2/18/2010

The little secret to trading success


 If you want to succeed in trading or in life in general you should understand the concept of self efficacy beliefs well.

Albert Bandura first wrote about self efficacy in 1977. His research on self efficacy is considered most influential in developing social learning theories. Anyone who has taken a course in educational psychology would be very familiar with Albert Bandura's work. Basically the research shows that learning is complete when the learners self efficacy belief for the domain being studied change. So learning and teaching strategies should be designed to enhance learners self efficacy beliefs.

Bandura defines perceived self-efficacy as
Perceived self-efficacy is concerned with people's beliefs in their capabilities to exercise control over their own functioning and over events that affect their lives. Beliefs in personal efficacy affect life choices, level of motivation, quality of functioning, resilience to adversity and vulnerability to stress and depression. People's beliefs in their efficacy are developed by four main sources of influence. They include mastery experiences, seeing people similar to oneself manage task demands successfully, social persuasion that one has the capabilities to succeed in given activities, and inferences from somatic and emotional states indicative of personal strengths and vulnerabilities. Ordinary realities are strewn with impediments, adversities, setbacks, frustrations and inequities. People must, therefore, have a robust sense of efficacy to sustain the perseverant effort needed to succeed. Succeeding periods of life present new types of competency demands requiring further development of personal efficacy for successful functioning. The nature and scope of perceived self-efficacy undergo changes throughout the course of the lifespan.



If you look at trading methods used by say Dan Zanger or Mark Minervinin or Charles Kirk or any other trader who has ben around for some years, you will find that there is no great secret behind their methods. The secret is in their perceived self efficacy beliefs.

Each one of them on their own through trial and error figured out a method which works for them. What was the process they used to arrive at that as opposed to several who attempt it ? That is the focus of self efficacy belief theory. What really happens that makes a person proficient in trading. Their belief system changes. They acquire confidence that they can do this on their own. They "figure out " or they experience a mastery experience. 

For example I have told you people many times how I at the beginning of my trading  career I  looked at 40 years worth of data and looked at top 100 price performers in each quarter. That is about 160 quarters of data. Now immersing oneself in such intensive study resulted in me figuring out "how market works" or "why stocks make big moves". After that once I started getting experience of actually trading  and looked at results of my trading ,it further enhanced my confidence. This kind of learnings is implicit learning. It is difficult to explain to others what really happens during such process.

Many of you are followers of Brett Steenbarger's blog on trading psychology and would have read his books. He is prolific writer , but what really is the core message of his book . The one line summary of all his books and blog and articles is that trading expertise can only be gained by implicit learning. This is exactly the same message from the book Cambridge Handbook of Expertise and expert Performance. 

Trading expertise is about implicit learning and within that it is about procedural memory development. If you understand that view then you will approach learning very differently. Expertise is about developing your procedural memory to a extreme proficiency level. To understand this better lets us look at expertise outside of trading. 

Every summer two fairs are held in our town and every year I take my daughter to these fairs. You will see some extreme example of procedural memory skills in fairs. Last year I saw a person who walked on a thin wire 50 feet above ground. Couple of years back I saw a person who rode a bicycle  without sleeping for 5 days (he slept on the bike). He shaved , showered, cooked his meals on the bike  without falling down. These kind of people have trained their procedural memory to extreme level. That is how they can do these kind of extreme acts. It is the same thing with trading. 

Traders train themselves through immersion and extreme practice or study to level where a new procedural memory about say swing trading or a pattern forms. If you study 1000 or 5000 examples of historical EP your implicit memory will develop. Then you see a  situation and you will instantly react in right manner. The name for this process is deliberate practice. Tons of practice is required before implicit memory gets trained. Not only that but you need right practice. Practicing wrong things will train wrong responses.

This is also the reason most working people and average investor has no chance of winning at the wall street casino. They simply don't have enough experience. Plus they don't have time to even attempt to gain that level of expertise. This is also the reason why you should try day trading. High frequency of trading in day trading helps you build up implicit memory faster. A typical hyper active day trader will do in a day more number of trades than I do in a month. So they can learn faster. 

Once you put enough effort in deliberate practice is when your self efficacy beliefs change. When those beliefs change you will have confidence in your own opinion and skills and will not follow the opinion of Gartman, Faber , or any other guru. 

So how does one enhance self efficacy belief? 

How can you enhance perceived self efficacy
Self efficacy is built through four processes:
Mastery experience
Role modelling
verbal persuasion
psychological cues.
These four are in order of importance. Most critical way to build self efficacy is through a mastery experience.

Mastery experience is basically a successful experience of mastering a task. Mastery experiences happen when the learner has reached the point where they understand the content knowledge enough to perform a task on their own or masters the task. It happens if the learner goes in to sufficient depth on material he trying to learn. It happens as a result of immersion in a particular field or task. It happens with plenty of prior exposure to the content.
At some stage the learners are able to interpret the results of their actions and use those results to develop their own capability to engage in future actions or tasks. Then the learner become auto learners. They are able to participate in tasks on a first hand basis with little or no assistance from outside influences. When you experience a intense mastery experience you get a feedback on your own capabilities. Long and sustained efforts are required for mastery experience. 

Self efficacy beliefs are critical not only in academic situation but in any task like sports. Self efficacy beliefs are task specific. So a person might have high perceived self efficacy beliefs in one subject but have less self efficacy in other field.

Self efficacy builds over a period of time and more mastery experience you have, you become better at a task and learning other tasks. 


Mastery experience is the main source of self efficacy. All other things are secondary. In training or coaching situation one can structure the situation in such a way that the trainee experiences a mastery experience. This is the fundamental principle used in training commandos and marines. In simulated and controlled situation they are put in situations where intense learning happens in a very short period of time. That creates a mastery experience. That forever enhances the trainees perceived self efficacy belief. Some years ago Discovery Channel had a 6 part series called Navy Seals Buds Class 234 , if you watch that , it is excellent example of creating mastery experience in a simulated environment. If you work for a successful start up at early stage, you will have a mastery experience. That is why you will find many successful entrepreneurs become serial entrepreneurs. 

Many people go through a lifetime without having a intense mastery experience in any field  and so have low self efficacy belief.  


Vicarious experience or role modelling is the second source of self efficacy. It is when the learner is primarily gaining self- efficacy or confidence in a given task through observation of a role model attaining success at a task The learner does not play an active role in such learning experience. They are learning more through the watching of someone who already understands the task or the objective or is on the same skill level as the observer.

The social persuasion or the verbal persuasion as it is also called is basically  the exposure to the verbal and nonverbal judgments that others provide that can impact the level of self efficacy that a student has.


Physiological cues is the next source of self efficacy beliefs. We judge our own  degree of confidence by the emotional state we experience as we contemplate or engage in an action. So our physiological states affect our  self efficacy beliefs. But such states tend to be temporary.




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3 comments:

The Rebel said...

Thanks Pradeep, this is a real good topic. :)

Engineertrader said...

Basically what it all all simply boils down to is 'Practice makes perfect', but make sure that what you are practicing is the right stuff, not the wrong stuff that will lead to the goal.

Engineertrader said...

So what it boils down to is simply 'Practice makes perfect', but just make sure what is being practiced is the right stuff leading to the goal!.