Thursday, October 01, 2009

A Cognitive Strategy for Overcoming Frustration in Trading

My recent post emphasized the importance of overcoming frustration in trading. In this post, we'll take a look at a cognitive approach to dealing with frustration and its effects on trading.

Cognitive theory suggests that we do not respond to events themselves, but rather to our thinking about those events. If I get a "C" on a test after not having time to study, I might feel very good, knowing that I passed. A different person taking the same test might feel depressed with the same grade, crushed that they did not finish at the top of the class. How we process the event affects how we respond to it.

Similarly, when traders are overcome with frustration, cognitive theory suggests that it is not their losses, but their thinking about their losses that generates their stubbornness, self-criticism, and overtrading.

Specifically, traders need to process losses as self-esteem events if they are going to generate strong emotional responses. (Note: lost opportunity can be as threatening for a trader as realized losses). The frustrated trader, at some level, feels that losing is a sign of weakness or incompetence: that taking a loss makes one a loser.

It is the desire to avoid feeling like a loser that typically gets the frustrated trader holding onto losing positions and overtrading to make money back. Ironically, those very reactions make it more likely that the trader will experience catastrophic financial losses.

A cognitive approach to overcoming frustration would be to rehearse ways of thinking that make losses non-threatening. This is why, in the coaching book, I stress the idea of actively embracing losses and learning from them. When we take a loss, it means that either we did not execute our idea well or that our idea was wrong. Either can be an opportunity to learn.

If our self-esteem comes from learning, growing, and developing--not from being perfect or being the best--then we do not need to fear our shortcomings. They fuel efforts at self-improvement.

A daily program to transform yesterday's losses into today's goals achieves an important psychological alchemy: we take what has been threatening and frustrating and turn it into a potential source of pride.