Psychology

The Power of Patterns and Principles

Many years ago, when my wife and I first made a home together with three children by a prior marriage, we encountered a problem. The kids complained that I was taking too much time in the shower in the morning, making them late for school. Upon a moment’s reflection, I recognized that I indeed was the culprit. But why would I do this? Was it selfishness or insensitivity?

The answer came in a flash of memory. My own parents came from troubled childhood backgrounds and bent over backwards to create a close family environment. In fact, at times, it felt too close for me. On those occasions, I craved solitude. So one way I created alone time was to take nice long showers. As much as my parents wanted closeness, they were sane enough to respect bathroom privacy!

So what was going on in my new home? The close family I was developing with my new wife was, at times, evoking the feelings of “too close”. Instinctively, I responded as I did in the past. By repeating my pattern from the past, I unwittingly created a new conflict.

One of Freud’s great contributions to psychiatry and psychology was the recognition of what he called the “repetition compulsion”. On the surface, it may seem as though we have myriad problems and conflicts. Frequently, however, these fall into a pattern: we repeat coping patterns that may have worked in the past, but now have outlived their usefulness. In the past, for example, I may have coped with conflict by avoiding and withdrawing from the situation. Now I experience conflict in financial markets when positions move against me and I avoid and withdraw rather than manage the risk properly. In a strict sense, it is not only our past conflicts that interfere with our present functioning, but our past coping. When we fail to consciously acknowledge and come to terms with the past, we unconsciously fall back upon outmoded ways of dealing with those. Freud recognized that we break these patterns of repetition through mindful, conscious awareness, recognizing the current situation as part of a larger life pattern. To change these patterns, we first need to stand apart from them and become their observers.

In contemporary positive psychology, there is a recognition that we repeat patterns of success as well as ones of conflict. Repetition of problem patterns is triggered by anxiety, which evokes emotionally-encoded past coping. Repetition of our successes is triggered by a very different state, which has been called “flow”. When we immerse ourselves in meaningful and fulfilling experience, we enter a state of hyper-focus. In that “zone”, time can pass without our conscious awareness and we experience heightened joy, creativity, and productivity. What is triggered by the new state is also our coping, but in this case it’s the coping based upon our strengths. For example, I recently watched a trader intently follow a particular stock, deeply immersed in its moment to moment behavior. At one point, he exclaimed that the stock’s behavior was like another stock he had traded over a year ago. He placed a trade on that basis and profited nicely from the position.

In both cases, patterns of behavior based on conflicts and successes, the repetition of our coping is triggered by a shift in our state of consciousness. It was the anxious state that evoked the repetition of my lengthy stays in the bathroom. It was the state of flow that evoked the repetition of a successful action pattern for the trader. Many patterns in our behavior are encoded as part of emotional experience. Evoking those emotions evokes the patterns: sometimes for better, sometimes for worse.

Thinking In Patterns
With the above as a backdrop, we can appreciate that what is known as “trading psychology” boils down to a set of tools and understandings for

a) avoiding thought/feeling/behavior patterns based upon past coping with conflict and
b) enacting patterns associated with our successes.

Much of trading psychology can be described as a means for recognizing anxiety, frustration, and uncertainty in real time; stepping back and recognizing maladaptive behavior patterns associated with past coping; and then making efforts to enter a zone in which we become able to access strengths. Stated in a different way, trading psychology enables us to shift from a focus on market patterns to an awareness of our own problem and solution patterns.

As the above example of the trader illustrates, thinking in patterns is central to money management, whether the patterns are derived quantitatively or qualitatively, whether they are framed in terms of macroeconomic fundamentals or price action, or whether they describe catalyst-driven events or longer-term investor behavior. If every market situation was perceived as entirely unique, we would have no basis for trading or investing capital. Every decision to take risk presumes the perception of a pattern that is associated with opportunity. So, for instance, in the work of Peter Brandt, those patterns are framed in terms of chart configurations. In his book Diary of a Professional Commodity Trader, Brandt makes it clear that charts are not used as crystal balls or predictive tools but rather as ways of framing hypotheses about market behavior that yield favorable reward relative to risk, as in the case of breakouts from areas of congestion. Brian Shannonalso frames ideas with the use of charts, but across multiple time frames and with respect to multiple reference points derived from volume-weighted average price. JC Parets examines patterns of relative strength and weakness across multiple instruments to frame the present in light of the past.

