Psychology and neuroscience push traders' buttons
You've heard it a million times in life, sports and business – keep your emotions in check.
It is one of the golden rules of trading as well. Even the best traders say they sometimes find themselves trapped in a cycle of allowing emotions to dictate their decisions, which creates a recurring pattern of poor trades.
The answer to that problem is often the following: separate your emotions from your trading. But there is a growing body of evidence that shows it isn't quite that simple. What is emerging is the perception that emotions are a powerful engine in our brain that affect decision making far more often than we believe or even realize.
“Common wisdom says 'control your emotions' and most everyone accepts that as a given,” says Denise Shull, a New York-based trader and trading coach with a masters degree in psychology. “But most people know that it seems to be impossible. It's impossible for a good reason – neuroscientists are discovering that we work with emotion and reason on equal footing at a minimum. And it's really impossible to pull apart emotional influences from cognitive influences.”
Shull, a trader who created the trading psychology consulting firm Trader Psyches last year, hears it almost daily from clients. A common example is: a trader plans a trade, does the homework, sees the trade setting up as planned and then when that moment arrives – does nothing. As that moment of opportunity comes and goes, he gets upset or frustrated and makes another trade that wasn't in the plan and that is often a loser. It's a common pitfall many traders know about but fall into anyway. Why?
“Traders make impulse trades and they're mystified by it,” Shull says. “That is because emotions influence cognitive thought. The emotional energy first blocks the taking of the trade and then pushes him to take the next trade.”
Blending experience with the science
Much of Shull's philosophy integrates
her own trading experience and education
in psychology. Her 1995 master's
thesis, “The Neurobiology of Freud's
Repetitive Compulsion,” fittingly focused
on the neurobiology of why we repeat
past mistakes and the cycle of emotions
– thought, action, reaction – which
recycles back to emotion.
“If you learn to pay attention to the signal, it tells you to take a walk around and come back with a clear head so you avoid that lousy trade you were inclined to take,” Shull says. “If you take it to its logical conclusion, in my opinion, it's the only path to becoming an intuitive trader.”
The concept of emotion versus reason is not new but it has led to a fast-expanding field. Daniel Goleman popularized the idea more than 10 years ago in his book, Emotional Intelligence, which uses psychology and neuroscience to see how the rational and emotional together shape our decisions and lives. In short, Goleman holds that IQ scores can illustrate how well a person can handle cognitive demands but doesn't address an individual's emotional component. Goleman contends that emotions are a powerful force in pushing us toward or away from various courses of action, a concept he refers to as “emotional hijacking.”
“As we all know from experience, when it comes to shaping our decisions and our actions, feeling counts every bit as much – and often more – than thought,” Goleman writes in Emotional Intelligence. “We have gone too far in emphasizing the value and import of the purely rational – of what IQ measures – in human life. For better or worse, intelligence can come to nothing when the emotions hold sway.”
More recently, MIT finance professor Andrew Lo studied the anxiety levels of 10 traders at a bank. He found that all of the traders showed some anxiety during periods of volatility. While fear, apprehension, nervousness are part-and-parcel of a trader's daily life, they can be viewed as a rather valuable part of the job, Shull says.
“There's always some level of anxiety, but that's not necessarily bad,” Shull says. “Some level of anxiety causes you to focus and can be a positive factor.”
Other neuroscience research is also scientifically reinforcing just how emotion works and is providing data that can help everyone from school children to large organizations in measuring overall intelligence and strengths.
The cure?
So how do traders overcome the emotions
that steer them wrong? According
to Shull, the first step is to accept the idea
that emotions and feelings are indeed
pushing trades. While that seems easy
enough, traders are often taught or firmly
believe they must check their feelings at
the door before they begin trading. So
getting traders to acknowledge that
emotions are creeping into those trades
is sometimes difficult.
Next, Shull says she helps clients to identify those feelings. This also is not a slam dunk because traders often operate from the prior mind-set that good trades are planned long before they are executed. Therefore, they often dismiss the idea that emotions are to blame for poor trades.
“It is actually developing the ability to even know there is a feeling happening,” Shull says.
So Shull coaches traders to train themselves “to focus inward.” As New Age as that sounds, the best way to suspend the emotional impulse is to find ways to identify it, she says. Shull has had success using two methods: keeping a written journal of thoughts during the day or simply voice-recording those thoughts as trading occurs. By doing so, Shull says traders can indeed see when and how emotions are affecting a trading decision.
Shull notes a “standard pallet of emotions in trading” – fear, frustration, regret and elation.
“For someone who has never done this, they may say, 'Gee, I do feel kind of nervous,'” Shull says. “Whereas before they were not consciously aware or they were intentionally trying to outthink the feeling, the new acceptance and process of identification make all the difference.”
From there, traders can use different methods to route the energy of an emotion away from poor trades. Any physical movement is a good place to start. One of Shull's clients went as far as putting in a punching bag at work.
Finally, there is another step deeper into the mind that connects the emotional intelligence concept with her own research into Freud's repetition compulsion theory. For Shull, traders make the same errors again and again because the emotional half of the equation is amplified via their internal expectations.
“If you really want to find out why you do things you don't want to do, then add in what your unconscious expectation of yourself is,” Shull says. “Everyone has an emotional outline that develops over time.”
Take, for example, a perfectionist who always thinks he should have done better in school, better at hobbies or sports and today believes he should be better at trading. As an individual, he brings that with him everywhere including the trading room. That trader often enters trades where he shouldn't because he believes he won't hit his targets and then exits trades too early for the same reason.
“Because the perception that he should have done better is so strong, what does that make him do?” Shull asks. “The strong feelings about always needing to do better make him cut his winners short. We transfer emotions we've had in the past into the present. And I've found traders do that without knowing it.”
As those realizations are made, traders can change those patterns, avert impulse trades and, at a minimum, preserve capital, Shull says.
“What happens by doing nothing in this realm is you get frustrated and take a bunch of trades or get afraid and don't take any at all,” Shull says. “By becoming aware of it and acknowledging it, it gives you the opportunity and ability to interrupt that process.”
Coming this fall Denise will be presenting a CME session (live and online) called: “How to Deal with Exaggerated Emotions When Trading.”
View Denise in a CME panel discussion on Peak Performance Electronic Trading:
www.cme.com/peak
