Saturday, June 20, 2009

Social Cognition and Trading: Part One

Social cognition has been a prominent topic of study within psychology for many years, as psychologists have attempted to understand how we make sense of our social worlds. Related to social cognition is the study of how we process information within social contexts: thinking as a social, not just individual, process.

We are accustomed to viewing thought as occurring wholly within our heads. Even casual observation, however, suggests that much of how we process information transpires within social interactions. Physicians consult one another over problem cases; teens sort out problems together; and children learn to make sense of the world through transactions with parents and peers.

I would argue that much of the value of counseling and therapy is that they provide a social context for processing self-relevant information and experiences. Many times, an individual in isolation cannot understand why he behaves in a particular manner and seems incapable of changing his patterns. Through the social medium of counseling, he gains a fresh understanding of self, which opens the door to new ways of acting and interacting. Indeed, many times the changes rendered by successful therapy first appear within the counselor-client relationship, only later generalizing to wider social networks.

In the business world, we commonly find work teams tackling difficult problems; group processes--rituals and ceremonies--also provide fresh perspectives within religions. Executives hire consultants; alcoholics seek peer groups through AA. It is difficult to find spheres of life in which people do not turn to social networks for fresh guidance. Indeed, the entire phenomenon of online social networking--from Twitter and Facebook to virtual communities--reflects a recognition that how we think overlaps how we interact. To a surprising measure, thinking is a team sport.

There are interesting corollaries to this view. For example, intelligence may not simply be a function of how well one can solve problems in a test, but also a function of how well one can marshal the interactions needed to arrive at such solutions. When I interact with others, I experience my own ideas in a new context. That can either strengthen my convictions or lead me to modify them. You would be surprised at how much time hedge fund portfolio managers spend on the phone with peers, analysts, and brokers: they think by interacting, catching patterns in others' thoughts that cannot be viewed in market data. To a large degree, they are not trading the markets; they're trading the biases and consensus views of others.

With this as backdrop, allow me to advance an important idea: Much of the emotional disruption experienced by traders is a function of cognitive isolation. Facing only a screen, largely cut off from social processing, traders become--in a manner of speaking--less intelligent. They lose access to normal ways of talking out and testing out ideas. Without the perspectives of others, isolated traders lose perspective: small moves take on disproportionate significance; small pieces of market data are blown into biased views.

The decisions we make in a group/social context are not the same as those we would make in isolation. To be sure, group processes can dampen creativity and divergent thought; there is more to truth than popular perception. But group processes can also serve as a check on our cognitive and behavioral biases. Many a spouse serves as a grounding influence on their partner; many a business partner has reined in a colleague's impulsive tendencies. When we place a person in situations of heightened risk, reward, and uncertainty and *then* isolate that person from normal social regulatory interactions, the results are predictably dire.

Could it be that many struggling traders could succeed if placed within the right social contexts? The next post in this series will demonstrate that this can, indeed, be the case.