For traders, of course, not all thinking in patterns occurs in the context of technical analysis. Jason Goepfert finds patterns of sentiment in markets that have been associated with directional market movement, as in the recent case where he looked at pessimism in the stock market. Jeff Miller, on the other hand, summarizes a range of economic data, searching for patterns and themes across the economic indicators. Rob Hanna examines patterns of price behavior through quantitative lenses, finding historical relationships that are associated with favorable trading outcomes. Note how all of these are ways of taking large amounts of market information and organizing them in ways that are potentially meaningful.

From the perspective of trading psychology, investors and traders run into two problems. The first is the more clearly recognized one, in which market events trigger our own patterns, leading to poor trading decisions and blinding us to the patterns described by the above researchers. The second problem is a bit more subtle. We might not be triggered into states of flight or fight, but our levels of distraction, boredom, or energy may keep us out of the zone in which we are most able to perceive and act upon these patterns of risk and reward. In other words, the challenge of the trading professional is not just an excess of emotion, but an absence of the flow state. To use an analogy, if the trader is a microscope scouring markets for patterns, problems can occur if the microscope is broken and if it is working normally but is unfocused. This is why many traders have gravitated to the use of meditation in their preparation routines. They recognize that peak performance requires not only the control of negative emotions, but also the enhancement of attention and our capacity to sustain functioning “in the zone”.

From Patterns To Principles
In a remarkable post, Ray Dalio of Bridgewater Associates writes that one of the most important principles for success is thinking in a principled way. He describes principles as lenses through which we perceive the world, explaining, “When one sees things through this principled lens, one sees that most things happen over and over again for basically the same reasons.” For instance, in his work on big debt crises, he shows how large cyclical trends in finance–and their navigation–are a function of decisions made by monetary and fiscal authorities. Notice how the principled thinking described by Dalio is an ability to perceive and act upon patterns of patterns. That is, when something occurs repeatedly (a pattern) and we can identify the reality basis (i.e., the cause-effect) for this recurrence, we see that the pattern is itself patterned and meaningful, not one happening by chance. Principled thinking, Dalio explains, is an effective way of dealing with reality, because it is grounded in why things happen.

From this perspective, optimal trading psychology incorporates a third dimension, besides the ability to avoid problem patterns and maximize mindsets associated with optimal functioning. This third dimension is the ability to translate our patterns of failure and success into concrete principles that guide our actions. In other words, an effective trading psychology enables us to live more principled lives: ones less reactive to the ebb and flow of moment-to-moment, day-to-day events and more able to navigate meaningfully and purposefully. Such an enhanced performance psychology suggests that everything we do, inside and outside of markets, can be an opportunity to cultivate patterns of success and avoid patterns of failure. Life itself thus becomes a kind of spiritual gymnasium, in which we move from station to station–across career, relationship, and personal contexts–to expand our capacity to live intentionally, by principles.

Brett Steenbarger can be contacted on this link: Brett Steenbarger

Brett N. Steenbarger, Ph.D. is Director of Trader Development for Kingstree Trading, LLC in Chicago and Clinical Associate Professor of Psychiatry and Behavioral Sciences at SUNY Upstate Medical University in Syracuse, NY.  A clinical psychologist and active trader for the past 20 years, Brett is the author of The Psychology of Trading (Wiley; 2003) and numerous articles on trading psychology for financial publications.  His book chapters on brief psychotherapy can be found in such reference works as The Psychologist's Desk Reference (Oxford University Press, 1998) and the Encyclopedia of Psychotherapy (Academic Press, 2002).  His newest, coedited book, The Art and Science of the Brief Psychotherapies (American Psychiatric Press, 2005), has been selected as a core training text for psychiatry residency programs.  In July, 2004, Dr. Steenbarger stepped down from his medical school faculty position and began intensive work with traders at Kingstree Trading.  He also coordinates their training program for new traders.  Drawing upon an intensive research program that began in 1998, he has created a number of unique measures of market trend, momentum, and institutional activity designed to aid short-term traders.  These measures--and the trading strategies derived from them--have been chronicled daily since June, 2002 in the Trading Psychology Weblog and on his web site.Dr. Steenbarger does not offer coaching or other commercial services to traders, but welcomes questions and comments at Steenbab@aol.com.

Brett N. Steenbarger, Ph.D. is Director of Trader Development for Kingstree Trading, LLC in Chicago and Clinical Associate Professor of Psychiatry and...