do anything else this weekend, do some self reflection and work on yourself, not more charts. Both are important, but you are far more important. The greatest trading strategies and systems in the world are all completely useless if the operator is flawed.


- D