The Psychology of Hedge Fund Traders (Insights from Elite Trading Psychologist)

Doctor Brett Steenbarger is the top trading psychologist in the U.S. he has worked for top hedge funds, asset managers and lucky for US proprietary trading firms like S and P Capital. In this video, Dr. Steenbarger breaks down how hedge fund traders gain a mental edge over most traders. I'm Mike Bellafiore and we're one of the top proprietary trading firms located in New York City since 2005 and proud to develop numerous seven and and even eight figure per year traders. Watch, take notes and learn from the number one trading psychologist in the US so you can grow your trading account.

What an event. Look at this. Look at this. Now here's my perspective on this. Seeing all these people. Somewhere in this room is someone you can connect with and maybe multiple people you can connect with to really move yourself forward.

Personally and in your trading. Somewhere there's a great resource or a few great resources out there. And so what Mike was saying about networking is so, so, so important. That's the value of being here in person.

So I would encourage you to make a commitment that you're not going to leave this conference until you have made at least one meaningful contact, that you will continue beyond this. And if you do that at each SMB event and each SMB event, eventually you'll build a true network.

I'll make another comment about this.

Based on my work at hedge funds. The reason the hedge funds I work with are so successful is that they are organized in teams.

Where I teach at a medical school in Syracuse, New York, which is colder than here.

The saying is, in medical school, each one teach one. In other words, you develop a culture where each person is teaching and sharing and each person is learning from each other. That's what you want in your network. Each one teach one. And that's how these very successful funds are organized. In these teams where everyone has a different specialty, everyone's learning from everyone else.

One thing I was sharing last night at the dinner event. Look at every high performance field. It could be the performing arts and it could be professional athletics. It could be professional chess. Look at every high performance field and what do you find? Two things. One is the presence of mentoring.

Think about it. Does a person just practicing on their own become an NBA basketball star? No, I don't think so. Or do they become a world famous opera talent just singing into a microphone themselves? No, there's always mentoring, there's always coaching. To develop ourselves in an elite way, we need to learn from people who are doing elite things.

And so that becomes very important the second Thing, and I'll be talking about this a little bit later on, is that think about every performance field.

And you will find a mathematical relationship in every performance field. Developing talent involves spending more time in practice and learning than in actual performing. Think about how much time is spent on a football field, practicing plays or on a basketball court. How much time is spent in rehearsals for a Broadway play. A big, big, big reason that traders don't succeed is that what do they want to do? They want to trade, they want to make money. And so they don't do the practice. It'd be like, I want to be an NBA star, so I'm going to go right on the floor.

That didn't work for me, by the way.

So you want to be in a setting where you are immersed with talent, with mentors, and where you have the opportunity to practice, practice, practice, practice, learn, learn, learn, learn, and, and then eventually you grow your talent and that's when you start putting good money at risk. You don't just start out trading big amounts and getting frustrated. That's a great way to ruin your trading psychology.

Okay, a few other broad points before we get into the.

Meat of the, the presentation and I will leave time for questions as well.

A key to success. And I'm going to say something that some of you may disagree with, you know, because a lot of times, especially with short term traders, where I started in Chicago, the average holding time was six minutes. Okay, so especially with short term traders, what do they look for to figure out what to buy, what to sell? They look for a setup, right? So how is this market setting up? And they're looking at charts and they're looking at, maybe also at news information or different catalysts. I think that's the wrong place to start. I think that's necessary for success, not, not sufficient. Your edge begins. And this is one of the most important points I'll touch upon. Your edge begins by knowing, really knowing who you are making money from because you are exploiting the behavioral tendencies and the trading tendencies of some other player players in the market.

And the big problem for developing traders is they don't know who they're making money from because they haven't worked at investment banks, they haven't worked at hedge funds, they haven't worked at different kinds of proprietary trading firms, et cetera, et cetera, et cetera. I used a lot of basketball analogies. I went to Duke. It'd be like if you were in the basketball tournament and you didn't know who your opponent was or you didn't study your opponent, how in the world are you going to effectively prepare for that game? So you want to know who you're going to make money from.

Now? Who do you think you're making money from? Any guesses?

What's that? Other retail traders.

Gamblers. Ok, now the correct answer is you're making money from me because I really suck. No.

