Jan

14

 Checklists have been shown to reduce errors, improve accuracy, and increase profits in many fields. Most recently, a study in the New England Journal by Atul Gawande shows that use of a 19 point check by surgeons could reduce deaths by 30% and save billions. Such simple things as knowing all the names of your colleagues and being sure that an adequate supply of blood and respiratory equipment is available are useful.

When it was suggested to me that a checklist for my own trading might be useful, I originally had the same reaction as the doctors. "I've flown with the eagles, climbed the highest mountain, captured the mountain lion, been a member of all the exchanges, played 12,000 refereed matches, went to Harvard." But then I read the reaction of the Drs. "I'm from Harvard. I don't need such a list. But if I was operated on, I'd like such a list."

Here's a list I came up with for the forgotten man, the hundreds of thousands of traders in stocks, futures and options.

Before the Trade

1. Do you know the name and numbers of all your counterparts, especially if your equipment breaks down?

2. When does your market close, especially on holidays?

3. Do you have all the equipment you'll need to make the trade, including pens, computers, notebooks, order slips, in the normal course and in the event of a breakdown?

4. Did you write down your trade and check it to see for example that you didn't enter 400 contracts instead of the four that you meant to trade?

5. Why did you get into the trade?

6. Did you do a workout?

7. Was it statistically significant taking into account multiple comparisons and lookbacks?

8. Is there a prospective relation between statistical significance and predictivity?

9. Did you consider everchanging cycles?

10. And if you deigned to do a workout the way all turf handicappers do, did you take into account the within-day variability of prices, especially how this might affect your margin and being stopped out by your broker?

11. If a trade is based on information, was the information known to others before you?

12. Was there enough time for the market to adjust to that information?

13. What's your entry and exit point?

14. Are you going to use market, limit or stop orders?

15. If you don't get a fill how far will you go? And what is your quantity if you get filled on all your limits?

16. How much vig will you be paying if you use market or limit orders and how does that affect the workouts you did knowing that if you use stops you are likely to get the worst price of the day and all your workouts will be worthless because they didn't take into account the changing price action when you use stops, to say nothing of everchanging cycles?

17. Are you sure your equipment is as good and as fast as the big firms that take out 100 million a day with equipment that takes into account the difference between being 100 yards away from an exchange and the time it takes the speed of light to reach you?

18. Are you going to exit at a time or based on a goal? And did you take into account what Jack Aubrey always did which is to have an escape route in case all else fails?

19. What important announcements are scheduled? and how does this affect when and what kind of order to use? For example, a limit before employment is likely to be down a percent or two in a second. Or else you won't get filled and you'll be chasing it all day.

20. Did you test how to change your size and types of orders based on announcements?

21. What's the money management on this trade?

22. Are you in over your head?

23. Did you consider the changing margin requirements when the market gets testy or the rules committee with a position against you increases the margins against you?

24. How will a decline in price affect your margin and did you take into account what will happen when you get stopped out because of margin?

25. What will happen if you need some money for living expense or family matters during the trade? Or if you have to buy a house or lend money to a friend?

During and After the Trade

1. What's your game plan if it goes against you and threatens your survival?

2. Will you be able to get out? Did you take that into account in your workout?

3. More typically, what will you do if it goes way against you and then meanders back to give you a breakeven? Or if it immediately goes for you or aginst you?

4. Would you be willing to take a ½% profit if you get it in the first 10 minutes?

5. Did you test whether taking small opportunistic profits turns a winning system into a bad one?

6. How will unexpected cardinal events affect you like the "regrettably," or the pre-annnouncement of something you expected for the next open? And what happens if you're trading an individual stock and the market goes up or down a few percent during the day, or what's the impact of a related move in oil or interest rates?

7. Are you sure that you have to monitor the trade during the day? If you're using stops, then you probably don't have to but then your position size would have to be reduced so much that your chances of a reasonable profit taking account of vig are close to zero. If you're using 10% of your capital on a trade, they you'll have to monitor it for survival. But, but, but. Are you sure you won't be called away by phone calls, or the others?

8. Are you at equilibrium in your personal life? You're not as talented as Tiger Woods, and you probably won't be able to handle distressed calls for money or leaks on the home front. Are you sure that if you're losing you won't get hit on the head with a 7-iron, or berated until you have to give up at the worst possible time?

