Back to Top

How to develop an enduring edge

Posted on 12/30/2013

If you want to be profitable trader you need to have a specific expertise on a setup or a bunch of setups. Expertise in skill like trading is developed through procedural memory development.
To become consistent trader you need to understand key concepts of setups, expertise and procedural memory.

Setup is a set of conditions used to find, enter and exit a trade. For example Momentum Burst is a setup with specific characteristics. It has specific criteria for entry, exit, risk, stops, profit target, and duration of trade. It is a structural setup in the sense this particular pattern repeats on stock after stock thousands of time in any given year.

Similarly Stockbee Trend Intensity Breakouts (STIB), Episodic Pivots, Double Trouble, Stockbee Lemonade Strategy for 401 k are examples of specific setups.

A setup encompasses a whole process of trading a specific trading method. If you know a traders setup you should be able to replicate his or her trade on your own. On this site the constant focus is on setups and procedural memory development.

Why is setup selection so important

If the setup you select is not based on structure of the market or is not based on observable phenomena it is extremely difficult to develop expertise on it. Setup selection allows you to narrow your focus down a specific and very narrowly focused process to be mastered. It allows you to concentrate your energy.

With proliferation of social media sites like Twitter, Facebook, Stocktwits and blogs there is constant sharing of trades. A trade is of no importance if you do not know the setup logic, scan and steps behind it. If you know the setup you know a replicable way to find that kind of trade on your own and also to trade it.

Many trading blogs or newsletter sites do not share their setups but only share their stock picks or scan results. Many traders believe if you share a setup idea and lot of people start trading it, it deteriorates. So they guard their secret sauce very tightly. Then they often claim setup is not important , but psychology is.

Once you understand the concept of setup and comprehend it you will look for setups rather than individual trades and tips. Individual trade or a stock tip might make you one time money but mastering a setup can make you money for 25 years or more.

Learning one good setup can make you thousands or millions of dollar. In order to master a setup you need to be willing to spend significant amount of effort one time till you can trade the setup consistently.

Setup selection is very important for new traders and those just starting out. In the beginning if you do not focus on setup, you will most likely blowup your account or have significant losses and never ever recover from them. Many new traders will end up giving up trading before they even find a good setup.

If you are just starting out in trading ,your task should be to hunt for a setup. Hunt for a setup used successfully by other traders. Understand it in depth. Break it down in terms of logic and process flow and then recreate it. Try it out for few months and then make changes to suit your personality. It will shorten your learning curve if you can work on existing setup than trying to find your own setup.

In the beginning of your trading career , if you are lucky enough to find a good setup it will save you 2 to 3 years of effort and frustration.

For a more experienced and successful trader, learning about new setups help you expand your repertoire of trading setups. It is easier for you to quickly learn new setup if you already trade other good setup. All successful traders trade a setup or a bunch of setups. They have skill specific to their setup. Successful traders have developed cumulative expertise on trading a very niche setup or basket of setups.

So if you are a trader looking to progress your trading further think setups and not individual trades.

Once you have a setup your problem of cognitive load will decrease because you will be doing a very narrowly focused task. Once you find your own setup you will be able to shut out environmental noise.

What is involved in developing expertise

Any expertise is task specific. So defining a specific task to become an expert at is very critical. The first step in becoming a good trader is to arrive at a tradable setup. And then become an expert in trading that particular setup. It is a very microscopic skill.
What is involved in developing expertise.

If certain task or skill is important to us we develop expertise in that specific task or skill area. These tasks can be as simple as driving a car, or cooking Italian food, or managing people, or more evolved like  developing java apps, or performing brain brain surgery, or trading the markets. As adults we develop expertise in specific tasks related to our work, our hobbies, our interests, or human relationship.

Developing expertise  allows you to earn money and have fulfilling life. Psychologists have studied this area extensively. Psychologists use the term expert to refer to an individual who is significantly more experienced than others in performing a particular task. A group of adults can have varying expertise on same task.

Expertise once developed allows you to do a task in less time and do it better. Expertise is developed through encapsulation. Encapsulation is a process whereby the adult learner’s cognitive energies and skills becomes focused on specific areas.  Once an expertise is developed the expert does the task differently from a novice.

Novices rely on formal rules and procedures to guide them in doing a task. Experts on the other hand rely on accumulated experience. You will see this in trading.

Lot of time you will see novice trader trying to do trading in step by step manner, while an experienced trader will take and exit the trade differently because he processes information based on accumulated experience. You will see expert traders develop intuition about coming moves or danger and act quickly while novices get stuck.

Novices are also conscious of the task performance process. They are trying to do task by referring to manual or trying to remember steps. This creates distraction and creates load on cognitive process.

As expertise grows the performance of task becomes automatic. This cognitive phenomenon is called automaticity. It is developed through procedural memory. You will see this in trading. Novice traders are flustered by steps involved in trading , they fumble to find right stops or scans, or exit a trade, while expert do the same task effortlessly without much thinking or being aware of what they are doing.

As expertise is acquired the learners cognitive processes become more efficient and they can process more information quickly. They can see the whole picture. They can learn similar task quickly.

Once you develop expertise you also develop situational awareness. Studies who experts are more aware of the specific circumstances in which they are working. They can quickly change direction. You will see this in good trader. They can quickly adapt to changes in market environment. They are more aware than novice traders about the situation.

Studies of experts also show that they have highly developed self monitoring skills. They do not suffer from motivational high and low like amateurs do. They can quickly bounce back from setbacks. They have high self efficacy beliefs specific to their area of expertise.

Studies of experts show that they have larger number of strategies to do same task and they can do it more efficiently. Experts know how to get out of trouble because they have multiple strategies to deal with unexpected situations. Anyone who has traded for long period of time knows how important this skill is.

Expert traders are more flexible than novices. They rely on intuition in ways that novice find difficult to comprehend.

Let us take a task of say driving a car. Did you learn it in one day? Can you learn it by trying it for a week. Can you do it by reading a manual about it.  Same way if you want to be good at trading you need to be willing to put in effort to master the task and develop expertise.

Only 5% of traders have that kind of time and attitude. Majority are just flirting from one thing to another and are just trying out bunch of things. That is why you will see high failure rate in trading.

Methods and philosophy


Mikhail said...

Man, your stuff is just phenomenal!! I've been reading all morning and can't stop )))
thank you for sharing your expertise.