You wouldn't be making much money in that case.

I am going to argue that increasingly over the last number of years, certainly the last five years or so, you have the opportunity to make money from hedge fund participants. Hedge fund participants are experienced, they're not retail rookies.

But what has happened in the hedge fund world is that it has expanded tremendously. You now have these quote unquote multistrat funds, multi strategy that are truly global in their.

Membership and they are managing increasing amounts of capital.

So it's not at all unusual for me to work with a fund that has 20 billion in capital, 30 billion in capital, 40 billion in capital and so forth. And the smallest trading account for a beginner, for someone they just hire, is 200 million.

And there are more and more and more of these funds that have started up literally all around the world.

So you have crowding, you have more people chasing pretty much the same markets.

Now in addition to that, the people who fund these businesses have become more tight in their risk tolerance. When I first started at a macro hedge fund, the allowable drawdown.

Was 20% before you would be kicked out, before you had to stop trading. Now it's not unusual for that number to be closer to 5% to 10%.

So you have more and more and more people trading and you have tighter and tighter and tighter risk controls. And what do you think that does?

Churning? Yeah, that's a good way of putting it. You have people who need to make money and so they get into positions and the positions start to go against them. What do they do? They have to get out. They can't afford to lose the money. And you have crowding people in crowds and they're all short fixed income and.

It'S not working out and so they all have to exit the positions and then rinse and repeat. So lots of crowding, lots of unwinding, lots of crowding, lots of chasing opportunities, lots of unwinding of opportunities. And for someone who has short term trading skills and knows how to read markets, you can be quicker than that herd and you can catch those opportunities where the crowd's getting in, the crowd's getting out. So I would argue.

That you have potentially.

An underappreciated opportunity.

To take advantage of who is in the market and how they behave.

Now what that means is that you have to think.

Like they think.

And they don't get into trades just based on quote, unquote setups. What gets them into a trade is an idea, something they've researched.

Something about central bank policy, something about economic performance.

Maybe a catalyst from geopolitical conflict. They have some idea about what's going to move the market. And then they translate their idea into a trade.

And it's when they are ready to make that translation from idea to trade. That's when they look at the setup, that's when they look at the chart. That's where they figure, where do I get good risk reward? But you want to know what ideas.

Are people chasing.

Because that will give you a good idea of where the crowd is running. The number one idea that people have been chasing unsuccessfully so far in the past year has been the anticipation of, of weaker economy, even recession. And the Federal Reserve and other central banks cutting interest rates. So the market, the hedge funds in the market have been very focused on rates, have been very focused on bonds and short term interest rates.

The yield curve inverted last year. That means short term interest rates are higher than longer term interest rates. The two year interest rate is higher than the ten year rate. And historically what does that lead to? Recession within the year. And so far, no, we have not had recession. And so a lot of people have been stuck in that trade. But what that has also meant is because that has been a primary focus they haven't been actively participating in in other markets. The people who have been making money have been looking elsewhere. Commodities have been hot. Look at oil, look at copper.

What else has been hot? I think stocks, at least some of them. Okay.

So many times by knowing what the crowd is focusing on, you can find opportunity in the less crowded areas.

And I'm happy to be in touch.

With the group to share whatever I observe as far as where crowds are and where opportunities may be.

So if we go to the slide, I titled this the Positive psychology of trading. Positive psychology is a trend within the field of psychology which looks at our positive qualities, our strengths and our competencies. And the idea is that we get better, better, better. We develop expertise not just by correcting our problems, but by building on the best of who we are. So that's why it's called the positive psychology of trading. So why the big picture matters? The largest players trade the biggest pictures. So you want to Know big picture. Where's money flowing to? Where's money flowing from?

Volume is very important in terms of telling you who is in the market.

That's why tracking our Vol is so important in your trading. If you see a market move and the relative volume is really increasing, that means the volume for that time of day is really increasing. What's that telling you?

New additional participants are in that market, are in that trade. Who are they? If you see big volume coming into a stock, you're trading the big volume is not a bunch of individual traders at home in their underwear trading three lots. No.

It'S a footprint of the larger participants of the market. So you can track with volume, with relative volume who's in the market, what they're doing. So you get a breakout move or you get a move on a catalyst.

You know how we talk about.

Breaking news trading?