9. After the trade did you learn anything from the trade?

10. Are you organized sufficiently to have a record of all your trades for your accounting and learning?

11. Should you modify your existing systems based on it?

12. How does recency and frequency and value affect your future?

13. Did you fit your after activities to your mojo?

14. If you made a good profit, did you take some capital out of the fray for a rainy day?

15. Have you learned to say "fair" whenevever anyone asks you how you're doing and are you sure that you don't spend a fortune after a good trade, and dissipate your profits with non-economic activities?

16. Is there a better use for your time than monitoring the ticks or the market every minute of the day if you do, and if you don't, do those who do so and have much faster and better equipment than you have an insurmountable advantage against you?

Well, specs, that's what I come up with off the top. How would you improve or augment it?

Nick White comments:

If a position begins moving against beyond what was anticipated in the workout can one, through either contacts or acquired counting skills, figure out as fast as possible why the move against is occurring? With that information, can one then discern whether or not such a move needs to be heeded, faded, or left alone?

What legitimate information sources can one leverage to better understand a particular trade? A buddy who is a floor trader, a mentor, a high ranking friend of a friend in a central bank?

Are one's current skills commensurate with one's trading goals and ideas? Perhaps, more importantly, are one's trading skills of the same league and caliber as those one is competing gainst in a particular market? If not, surely best to wait and keep capital safe until one is sure of one's edge. This strongly accords with Chair's admonition to never get in over one's head, and to not spend inordinate amounts of time watching each tick when that time could be more profitably invested in training and developing new and existing skills — counting, programming, etc.

Make the strongest effort possible to find out whether the tail wags the dog in a particular instrument that you're trading. If it turns out that it does, does it happen with significance at a particular time, such as expiry? Or after a particular event? Can it be exploited after costs or is it better to fade it after the fact?

If one asks these questions and takes note of them in the essential lab notebook that ought to be at one's fingertips during all trading and researching activities, have those questions subsequently been answered by oneself? I have found this to be the most fertile soil for developing new insights and ideas. If you observe it, note it and question it — hypothesize about it and answer it.

Alston Mabry comments:

Here's one: Don't fool/confuse/tire yourself by making your execution more precise than your analysis. If your target is 2% within the next five trading days, then chasing two bps on the entry isn't going to make or break the trade.

Easan Katir adds:

  1. If you trade odd hours, get enough sleep and appropriate caffeine dosage.
  2. One well-known S&P pit trader advised two bowel movements in the morning before setting foot on the floor.
  3. Start the day with a centering routine — affirmations and goals. Remind oneself of one's larger purpose.
  4. List important times and dates on an online calendar with appropriate alerts: government numbers, earnings, ex-dividend dates.
  5. Rehearse successful behaviors and outcomes. And disaster recovery.
  6. Minimize other life stressors: long commutes, family arguments, risky vices, debt.
  7. Test backup equipment and systems regularly. I test my diesel backup power generator weekly.

Victor Niederhoffer responds:

I would add a small point. Trading foreign markets always seems much more difficult than domestic ones. For one, you never know what the important announcements are. For two, you get killed on the spread on your foreign exchange prices. For three, it seems to be 100 times more time-consuming to get into the queue than even the 1/100 of a second that's enough to give the domestic high frequency traders an insurmountable edge on you. For four, you have to go without sleep for at least one night, and then on the second night when you can't stay up the required 48 hours without sleep the move you expected and closed out is sure to happen.

Alan Millhone writes:

Checker master Tom Wiswell said to always keep the draw (escape) in sight.

Scott Brooks adds:

I have to disagree with Easan on the caffeine. I know there are many people that have to have their morning cup(s) of coffee to get their day going, and without it, don't feel/function right.

I do not want to go through life being so dependent on something that I have to have it to make myself feel right, let alone function right. I know this will be anathema to most (everyone?) that reads this, but I have to say it.

When I removed the caffeine addiction from my life (and don't fool yourself, it is an addiction…..if you have to have it everyday and then quit it, you will go through withdrawals……it is an addiction), my life changed so much for the better. I can think clearly. I can process information more quickly, and I can see solutions with greater clarity.

And your sleep will improve immensely. I suffered from severe insomnia for years. Kicking caffeine out of my life has lead to my being able to fall asleep, usually within minutes and being able to get up earlier and feel more refreshed!

You will find a level of "mental processing" that you never thought possible when you replace coffee and caffeine with purified water (I drink around a gallon a day) and a glass or two day of the organic juice of your choice.

But be prepared, you will likely have around two weeks of headaches when you go through caffeine withdrawals (you know, from the caffeine that you're not addicted too).

