Tuesday, November 03, 2009

Trading and Response Inhibition

A trader recently told me of an interesting problem. He had no trouble making money during the trading day. His problem was holding onto the money. Basically he kept trading until his profits were gone. After repeating this pattern day after day, he was left with the frustrated sense of being a talented trader who had nothing to show for his talents.

His problem is in an area that cognitive neuroscientists call "response inhibition". Response inhibition is the ability to suppress actions that are no longer useful, so that attention and behavior can be channeled more fruitfully elsewhere. A function of the frontal cortex of the brain, response inhibition is central to executive control: without the ability to hold off unwanted behaviors, we cannot direct ourselves toward meaningful goals.

People with attention deficit/hyperactivity disorder have particular problems with response inhibition; this appears to be at least partly a heritable characteristic. This raises the interesting possibility that people are wired differently for response inhibition, with varying degrees of control. It also suggests that, just as children with ADHD can learn skills related to attention and rule-following, people may be able to learn response inhibition as a skill.

We generally think of trading simulations as teaching the ability to trade. For some, however, their value may be even greater as tools for learning to not trade. In other words, simulations can be used to exercise one's capacities for self-control. One way of accomplishing that would be to limit the number of "clicks" allowed to the trader during a trading session: if only a limited number of trades can be placed, the trader's task becomes one of finding the best opportunities to make the clicks. Most importantly, the trader learns in ambiguous situations to *not* click: to inhibit the trading response.

It is common to hear traders describe trading as 90% psychological. It could be, however, that the lion's share of trading is neurological: dependent upon our wiring for planning, control, reasoning, and proper response inhibition. Training programs teach people to make trades; some traders, however, could equally benefit from a gymnasium of the mind that trains them to refrain from action.


ChartingStock said...

Excellent Point Concerning The Importance Of Refraining From Decremental Action. Keep Up The Great Work & Thank You For Sharing.
Posted By @ChartingStock

omi said...

Right on! I had that problem earlier, it was grave. Now I'm making less trades and often not trading. The counter side is I'm not taking many setups that I'm upset they would work out so well...

However, I realize that it's for the best. The same thing as the penalty for taking on less risk is smaller than the penalty for taking on larger risk.

Steveo said...

Market Perspective
Tim Knight is strong on using log scale. Others prefer linear, sometimes for shorter timeframes.

This Dow Jones Total Market chart shows a point between the log and linear.

And a hell of a confluence of trendlines like a laser war and the DCW index totally tapped its 50% Fib line. Amazing, and thank you Mr. Fibonacci. You rock almost as much as Bernoulli.