You get a catalyst and you get big volume coming in.

Some big players are participating.

Another aspect of the big picture that a lot of people don't appreciate.

Is you have trending momentum markets. So markets that are moving in a particular direction. And what's the opposite of a trending momentum market?

Yeah, what a lot of people will say is a choppy market. And what they mean by choppy is that it's unfucking tradable.

That's a technical, psychological term.

So if they don't see a trend, if they don't see momo, they think there's no trade to be had. Wrong, wrong, wrong, wrong, wrong.

Many, many, many, many times. The alternative to a trending market is a rotational market. In other words, the amount of money from institutions in the market is not decreasing.

But it's being reallocated. So you're seeing money going into growth stocks and away from value stocks.

You're seeing money going into.

Consumer discretionary shares away from consumer staples. So money is rotating from one sector to another sector, one part of the market to another part of the market. Money is rotating from big cap stocks away from small cap. These are all rotations.

And.

By tracking relative strength, how one sector is behaving versus another sector.

We can track how relative strength is trending. The trend is not in the overall market. The overall market might be trading in a range, but in terms of the relative play, there's a trend there, but people don't look at it. You want to think in relative terms.

Not only absolute directional terms. Lots and lots of opportunity there. And I would argue that in the current equity market, in the current stock market, we're seeing rotation even Though the market's been going up, up, up, and we've been making new highs.

Certain things have been quite strong. You probably haven't noticed the technology names.

And what's. I mentioned this to a group yesterday or dinner. What's not making new highs?

What sectors are relatively weak?

Regional banks, real estate. Look at ETFs and look at funds that are just in commercial real estate.

They'Re underperforming considerably. Now, in a raging bull market, if you have sectors that can't make new highs even in that environment, that's telling you something.

As a rule, patterns of relative strength and weakness tend to precede patterns of absolute strength or weakness.

So it'll be interesting to see going forward what happens when with the regional banks that are funding commercial real estate in particular.

We get spending, spending, spending.

We suddenly get the spending translating into inflation, the inflation translating into higher rates, the higher rates hurting the commercial real estate further, hurting the regional banks further. So we may be setting up, not immediately, not tomorrow, not next week, not next month, but we may be setting up with some themes by looking in relative terms.

And conversely, when the market's weak and certain sectors can't make new lows, that's real information. I've written quite a bit about the role of creativity in trading. The ability to see new things, the ability to see things differently from other people.

When we process multiple markets, when we process different inputs to different markets.

When we have an open mind to seeing new and different things.

That'S what helps us generate.

Promising ideas. It's a creativity process.

One of the patterns that's been most reliable in my experience and in my own trading.

Is identifying opportunities or occasions where you have buying pressure, buying pressure, buying pressure. But you can't make new highs.

Or selling pressure, selling pressure, selling pressure, and you can't make new lows.

So one of the indicators I've talked about is the NYSE tick T I C K. That's the number of stocks up ticking versus down ticking. And that's out there for The NYSE like 20 times each minute.

And so you can identify when stocks are ticking up, stocks are ticking up, and stocks are ticking up, but the overall index isn't going higher, and vice versa.

Back in Chicago, we looked at every single transaction, every trade in every stock, and is that trade occurring nearer to the bid price or nearer to the offer price?

If people are transacting and lifting offers, it tells you there's buying interest. If they're transacting and they're hitting bids, it tells you they Want to get out. And so you can get these patterns where they're hitting bids and hitting bids and hitting bids and we don't make new lows. All those people hitting bids.

They are shorts that are going to become trapped. And you can make money when it turns around. That's a reliable pattern.

But you need to process markets differently and uniquely to find those kind of opportunities. Barbara Fredrickson, psychologist, talks about broaden and build that. When we are in an open minded mindset, when we're in a positive mindset, we tend to see more of the world. Our perception is broader and we can build upon the breadth of those things that we see.

The really successful traders I work with just look at more things and then they have the ability to look at more things in different ways. So they're playing in a vastly expanded universe.

When I first Mike was mentioning, when I first worked at SMB 2007, when I first started working with Kenny Sharkness, Shark, what do you think? The first thing I noticed was you have a guest, Mike.

So many things.

His hair, what the.

How is his desk different from the desks of the other people? More screens, Hugely more screens. He had so many screens open. He's looking at different things and this and this and this and this. And he could quickly point out.

