Trading and Performance Part II

Ok so by now I’ve read enough of the book so as to not try and rehash it (it’s just too hard and wouldn’t do justice to it), so I’m going to summarize what I’ve read so far (including my own interpretations) and try to use some trading examples in the process. (Click here for the link to my first post on this). Once again I reiterate that if you want to achieve high performance at anything (and who wouldn’t) then you need to read this book!
The ingredients crucial to developing great performance are:

1. Developing deep domain knowledge – This is a no brainer. If you want to be an expert on something then you need to have extensive knowledge on it. Ie if you want to trade options, you should read as many option theory/trading books you can (although after a while, they’ll all start sounding the same). You shouldn’t stop there though as you will be trading in the markets so therefore you need to understand the markets and how they work. This means reading market related books and this is an infinite list. The last thing is understanding yourself and your own psychology as you are the one pulling the trigger so you need to be self conscious of your behavioral patterns and perhaps modify them if they are detrimental to your trading. An example of developing deep domain knowledge is if you are learning about option volatility, then you should have a very good understanding of how the VIX is calculated, what the VXV and VXX are etc etc and how they are related.
2. Creating highly developed domain mental models – This is called building and completing the jigsaw puzzle. Great performers not only have very deep domain knowledge, they have over time been able to use the knowledge to construct a vivid mental model. There is no point knowing all this knowledge as in point number one if you cannot create a logical structure for where everything fits! It’s like learning all the parts in a car but not knowing how it all fits together. Thus when given a new piece of information you will not know where it goes and how it affects the other parts (the important concept here is that you are trying to build a model to match inputs with outputs). A trading analogy would be knowing how to construct a bond option butterfly but not knowing what factors affect the bond price (ie monetary policy, inflation etc etc). Or learning how to trade options but not knowing anything on the greeks. Great performers have very rich mental models. They use it to build upon their already deep domain knowledge. This is like creating a filing cabinet of where to put your knowledge. It’s the difference between remembering random letters of the alphabet and learning words in the English language. A highly developed mental model also helps great performers to separate the relevant from the irrelevant information (this is like a novice trader reading the entire wall street journal while a seasoned trader only reads a few articles because he knows which are more relevant to trading). More importantly a highly sophisticated mental model allows you to predict the future as your brain becomes efficient and accurate at analyzing multiple variables and predicting highly probable outcomes.
3. Deliberate practice – is a targeted approach to get you to the next level. It’s comes from looking at the whole performance model and then looking at specific inputs to determine where improvement can be gained to get better performance. For example, Michael Jordan worked tirelessly in the gym just on his footwork in the "post" (back to the basket moves) and so it’s no wonder he was one of the best players in the game. Tiger Woods repeatedly hits balls that have been stepped on in the sand trap so when the rare time comes he does get into that situation he won’t lose that extra stroke that everyone else does. In trading, if you are learning about option volatility, you should be noting/calculating the daily skew and its changes as well as how volatility in general is changing. Perhaps you should also compare implied with historical volatility. If you do this enough times, you won’t even have to put them in a spreadsheet as your brain will begin to form a vivid mental model and you can probably do the math in your head from all that calculating and doing the exercise over and over. For myself personally, I saw a need to get better at my direction picking skills on top of what I already knew about trading options so I decided to day trade the e-mini futures for a few months as there is no better way to force yourself to get better at picking direction than trading an instrument where you only make money from getting direction right. Not only am I now better at picking short term direction because I picked up on the tools that short term futures traders use, but by pulling myself out of my comfort zone, the exercise has allowed me to learn about other realms of the market which all feed into both points number one and two above and allows me to continually refine the mental model that I have.
4. Every performance has a well defined goal is and measurable - Top performers are in constant search of feedback so as to create benchmarks by which they can measure their performance. Fund managers in general are ranked on alpha and Sharpe ratios etc etc but great performers are even more specific than that. Great performers document everything so they can scrutinize every little detail (as a probable input for designing deliberate practice), which then goes back into the performance loop to continually refine their method/skill. Therefore the goals that you set should be as specific and measurable as possible so the results are clear. In trading it's not just all about the bottom line but more about getting the processes right (ie have I followed my plan, done my due diligence etc etc)
5. Repeat, repeat and repeat some more – We’ve all heard the saying that practice makes perfect. This is definitely true and the funny thing is when you do something enough times, your body and brain begin actually begins to adapt to make you more efficient at it. When combined with some sort of feedback (comparing outputs to inputs) then this can lead to pattern recognition. A trading example would be that someone who has a good education in classical chart patterns may begin to pick up on the tone of the overall market just by looking at lots of charts day after day, week after week. (Some top traders are known to look through 1000 to 2000 charts a week). It's quite plausible that they will be programming into their brains some sort of subconscious pattern recognition. Again it's all tied back to the previous points and probably arises because the mental model they have is so complete that it becomes extremely sensitive to the subtleties that they see. Top chess players for example, have studied all the different chess moves/scenarios so much that they can play blindfolded against multiple opponents because once the positions are described to them their brains instantly recognizes the pattern that they've seen so many times from all the studying and playing which is why they automatically know what move to take next. I posit that it's much like how market makers who stare at option prices all day looking at put call parity pricing, pricing straddles, strangles, boxes, reversals and conversions begin to develop a feel when something is amiss just through the tiniest discrepancy in the pricing. Or how about great day traders that have learnt market structure (again you need structure for reference & feedback), and that have put so many hours looking at the one minute bars forming on the screen that it allows them to take the highest probability set ups because they recognize the probable market structure so early (when combined with looking at other things like market internals etc etc).
6. Responsibility - Great performers take full responsibility for their performance. This is empowering because it says that nothing is out of their control which means that there can always be room for further improvement.

