Sunday, February 25, 2007

P&L Management: A Best Practice in Trading

From Brett: Our next best practice in trading comes from David Aferiat of Trade Ideas, who passes along a practice from some of the firms he works with. The idea is that we can become emotionally connected (or disconnected) to the specific stocks or instruments that are most recently contributing to our profit and loss (P & L). Such reactions take our attention away from sound money management. My comments follow David's submission.

From David: We work with many trading firms across the country that use Trade-Ideas to assist in their idea generation and risk management decisions. Dan Mirkin mentioned this in his recent appearance at the NY Traders Expo. Several firms teach their newer traders to remove a common heuristic that emphasizes previous winning trades over losing trades.

Traders tend to review their P&L and focus more on what symbols were winners for them in the current session. To reduce the tendency to get tangled up in winners and losers, these traders, who manage an average of 10 – 12 positions at any given time; minimize the ‘Symbol’ field in their open portfolio view. Only ‘Number of shares’, ‘Last Bid/Ask’, and ‘P&L’ fields are viewed.

When a trader does not see the symbol or name of the instrument, all the focus shifts to the P&L and the money lost or won in the position and making decisions based solely on money is a lot easier and quicker to process than a mini-internal debate about what the symbol is doing to your P&L.

From Brett: A similar practice that some traders found helpful at the proprietary trading firm where I worked was that they would cover up their day's P/L display so that they would not become overly focused on the money in making decisions. They knew that they had a risk manager at the firm who would call them if they hit a "warning level" of losses for the day. They didn't want to become too aggressive when they were winning, and they didn't want to become too risk averse if they were down money. The idea here is to separate out as much as possible your trading decisions from the ups and downs of what has happened most recently (much of which is random). Once you have your position sizing, price targets, and stops in place, you let the profits and losses take care of themselves based upon the edge you've cultivated. You want to be trading opportunity, not your mood of the moment. Tuning out data that would bias your trading--whether it's the TV, the "hot" or "cold" stock symbols, or a green/red P/L number--is helpful to emotional P&L management and a best practice. Thanks to David for passing this along.