He had that speed of processing.

And he had that ability to see different things in different ways and he just had more opportunity as a result of that. So in terms of what I've observed at hedge funds but also elsewhere.

A key to success is identifying and maximizing your strengths.

Many times people keep a journal and what do they write in their journal?

Basically, it's how I shit the bed.

Another technical psychological term. They write down all their problems, everything they did wrong.

When it's just as important to learn from your successes.

What did I do today? What did I do this week that was really good?

And once I identify what I did really well, how could I do that again? How could I do that again? How can I build upon that?

Strengthen teams, teaming up with people who have strengths that are different from yours.

So that you can learn from them, they can learn from you.

The best teams.

Are multi specialty, so to speak. They look at different things, process information different ways and they learn from and with each other.

Finally, there's research on what's called the flow state.

We concentrate, we focus so much that we get into the flow, we lose sense of time and we become absorbed in what we're doing. And the research suggests that flow.

Enhances creativity, that we best See new things and different things when we're in a state of high focus.

So we want to be looking at different things in different ways, with different people in a focused way.

So in terms of positive psychology, four big dimensions. Happiness. Doing things that we like, doing that we enjoy.

Fulfillment. Doing things that are meaningful to us.

Energy. Doing things that give us energy and affection. Being close to people who are important to us.

What the research on performance tells us is that we are going to perform better. We're going to be able to broaden and build and be more creative when we are firing on all four cylinders.

So you want this to become a kind of checklist for you. What are you doing.

Each day, each week to make yourself happy, to bring yourself fulfillment, to give yourself energy and to be close to the people that matter to you.

There's a common perception that if you're going to be successful in trading, you have to focus on trading, trading, trading, trading, trading, and have such a passion for trading, that's all you care about. Bullshit. That's called an unbalanced life.

And eventually your psychology rides up and down with your P and L. You want to have many sources of happiness, fulfillment, energy and affection. That gives you energy, that gives you focus and helps your trading.

Big, big, big idea from positive psychology. Many challenges we face result from the absence of positive experience, not the presence of conflicts and deficits. If we're having problems in our trading, it's not necessarily that we have no control over our emotions or we have some inner block toward being successful. Many times it's the absence of the positives in our lives that makes it difficult to really focus and sustain. Focus in the markets. I know we're moving on in time. I'll just mention a couple other ideas because I do want to leave a little time for questions.

Think of trading not as a process, but as multiple processes, processes. It starts with generating an idea, and that's where creativity is important.

So, for example.

An idea might be that.

In certain assets we're seeing inflation, we're seeing certain assets going up, up, up, up, up. Crypto. We're seeing it in some commodity markets.

But everything is denominated in the currency. You know, bitcoin versus US dollar, copper versus US dollar. Maybe it's not that the numerator is going up, up, up. Maybe there's a trend that we'll be seeing for the denominator to go down, down, down.

And what would that mean if we had a weaker, weaker, weaker $?

So you start to look at different markets. That's idea generation. You look at statistics, you look at different markets, you talk to different people and then once you have an idea, then you look at the setup, you look at how to structure the idea as a trade. Where do I get good risk reward in my own trading and in the work I do with people, we look at trends, that's a linear component of price change and we look at cycles in markets.

And even the trending markets do have cycles. It's just that the, if it's an uptrend, the trough cycles may not be very deep, but you can put a short term RSI for example, on a time series that's trending and you'll see that there are relative ups and downs. Certainly in the recent stock market that's been true. And so in terms of straight trade structuring, you can use those cycles to time when and how you get involved in the trend.

Then once we have the trade on, there's trade management. How do we manage the position, where do we take profits? We, where do we add to a position?

In the hedge fund world there's also what's called portfolio construction. They trade portfolios, not individual positions and they want diversification.

So their portfolio at any one time may involve certain trades in commodity markets, certain trades in currency markets, certain trades in equities in different parts of the world and they get balanced that way. So, so if one trade doesn't work out, other trades will work out and their overall portfolio will have some diversification benefit.

For us shorter term traders, your portfolio is not what you own at one point in time, it's what you trade.

Over time. Are you trading different stocks? Are you trading different patterns? In other words, you could achieve diversification benefit by trading different instruments, different stocks, different time frames.

