How Do You Fix “Trading on Tilt”?

Mike Bellafiore asked this question on Twitter yesterday. It’s a great question that almost every trader deals with at some point.

There are a lot of thoughtful replies in that thread with some good advice: step away from your trading desk, trade with half your normal position size, stop and go exercise, etc. Of course these are all things you should do if you find yourself in this situation. All of these “solutions,” though, are temporary band-aids for a more permanent problem. If you don’t address the deeper problem you’re likely to continue to find yourself in these difficult trading situations.

The Deeper Problem and How to Fix It

What is the root cause of trading on tilt? It’s really a symptom of a much deeper problem that you should try to solve: you don’t understand your trading system well enough.

If you’re trading on tilt then it likely means that the market has put you in a situation that you didn’t realize could happen ahead of time. “I had no idea this many trades could go against me in one day!” or “Who knew that I could lose so much money in a single trade!” Having these thoughts in the middle of a trading day is a major flaw in your system that must be addressed immediately. How?

The fundamental problem is that you haven’t done enough work outside of the trading day to fully understand your trading system and why it works. What are the best and worst days that your system is going to have? Under what types of markets does your system work well? When does it perform most poorly? You can’t predict the future but you can look in the past and get a really good idea about the range of performance you can reasonably expect from your system. If something surprises you during the trading day, it’s likely that you’ve skipped this arduous but critically important step in preparation.

Peer into the Past

Historical market data is really easy to get access to now. Go back and backtest your system for as long as you can go back. Look at the equity curves — are they smooth or do they have spikes? (And be careful, if you look over a large enough timeframe all curves look smooth!)

Here’s an important step that most traders skip — look at the performance by day of your trading system. What were the best days? The worst days? What days did it trade the most? How many days are there with no trades? Look at the trades it took on those days and truly visualize what trading that day would have felt like with size. Could you have kept up on the days where it traded a ton? What would you have done on the days with the biggest intraday drawdowns?

This is the hard work required to be prepared for any given trading day.

Easy for you to Say, Dave — You’re an Automated Trader — I’m a Discretionary Trader!

What about traders that trade with their instincts? “You can’t backtest my super-duper trading discretion. I trade with my extraordinary feel for the markets.”

I know plenty of traders like this and while it seems like these are fundamentally different styles, they’re really very similar: You get a signal where you’re confident you have a trading edge and you take the trade. Sounds pretty simple and in a lot of ways it is.

How you attain that confidence in your edge varies from trader to trader. Confidence for a discretionary trader comes from experience and trading results over time. This is more valuable than any backtest but it takes time to develop that experience.

If you get into situations where you end up trading on tilt, then you’re probably trading with too much size and you should reduce your size until you gain more experience with your system.

Of course there are no easy answers but if it were easy everyone would do it!

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