Trader, Know Thyself

Last week marked the first chapter of "Building your own Methodology" and focused on the important topic of knowing yourself. This week, I'll continue with those thoughts.

"How do you find out what 'yourself' is like?" Hmmm, as usual, I had the good question, but not the good answer. Fortunately, in some back-and-forth e-mail correspondence, reader Ron Martin weighed in. His initial note gives his perspective.

Ron's Trader Psychology

In my former life (30 years as a Ph.D. clinical psychologist before selling my business and trading full time for a living), I came to see in great detail how people trade as an extension of how they live their lives. One's trading style is like a giant Rorschach ink blot...you can tell a lot about a person by seeing how he or she trades, AND, the happiest, most successful traders trade in concert with their personalities.

So, what does that say about one who primarily makes short-term trades on volume breakouts from congestion? Hummmm, just lie down on my couch here, and make yourself comfortable....

Do Your Own Self Analysis

The Doctor piqued my interest, so I asked him how a trader could go about doing his or her own self-analysis.

Gary,

I got out my pipe, stroked my beard thoughtfully, did a quick review of my trading library, and tried earnestly to find what I knew would not be there: A first-class, current, well-researched, validated test to determine one's "trading personality type," a test created by a respectable, psychologically trained trader with a proven market track record.

Okay, so that was a mouthful. But why not shoot for the best? There may be one out there, but I am not aware of it. A close second is outlined at the close of this e-mail.

But wait, there's more! Short of the lofty criteria just outlined, there are some also-rans.

First, there is Dr. Van K. Tharp's "Investment Psychology Inventory" as described in the first Market Wizards book. This purports to measure one's "success level" along eleven criteria such as risk control, patience, knowledge of technical factors, intuition, responsibility for results, etc.

The focus of this test apparently is to determine whether one has "losing" or "winning" attitudes, hence it attempts to identify those likely to make money as opposed to lose money in the markets. Notice the focus here: It is NOT to identify one's personality style and correlate that to a compatible trading style. It identifies attitudes that are "winning" (good) and those that are "losing" (bad). It is static in this sense.

Similar to this, but without the test, is Charles Faulkner's interview in The New Market Wizards. This details Neuro-Linguistic Programming, or NLP, and how a person can learn to model the trading excellence of successful traders. Again, it is more static than dynamic because it says, in essence, here are proven, successful trading behaviors which the would-be trader can learn to emulate.

It does not adapt the trading style to the trader (what I think you and I are trying to get at), but attempts to adapt the trader to those who have proven themselves as successful traders. Perhaps a subtle distinction to some, but critical to me.The closest to what you are looking for (that I have seen) can be found in The Inner Game of Trading by Kopell and Abell. This is not a neat test which one can take in 20 minutes, but a dialogue, a journey through the myriad of factors involved in becoming a successful trader. Chapter 7, "Matching a Trading Style to Your Personality," contains a list of 10 open-ended questions for the reader to answer by actually writing in the book. The chapter ends with an intro to interviews with successful traders, and says (p.66): "We will see what it is precisely that makes them (top traders) so successful; how they were able to develop trading strategies that adjust to the needs of their unique personalities."

Bingo.

Ron was gracious enough to give us start, and his efforts are truly appreciated. In fact, I've taken both the Van Tharp test and have read the Inner Game of Trading. Both are helpful. But, what else?

The answers, of course, are all around you as they are me. In golf, I know who I am. I'm Tom Kite. Thoughtful, conservative, precise. I am most definitely not carefree, wild, and imaginative. So, it'd almost be ludicrous to envision myself swaggering up to the table and loading up with Amazon.com (AMZN Quote - Cramer on AMZN - Stock Picks), eBay (EBAY Quote - Cramer on EBAY - Stock Picks) , and the rest of the long ball crowd. No, you know my trading. It's a mirror image of my golf game -- thoughtful, conservative and precise. I make a lot of small profits pounded out incessantly week after week. I don't make a lot of birdies, but I don't make a lot of bogeys. No, just a lot of pars. John Daly, I am not.

But, let's leave golf for a second. Are you excitable? Patient? Methodical? Short-tempered? Focused? Egocentric? Answer honestly, or have someone in your family answer for you. Draw up a list of strengths and weaknesses, warts and stellar qualities. What do you do well? What do you do poorly? Is chess your style, or do you prefer gin? Do you walk fast, or slow?

And, of course, you already have a wealth of clues in your current trading. Enjoyed riding Entremed (ENMD Quote - Cramer on ENMD - Stock Picks) up 100% and no problem riding it down 50%? Then you would most definitely not be happy using my methods.

Conversely, do you wake up every morning sweating that an open position will go against you? Then, perhaps a method with tight, trailing stops, or even day trading is more your style.

You see, there are no "right" answers, just as there is no "right" trading style. The right trading style is the one that best matches your personality.

So, a lot of verbiage on "trader, know thyself." And if you're still with me, that begs the question: What do you do with that knowledge? Where is the grid that says: If my personality is "x," I should use "y" style of trading?

Well, some answers are in the resources Ron mentioned, but I've also found a wealth of material in the biographies of successful traders. These books aren't written, of course, as answer guides, but that's how I've always used them. Therefore, read through both "Market Wizards" and "The New Market Wizards" both by Jack Schwager.

The Buffett biographies will also give you a feel for his style. And, of course, Jim Cramer lays out his style -- and personality -- multiple times per day. There are countless other books, many very good. The trick is to know what you're like, then find a successful trader who matches your personality. How he or she trades is secondary. If he's successful, his method already fits his personality. And that kind of match will give you a good start in building your own methodology. And a good start is what you should be looking for.

Next Monday: Your trading method's first draft.