Different patterns. And so when one thing may not be working out, other things will. That's your portfolio. If you're, if you're a one trick pony and you're only trading one thing in one way, all your eggs are in one basket and that's a pretty vulnerable place to be financially. Some components of success that I've observed in the hedge fund world, creativity and idea generation rigor.

Process orientation in managing trades.

Process orientation in terms of improving performance, the teams I work with that are successful, they regularly review their performance.

And they figure out what they could do better, what they've done well. So they're constantly, constantly turning the wheel and learning.

And back to the idea of positivity, managing their energy as well as they're managing their time.

Because a common occupational Hazard in the trading world is burnout. And once we start to burn out, we become less creative, we become less productive and less successful.

Okay, couple ideas to leave you with. Then we'll do just a little Q and A and at any point, Mike.

Just say stfu. I'll get it, I'll get it.

This is so important.

In some measure.

To some degree.

You are already the person you seek to become.

You want to study you at your best.

Now, it may not happen often, it may not happen all the time, but at times.

You do things greatly.

And you want to learn.

From when you're doing things really well and expand upon that. You want to reverse engineer that success. Psychologically, your peak experiences point the way to your path. When you are having your best experiences as a trader and it's really rewarding, not just financially, but emotionally, it's fulfilling. You're doing something right, you're doing something that's meaningful. You're doing something that's important to you, that's your path.

And that's why it's so helpful early in a trading career to practice, practice, practice, trade different markets, trade different stocks, trade different time frames, trade different patterns. Because eventually you'll find a fit, something that clicks for you, that makes sense to you, and you'll have those peak experiences and there's your path. So I'll leave you with a quote that I've shared online recently.

The novelist, philosopher.

Whose group I joined when I was in college, Ayn Rand.

Said.

Anyone who fights for tomorrow lives in it today.

That's what we're meant to do.

We're meant to find the best within ourselves.

Fight for tomorrow, fight for our tomorrow. And we'll experience some of that tomorrow right here, right now. Thanks so much for this event. Thanks for having me.

So do we have time for a few questions? My question is, you mentioned about the trending market versus the rotational market. How do you identify the rotational markets?

The rotational market will generally be in a range. It will have some cyclical structure. And so anything that looks at short term highs and lows, a technical indicator like an rsi, if you see some patterning to that, that's helpful. Now there is formal quantitative work on cycles. John Ellers, E H L E R S has done some of the foundational work in that area and he has a program that's commercially available called MESA M E S A.

And it identifies dominant cycles. In any financial market. You're looking at any stock, any futures contract.

But if you have short term overbought and oversold Levels, There is some cyclical structure and you want to see if there's some regularity to that.

Now to give a little example of creativity, what's on the x axis, the horizontal axis of most charts? Time. Time, Right.

I was amazed when I was working in Chicago, particularly with the quant funds, the firms.

Time was not on the x axis.

What was on the x axis?

It was volume. Yeah. So each bar represented a certain amount of volume. You didn't have five minute bars or one hour bars. You had a bar that represented, let's say in a futures market, 10,000 contracts traded. And that could be in a few minutes, it could be in a couple of hours. And each bar draws an open, high, low close for that amount of volume. And it turns out that when you look at markets denominated in volume rather than time, those cycles become more regular.

Look at all the good shit I'm dishing out.

But a very important concept because if you can identify some cycles in a market, then you can participate in a rising market by buying the short term oversold that's occurring at a higher price level and vice versa. It really helps with timing and it helps you get good risk reward. And if you have really good risk reward, you can trade better size. My name is Zach and I've been trading full time for the last four years. And I was wondering what the longevity of this career as a professional trader. What's the longevity? I'm sorry, of this career.

As a trader.

That varies. It's a very good question. What happens is a lot of people don't survive their learning curves and so they have short careers. And the reason they don't survive their learning curve is not because they lack ability or lack motivation. It's because they put their money at risk too quickly and they just lose too much. And so that shortens their careers. The really great traders and I've worked with a couple of people who are in market wizards books.

They are not just trading to make money, they're trading for other purposes.

And as a result it's meaningful to them even when they don't need the money. And they enjoy building a business, they enjoy mentoring others, they enjoy giving to charitable causes and so they tend to have very long term careers.

