Achieving trading competence – part 3

This week we begin to look at how to get from trading incompetence to trading competence. That is, moving ‘above the line’ on our competence matrix as shown in the figure below in order to achieve consistency and objectivity in our trading. Through trading in a disciplined and mechanical approach we are now able to achieve consistent profitability and outperform a chosen market. In Australia this is the All Ordinaries Index.

At the Conscious Competence level, the individual understands or knows how to do something. However, demonstrating the skill or knowledge requires conscious effort or concentration. As more events (mechanical trades) are completed at this level, less effort and concentration is required.

With respect to trading, the individual attains the mental skills of objectivity and consistency and begins to consistently outperform the market indices. It has been proven that the highest probability and quickest way of acquiring the Conscious Competence skill level with respect to trading is to trade with a mechanical trading system that has a proven positive mathematical expectation—an ‘edge’. That is, the statistical probability of not just making profits but handsomely outperforming the market indices, is heavily stacked in your favour.

Everything we do in life, whether it be a mental or physical activity, begins with a mechanical stage of learning. This is necessary because the learning process requires that a skill first passes through the logical conscious mind for a period of time before being transferred to the subconscious mind. The conscious mind comprehends the mechanical steps involved in the activity and, in the early stages of learning the skill controls the actions to be undertaken. Through repetition, experience and a feedback loop, the necessary actions to take on the skill are transferred to the subconscious until new habits and new beliefs are formed that are in harmony with the new activity.

The degree to which the skill is transferred to the subconscious mind without the need for conscious thinking is the degree to how well the skill will be executed. The more automatic the execution the better it will be. The logical mind is good at planning and solving problems; the subconscious mind is good at executing, whether it be mental or physical execution.

The mental activity of learning to read requires that the mechanics of words be comprehended by the conscious mind. Try to read in a different language! After the logic of word and sentence structure is comprehended by the conscious mind and then repeated over and over again, the skill is transferred to the subconscious mind. The individual now has a ‘trained eye’.

The same applies to physical activities such as learning to write, crawl, walk or run. The same learning process applies to driving a motor car, hitting a golf ball, brushing your teeth and to trading the market. Many repetitions lead to mechanical comprehension in the conscious mind; eventually the subconscious takes over.

A mechanical trading system uses unambiguous criteria to determine market entry and exit points. Unambiguous means ‘no doubt or misunderstanding’, and ‘having only one meaning or interpretation and leading to only one conclusion’. The unambiguous criteria are well defined and objective thereby making the buy and sell decision simple, clear and certain, even though the outcome is not. If the entry and exit criteria are discovered through rigorous research on large samples of historical market price action, an edge in the favour of the trader can be discerned.

A mechanical trading system operates from the paradigm of market price action from whence it was researched and hence originates. Active investors using a mechanical trading system take on the paradigm of the mechanical system and make buy and sell decisions from that paradigm.

Active investors not using a mechanical trading system use their own paradigm to determine entry and exit points which operate from their own perspective. Their paradigm comes from the sum total of their experiences in their life, which is very different to the experiences of market price action. Humans are programmed by their environment and societal life experiences. A mechanical trading system with a positive ‘edge’ is programmed by market price experiences.

Societal paradigms do not work in the environment of the market; they work in the environment of society. We have discussed the difference between societal paradigms and trading paradigms in previous Blogs. Unconscious and Conscious Incompetents operate from a societal paradigm; they think from the perspective of societal living when making market decsions. Conscious and Unconscious Competent traders operate from a market paradigm; they become empathetic with the market.

It can take many years for an individual to change his or her way of thinking to that of the market’s perspective. Some will never be able to change their way of thinking for various reasons which can be discussed in future Blogs. The highest probability way of succeeding in changing is to use a mechanical trading system with a positive ‘edge’ for the reasons discussed above.

It is at the Conscious Competence level that active investors begin to attain an ‘edge’ over the market where their winning trades total far more than their losing trades. Losing trades are cut short while winners are allowed to run and the portfolio equity curve continues to rise with acceptable drawdown levels. Large loss trades which are detrimental, if not fatal, to portfolios become a thing of the past.

To be consistently successful in trading, and to remain so, the individual need only remain at the Conscious Competent level. However as more mechanical trades are completed the individual will come closer to achieving the highest level of learning, that of Unconscious Competent. We will discuss this highest level next week.