Nick White agrees:

Ditching caffeine is a good move. Best to save it for when may really need it on an overnight (or two) session. As mentioned in the past, Dr. Shinya is fervently anti-caffeine. Like many others, I found Dr. Shinya's principles promoted many positive health benefits for my wife and me.

On that note, i find that the Shinya nutritional principles — when moderated by the ideas behind the paleo diet — are a real winner; the increased "good" protein from the Paleo program does much to mitigate weight gain from increased carbohydrate consumption when kicking off on the Shinya program. There is a Paleo program for those involved in elite endurance sports.

George Parkanyi writes:

On any project or major activity, the first question I ask is how much time I have. That frames everything that is to come.

The very next thing is to build a contact list with names, phone numbers (backup phone numbers) and email addresses (and account numbers and passwords). This is also true in Scouts, where we need to have that information at our fingertips for safety reasons — in fact for every camp we have to draft an emergency plan — police, hospitals, parents, primary first aid responsibilities, etc. In a trading operation this is critical. If you have key support resources who have to act on your behalf at a moment's notice, then they need to be available, you need to able to access them, and if not, there must be a ready backup contact and plan B, even C. Chair's point about having a pen available can even be a critical detail — what if, in the heat of battle, you have to write down, say, a wire transfer number? In my case, reading glasses would be another.

Kim Zussman comments:

As a periodontal surgeon, I have found it much easier to stay composed and rational during difficult surgery than unruly trades. Chair's excellent list hints at why, in the form of the question "how do you know?".

Surgical complications follow rules of biology, and mistakes usually come when overlooking something or miscalculating the compounded risk of several factors. One can and should practice with a large margin of safety, which in almost every case is easy to determine. Biology is almost immutable, but markets morph wildly in real-time. It is very difficult to stick with a position if you are honest about your cluelessness and unwilling to go down with the ship. When the trade goes bad:

1. What was your hypothesis? How many others had your idea too? Or the opposite one? Are they right? What do they know that you don't? What is the source of your confidence that you can out-smart (or out-run) the million-mind-march?

2. Did you test properly beforehand? Did you miss something; a signal from another market, a subtle backdrop to your traded market? What is the chance this time is different, and should this doubt change your mental stop?

3. How heavily is your market being manipulated? By government? Big banks? Goldman's trading desk? Does persistent manipulation / insider trading change your hypothesis or render hypothesis formation useless?

4. How do you know whether the move is merely noise of your correct hypothesis, or part of a regime change you have not noticed?

5. Deep and abiding doubt is essential to science, but how do you incorporate doubt into market prediction when most of the movement is random?

6. Does the non-linear, mostly random reward system of trading corrupt your judgment (sleep, personal life, etc)? Do some people lead a happy, well-rested life with long periods of gut-wrenching loss alternating with gain, and are you one of them?

7. What unalterable beliefs are necessary to trade successfully? If you hold them, are you sure they are the right ones? Should some beliefs be discarded as a result of a changing world? Are there new ones you should know, and are you confident you will see them when they develop?

Steve Ellison adds:

Margin of safety is a key concept in many fields. While skiing, I put on the brakes a bit earlier than I absolutely must so that if I miss my footing or hit a patch of ice, I have another chance to avoid the hazard (e.g., other skier, tree, out of control speed). Graham and Dodd wrote about margin of safety in investing. Rather than buy a stock that is below book value, a value investor might wait for an opportunity to buy a stock below 80% of book value.

If I ski 10 times a year, even on the same mountain I am likely to encounter 10 different sets of conditions — temperature, wind, length of time since last snowfall, etc. One day last year, the fog was so thick I could not see the trees on either side of the trail. Some conditions dictate caution; others are more forgiving and allow me to be more aggressive. A warmup run is an excellent way to get a feel for conditions.

Nigel Davies proposes:

Checklists are very good whilst learning, but I believe that one should ultimately aspire to be able to do without them because everything has been internalised. In my own field I tend to believe that conscious thought of any kind can be a distraction, which is why I don't like the old Blumenfeld Rule (a checklist used before playing a move).

Ken Drees writes:

I just did an experiment with my son with one of his Christmas presents, an electronic learning kit. We have learned so far the basics of how electricity works. Resistors (series and parallel), Capacitors, etc. Each lesson has a page explaining the experiment, a schematic, a drawing of the circuit in relationship to how water moves through pipes — the water analogy for electrical flow resonates with my son. And each experiment has an electronic "wiring checklist'.