So it really varies. But my experience is that the primary motivation for trading when people are beginning and when people are young evolves to a different motivation for trading later in life. There's a good book by David Brooks called the Second Mountain that's relevant here. His thesis is that successful people climb the first mountain, and they achieve success and they do well, fame and fortune. And then what do I do? Okay, I'm not ready to retire and I've achieved these things. They find a second mountain to climb. And the second mountain is often different from the first and is more about what they can do in the world, how they can make the world better, make others better.

They stay in what they do, but for a different motivation. What is the psychology behind trapped buyer or trapped sellers? Some of the indicators that I mentioned.

You want to have measures of buying pressure and selling pressure that are different from your measures of price change.

And so looking at upticks versus downticks, looking at where trades are occurring in the bid offer matrix, or trades going off nearer best bid or best offer, that will tell you if buyers or sellers are dominating. And then you look at price action, how much price change are you getting for the amount of buying pressure, selling pressure going on? Now what's happening in the real world is if you have people buying, buying, buying, buying, and the market can't go up or the stock can't go up, why is that happening? There's a big sell. So there's a big sell. Yeah, the iceberg orders. Yeah. There are larger players absorbing that buying or absorbing that selling. And so you get people trying to push the market down, Push the market down. You can't make new lows because underneath, bigger players are buying. So you need some measures like that to identify where people are trapped.

So you talk a lot about trading a lot of different ideas, but I've also heard you talk previously about tracking a lot of your statistics. So I was curious about how you would recommend doing that most efficient, effectively when you are trading so many different ideas. Because I know for me, sometimes when I do trade so many different things, it makes it really hard to track all the details about my trading.

Yeah, that's a great question. And you want to track performance details that would be relevant across markets. So what's the average size of your winning trade compared to the average size of your losing trade?

When I place more trades, do I tend to be more profitable or more unprofitable? You can track all of these things and it doesn't really matter whether you're trading a futures contract or individual stocks or some combination thereof.

My average holding time, I'll break it down. What's my profitability? For trades I hold longer, for trades I hold shorter. I had a trader reach out to me this morning and we studied his performance. And in the vast majority of situations, his Trades would start out profitable.

And then what would happen?

Exactly, it would just reverse on now. So we tracked profitability as a function of holding period.

And that could be done in any market.

When you have low volatility on average, you're going to have more reversals. You don't have that momentum effect. So what was happening is that he was trading a momentum long volatility strategy, when in fact the mark, his entries were good, but the market wasn't sustaining that kind of momentum. Your statistics, if you keep the right stats, can tell you all of that.

So you're an active trader, not doing as well as you want, not doing as well as you deserve. And you just can't figure out why you can't become profitable no matter how hard you try. Well, let me show you why. This is your competition. The traders in this room. This room right here is full of elite traders, some of whom are making seven and even eight figures a year. In fact, our top guys have made nearly 20 million each in net trading profits in a single year. Let's head to my office so I can share more. So you're probably used to seeing videos of lavish trader lifestyles, trading gurus trading off of a laptop for an hour a day, heck maybe even 15 minutes a day, then them relaxing on some secluded beach for the rest of the day. Well, all I can tell you is that our traders train like pro athletes. They live and breathe the markets and are continually working on their trading skills. Because at our firm, that's what we found it really takes to make it in this game. I'm Mike Belafury, co founder and managing partner of S and P Capital, one of the world's top top proprietary trading firms located in midtown Manhattan. And we're always looking for trading talent to hire and develop. And not just to trade in house on our desk, but also to trade from their own home entirely using our firm's capital. And we have numerous traders doing just that, allowing them to make upwards of seven figures, trading the firm's capital without risking their own money. But to even get a shot at something like that, you need to have the right training. That's why we're doing a new free online presentation in which we share how you can get an interview with SMB to become an in house or remote trader trading firm capital without risking yours and gaining access to all of our firm's coaching and resources. And the best part, you don't have to be a profitable trader yet. In fact, we prefer to mold profitable traders with our methods and our techniques. That's why we have just three simple criteria that can earn anyone an interview. We're looking for highly ambitious and determined traders who fit our culture first and foremost. So if you believe that could be you, sign up for the free one hour online presentation by clicking the link that's in your top right corner of your your screen now.