Thursday, October 25, 2007

The Psychology of Behavioral Premises

I'm going to try to explain an important psychological concept and why it's of paramount importance to trading. The concept is something I call "behavioral premises". A behavioral premise is a rationale for our actions; it's the set of assumptions that drive our choices and responses in various situations. The network of our behavioral premises represents our belief system about ourselves, others, and the world around us. These beliefs may not be enunciated, but they are the filters through which we perceive the world, thus coloring how we respond.

An important principle is that our behavioral premises tend to evoke responses from other people that, in turn, reinforce those premises. That is, people's responses toward us will be shaped, in part, by how we approach them--and the beliefs that underlie our approach. Here are a few examples:

* A person has been hurt in past relationships and doesn't want to face rejection again. Her behavioral premises are that relationships are dangerous and that others don't really care about her after all. As a result, she maintains a guarded stance with people who might otherwise want to get to know her. Seeing that she is not approachable, others keep their distance from her and make no effort to open up themselves. This reinforces her premise that people are uncaring and unavailable, convincing her that she must stay all the more guarded.

* A job applicant believes that he has no chance to land a desirable position. His behavioral premise is that he lacks the charm and personality to come across well in an interview. As a result, he is nervous throughout his visit to the firm and comes across as unsure of himself. Sensing this, the interviewer concludes that he won't be an effective representative of the company and turns him down. This confirms the man's belief that he is not cut out to be hired for a good job, and he approaches the next interview with even less confidence.

* A businessman is convinced that others are out to cheat him. His behavioral premise is that he needs to be on guard at all times, because his employees can't be trusted. He establishes strict rules and maintains stifling oversight of his employees, even after their training phase has been completed. The employees, feeling untrusted and not valued, leave the business one by one to find a more suitable work environment. This convinces the businessman that he's right; that employees will just take his training, use him, and move on. As a result, he trusts the new group of employees even less.

Notice that each of these scenarios is one in which there is a vicious cycle. The behavioral premise leads to actions that bring outcomes that reinforce the premise. This is one major reason people stay stuck in self-defeating patterns.

The same dynamics occur in trading. Imagine that, feeling like a defeated trader (per the recent post), you act on the behavioral premise, "I just can't make money in the market." You follow your rules, enter a trade, and it moves a few ticks against you. This only reinforces your negative belief and you quickly exit the position before the loss becomes too great. Meanwhile, the market chops around a bit before eventually moving in the direction you had anticipated. All you can do is shake your head: your premise has proven true once again.

So how do people escape from these vicious cycles? Most people can't talk themselves out of their premises; they need direct, powerful emotional experiences to show them that their beliefs are wrong. This is one reason I emphasize solution patterns with the traders I work with. We spend extra time examining trades that have worked out and isolating what the trader did right on those trades. By creating a model for good trading out of these successful trades, we increase success and disconfirm negative behavioral premises.

One of my favorite exercises is to look at what happened in the market after exiting a trade. Very often the basic trade idea was right all along; it was the timing that was off. This also disconfirms negative premises. The message is that it's not that you can't read the market; it's just that you need to refine your execution: when you enter, how large you enter, and where you stop yourself out. I've often seen big results from such seemingly small refinements. Why? Because the process of making those refinements challenges the behavioral premises that led to the "stuck" patterns to begin with.

We will always live up to our most deeply held behavioral premises--for better or for worse.


Solution Focused Trading

The Question to Ask When You're in a Slump


Jeff said...

thank you so much for this very helpful post!

Anatrader said...


For us to have a proper perspective of the market, we need to put on bifocals, so to speak.

We need to see the basic makeup of a person ie attitudes, actions, fears, hopes and greed.

From a distance, we see how the mass of investors/speculators shape the course of the market through their collective behaviour.

Hence, we need to consider Behavioral Finance as a friend.

Krasimir said...


Excellent post. Thank you.

Globetrader said...

Hi Brett,
prior to reading your article I posted something on my blog, where I described how turning off my account information on my trading desk improved my trading results.
It actually took me 5 years to realize how dependant I had become on that information. That I actually made trade decisions based on how my account was doing.
Sounds crazy, but that's what I was doing. Switching off the information led to less stress in a trade and allows me to see the charts a lot more objectively. Thing is, seeing the results of a trade decision right on your screen might be detrimental to your trading, if you see your account ticking up or down by tens, hundreds or thousands of USD with each tick in the market.
It's one thing to know I'm down 10 ticks on a long ER2, which now trades at a support and most likely will bounce 20 ticks in no time, it's something different to see your account down say 1,000 USD in 15 seconds. Separating yourself from the money your position represents within a trade and only seeing the ticks your up or down is one thing, but seeing the result right on your screen makes sure you can't ignore it. You can't say to yourself it doesn't matter that I'm down 1 grand. You instinctively know how much you can buy with that 1 grand you just put in the sand (at least temporarily)


The Financial Philosopher said...

Dr. Brett:

That was one of your best posts in a while (and their all good)! Thanks!

Not being a PhD, my question is this: Are those life situations that create the "behavioral premises" or personal "setbacks" you describe be more a result of personality than a "behavioral premise?

As you may agree, each individual has a certain given set of skills. Some have strong "built-in" coping mechanisms and may not even be phased by any of those life situations you described. Others are "affected" by every minor setback that comes along -- those are the ones who can use a Psychologist or, even better, a consistent "diet" of philosophy books...

BundFox said...

Hi Dr Brett. I am a regular reader of your posts and particularly enjoy those about trading psychology. As full time trader of over 8 years trading my own account and training others in London prop shops I feel I have both a good understanding of the markets and the ideas and concepts that you speak about. Behavioral Premises are something that I often find in my trading and indeed I do apply the technique you describe to try and focus in to what I feel is the key skill in trading, that being trade location. Recently my trading has fallen away and anxiety about my performance is a daily challenge that I have to face. Having to consider all future possibilities about my position I found myself considering having to go back into employment and the behavioral premises example of the job interview you have given really resonated with me. Although I would like to think that I will be able to dig deep and not have to face this challenge, I am curious as to what solution you would recommend to somebody with the behavorial premises such as the job interview example.
Kind regards

Brett Steenbarger, Ph.D. said...

Hi Chris,

That's a great observation. Focusing on the trade itself and how the market is trading is key; focusing on P/L during the trade can be an incredible distraction.


Brett Steenbarger, Ph.D. said...

Hi Financial Philosopher,

Yes, I think you raise a great point: certain temperaments and personality traits are more likely to fall into particular patterns of behavioral premises. Personality does influence what and how we think, and there are strong biological determinants of personality!


Brett Steenbarger, Ph.D. said...

Hi Bundfox,

It's a great question; thanks. My short answer is that a focus on strengths is very helpful in any job search process. By addressing the strengths that would enable you to excel in the new position, you counteract the tendency to focus on past disappointments (which saps confidence).


joachin said...

Is this what Schiller calls ¨framing¨?

I think there is also a relation with neurotic behaviour.

A trader must be a truth seeker among market patterns. His search engine comes to be his/her edge.

rubin said...

I just wrote a long post then had to register with google and the post disappeared. I would be happy to re-compose it another time. But for now you will find info at ,supporting my views and which I feel will offer more equanimity and liberation from attachment to dis-empowering beliefs. Thanks to Brett for service.