The checklist comes in handy since its easy to forget a connection, misrun a wire, or leave an extra connection from a previous experiment in the lab circuit.

I associate checklists with "must have"–high accuracy functions. Like programming, wiring, piloting, fixing a car, cooking –its all routine, but items can be omitted, done wrong and can be forgotten due to human error. The checklist is a tool, an aide that removes ego from the scenario. Used in trading it helps set the trade up, helps initiate or close the trade, and removes emotion from what needs to be done automatically. A checklist in the grey area of a trade like the middle game in chess, or an operation where the patient is being worked on really doesn't help much–you need to make gut-inferred decisions, unless your trade is so automated that you remove yourself from the trade entirely and rely upon a program.

Using trading checklists help bring focus and energy towards the trading exercise. Using checklists of some sort during the "live–life of its own phase of the trade" must be explored further. Maybe there are ways to check off your decisions, check your options, use your skills with the pressure of time taken into consideration–during this live phase.

But when your hand is on a hot stove, trade going wrong, does one need to look at a post-it-note do determine if one should remove hand from stovetop?

FYI: a 9 year old boy is understanding electricity –public school may teach a child these ideas in 7th grade. I am amazed at what can be taught to children that most think is way over their heads.

Alan Millhone adds his two cents:

I will add my two cents. Some years ago I bought an International dump truck and it has air brakes. My late father and myself drove it for use in our construction projects. Because it has air brakes you need your class B driver's license to be legal. We drove it several years without the proper license. Finally my father got the book and studied and took the written part for class B. After he took that part he gave me the book and I studied and took the test and passed. Quite a book to study.

Now the second part was an over the road test with the instructor in the truck with each of us. He said he had never given a back to back test to a father and son. Dad and myself had to back the truck then drive to the right close as we could to an orange cone– without touching the cone. Then each of us had to do a 50 point check list of our truck that we earned (I still remember the list ) and still check my truck before taking it onto the road. So checklists are valuable in many applications ranging from dump trucks to the Market.

On a side note, dad and I rode to the test center in our dump truck without the proper license. The instructor said he was not going to ask how we got there.

David Brooks comments:

All very good ideas. I wish there were some good way to test Atul's theory historically. Why? Because I am convinced that poorer outcomes in the last decade come from fragmentation of the system - shift work, decreased work-hours by house staff, the high volume being forced through the system and de-professionalation of nurses.

Alas, we can't measure the past, but I am convinced that the hospital I started in (The Peter Bent Brigham of the early to mid 70's) was a safer, more humane place with better (allowing for technological changes) outcomes.

All the same, the reason we have embraced checklists a la airlines has to do more with the aeronautical outcomes than medical outcomes. The amount of information that a pilot has to process is order of magnitudes more than what a surgeon has to process. Furthermore, when a pilot fails completely 300 lives are lost, and when a surgeon completely fails, 1 life is lost. The former is far more dramatic, of course.

It's nice to know the anesthesiologist's and scrub tech's name, but it's hard to believe that that is going to affect the outcome of a significant number of operations.

That said, I have the greatest admiration for Atul. He sits a short distance from me, and I am proud to have had even a small role in training him. He is a remarkable young man and we will being hearing from him for many years to come.

Newton Linchen comments:

Once I took an airplane pilot course, and I was amazed how everything was done with checklists. Actually, the first time I heard the word 'checklist' was there. (Even here in Brazil they keep all the terminology in English, for standard procedure). I realized how checklists can keep you out of trouble and save your life. In markets, perhaps a great deal of losses could be avoided if I followed my own trading checklists.

Russ Sears writes:

Checklists can be very useful in an emergency. I have found that a simple checklist was valuable in a race. When the going gets tough it is easy to panic. The list It went something like this 1. relax 2. pump the arms smoothly 3. breath in normal rhythm (One hard puff out, relax in). It is easy to panic on the edge of your limits. These 3 things are the first signs that you are starting to panicking, subconsciously without knowing it.

Runner, use checklist often as part of their diary. Each day you check your weight, evaluate your nights sleep and your overall mental state. You check your diet and fluid intake .

Before a race you follow your pre-race checklist from what to pack, to when and what to eat, and when and how you should be warming-up and stretching.

Then after the race you check how well you followed the plan, where the plan worked and where if failed.

Finally at the end of the year you check the philosophical underpinnings of your training. Your goals, why you are doing it all, what are the cost that you are willing pay and what is the best path to get there.

So checklist have there place, but you need to 1. put them in the right point of time in the process, 2. not let them lose their relevance and meaning . 3. keep them simple at critical points, simple enough that they are potent.

