Friday, July 04, 2008

Cross-Talk: The Role of Emotion in Trading

SFO Magazine has another trading psychology issue available, and there are several articles worthy of a look. Here is the link to my article in that issue.

The theme of the issue, as titled on the magazine cover, is "Contain Your Emotions". Here is a sampling of quotes from articles included in the feature:

"It is a generally agreed upon industry fact that traders spend a disproportionate amount of time focusing on external market analysis and significantly less time on understanding themselves as traders."

"...while it's difficult to contain emotion 100 percent of the time, the more you can keep it at bay, the better off you will be."

" is be able to sustain calm without having to mask roiling emotion. One key to success is to be calm and methodical in general and at every point in the trading journey..."

"Markets are full of endless opportunities, and the only obstacles preventing us from consistently capitalizing on them are our own mental models..."

Well, you get the idea. Emotion is bad and if you control emotion you'll succeed.

Contrast that view with this quote from my article:

"Just ask yourself: Would you want to be operated on by a physician who put as much time into keeping on top of his profession as you put into your preparation for trading? Would you want to be represented in court by an attorney who put as much preparation time into your case as you put into your trading days?"

If you don't understand markets, if you don't systematically prepare for trading, and if you haven't sufficiently rehearsed trading-related skills, you'll perform miserably and you'll become emotional. Plenty of emotional traders contact me seeking help; the vast majority trade simple patterns that have no demonstrable edge whatsoever, do not understand intermarket relationships, and do not know how to read intraday market sentiment. They're emotional because they haven't a clue.

Because emotionality enters into much bad trading does not mean that controlling emotion will, in and of itself, lead to successful trading. That's like saying that infidelity is common in bad marriages, so if you contain your urges for people other than your spouse, you'll enjoy a blissful union.

The question that should be addressed is *why* emotion is playing a destructive role for some traders and what, specifically, can be done about that (just as the question for any competent marriage counselor would be *why* the desires for infidelity are there to begin with). The idea that emotion is bad and should be minimized in decision-making is flat out wrong; cognitive neuroscience research is clear on the role of emotion in normal, sound thought and decision-making. When people's capacities to feel are genuinely minimized--through brain damage--*that* is when they behave in irrational, maladaptive ways.

Of course, emotions of fear, greed, overconfidence, and anger can skew our decisions and actions. But there are two major reasons these emotions can intrude into trading:

1) The trader is biologically predisposed to a high degree of negative emotional experience (i.e., the trait of neuroticism) and probably shouldn't be operating in a field with high degrees of risk and uncertainty;

2) The trader has not sufficiently studied and learned markets, is not succeeding at his/her decision-making, and is becoming frustrated and emotional as the result--not the cause--of trading problems.

It's unlikely that trading coaches offering commercial services will emphasize either of those perspectives. Many traders, as well, want to hear the message that if you just "contain your emotions", you can participate in "endless opportunities"; that traders don't need to spend as much time on "external market analysis" as long as they work at "understanding themselves as traders."

The truth of the matter, in trading as in other performance fields, proper training is the best source of discipline and the most effective safeguard against intrusive anxiety and impulsivity. Learn how to trade well and you'll master most emotional difficulties associated with performance. Learning to "contain emotions" without proper cultivation of trading skills will only help you more comfortably part with your capital.


Somatic Markers and Trading

Trading and Intuition

Trading Psychology Myths