Well they are my main takes after reading the book but what about some tips to speed the whole process up? I mean what is most efficient way to get really good at something? I'm drawing on my own experiences here but these are my tips.

1. Seek knowledge that gives rise to distinction so that your mind can create structure to help develop your mental model. This is information that helps you to classify/categorise stuff. For example there was an example in the book describing how pro-tennis players are so much better at returning really fast serves not just by having better reflexes and reaction times than the rest of us (research shows that there is a human limit to this and that further practice yields very little improvement ie 80 – 20 rule) but because they have acquired the knowledge or more correctly the distinctions as to anticipate where the serve is going before the ball is hit by looking at the server’s toss, angle of hips, rotation of the arm etc etc. These are things that are not distinct to an amateur tennis player. For someone dieting, how about the distinction that Calories has no relationship to the volume of food (ie a doughnut has more Calories than a 1kg bowl of cucumber). Would that bit of information help if you were trying to lose weight? I would think so!! What about a trading example? Well how about the concept of weighted vega? I’ve been trading options for 5 years and had no understanding of this until, it was pointed out to me late last year. Now I know that front month vols react faster than back month vols and how that can affect my option trades. This has been a big revelation and has really helped to increase my mental model of options. There are numerous examples of these distinctions. You know it when you have one of those "ah ha" moments, like the light bulb just came on inside your head. One should be able to know how good some piece of information is because the light bulb should be constantly lighting up in your head. Thus you should be able to determine whether a book is worth reading just by skimming the contents for these "ah ha" moments.
2. Seek out knowledge experts and make them your mentor - this is pretty self explanatory and I've mentioned it before. Just like in point number one, a good mentor/coach should be one that imparts knowledge to you in a way that builds the mental model. ie there should be some structure to it.
3. Knowledge immersion and staying abreast of the current body of knowledge. In trading this would be similar to participating in discussion groups, trading communities and reading current blogs from top traders etc etc. Experts are always the ones that are at the forefront of the most up to date thinking. If you want to be one of them, then you have to do the same! Books are great for theory but they lose their practical value because they are not current.

Some characteristics of great performers

1.    They know more. But we knew that already. Enough said!
2.    Perceive more with less - because they are so much more efficient at analyzing relevant information.
3.    Remember more - By virtue of having highly developed mental models, the ability of the brain to recall well organized information is far superior to other people. 

Well hopefully the information I described is structured well enough for you all to develop a good mental model of what it takes to achieve high performance. Let me know if the light bulb was on whilst you were reading it. I sure hope so!!