Easan Katir adds:

Thinking about checklists, and watching the Haiti disaster coverage, made me think about a checklist for emergencies. Then thought about a list of the various types of emergencies one might encounter, big and small. What came to mind:

earthquake

tsunami

meteor

fire

invasion

home invasion

looting

mistaken id

false accusation

suit

accident

disability

death

audit

missing person

interment

currency replacement/devaluation

market crash

partner deceit

embezzlement

power outage

plague

pandemic

mugging

i suppose each needs its own checklist, though some may overlap. What did I miss?

Scott Brooks adds:

The best checklist you can have is to either be a great leader or be around a great leader.

It's been my experience that average and ordinary people need checklists (which they rarely if ever have or use…which is one of the reasons why they are average and ordinary), but smart people with leadership skills don't need a checklist when it comes time for a disaster.

Most disasters/problems rarely follow a fixed pattern. It takes a leader who is capable of thinking on his/her feet who can stand up, take charge and direct people as to what they need to do.

And this doesn't have to be right all the time, he just needs to make decisions and get people moving and be willing to take responsibility and shrug of criticism of the naysayers…..while listening to them to extract the wisdom that might be contained in their "naying" (I think I have just made up a word).

A leader has to have insight and the ability to see several moves ahead. A leader has to be able to see correlations and connections between seemingly disparate pieces of information.

A leader has to then take this data and formulate a solution and then direct people to execute the solution….and if possible, get people to see the vision of the completed project so that they can begin to work towards that goal with minimal supervision.

But most importantly, a leader has to be willing to make a decision when it comes time to make a decision even when the solution is not apparent. A course of action that fails is better than inaction that is guaranteed to fail.
 


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8 Comments so far

  1. Rocky Humbert on January 10, 2010 9:31 am

    I am an avid checklist user, and find it unsurprising that checklists improve surgical outcomes since they reduce the loss of "horseshoe nails." See: http://tinyurl.com/yen7tgc For me, the most useful checklists are extremely short, and only require a check. (That's why they call 'em checklists!) Questions that begin with the word "why" or "what" generally require subjectivity, and that can both delay and reduce the utility of a checklist process. Using a checklist requires an admission of fallibility. This can be a good thing because recognizing one's imperfections is a necessary condition for improvement.

  2. Rocky Humbert on January 10, 2010 9:39 am

    The corrected URL for my “horseshoe” comment above is:

    http://tinyurl.com/yen7tgc

  3. Jeff Watson on January 10, 2010 11:27 am

    It's only Jan 10 and this is the best post on DailySpec in a long time. With some extrapolation, I suspect that it is only going to get better and better. The Chair certainly raised the bar to a new level with this post.

  4. vic niederhoffer on January 10, 2010 12:17 pm

    One would add a third point which is that if you're an adviser you should always ask " does your current position and estimated holding time take into account what will happen if you get redemptions, especially guaranteed when the position is at the bottom, and it's the worst time to be forced out. ?" Do you have in your operation any third columnists who are likely to defect to the enemy at the first time of trouble or opportunity? Such was a crime punishable by death in the British Navy, and perhaps not as harsh a punishment would be appropriate in market operations. vic

  5. michael bonderer on January 10, 2010 1:47 pm

    good post, i found it interesting how atul looked at boeing's solution to the early b-17 introduction and the in-cockpit 'confusion' with the advent of four engines experienced by pilots and adapted these check lists for his surgical checklists and how he visted the kitchen of a prominent boston restaurant and spoke with various sous chefs to also get ideas on formulating his checklists.

  6. Pacific SW on January 10, 2010 9:30 pm

    what one would like to know is this: have you considered all the workouts are useless? i know one time one used the analogy of the boeing through the junkyard when analyzing one's career, but maybe the success was due to understanding and being positioned on the right side of the drift? i wonder if this could even be tested.

  7. reid wientge on January 11, 2010 9:28 am

    My experience with caffeine withdrawal (I tried to quit coffee many times before success) lead me to these discoveries. To minimize caffeine withdrawals drink a mild detox tea, like Yogi brand Peach Detox (any large grocery will carry it or a similar one) two to three times a day. Drink lots of pure, but not distilled, water. And, take a multi with minerals. This should alleviate or mitigate headaches and shorten the withdrawal time by a full week.

  8. Market scout Report « Mkt student on January 12, 2010 1:40 pm

    […] My Checklist, from Victor Niederhoffer […]

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