Monday, December 21, 2009

Hedonic Adaptation: Taking A Break When You're Making Money

Consider the following scenarios:

* A person wins a lottery and is delighted to receive millions of dollars. Within a short amount of time, however, he adapts to the new financial status and is no happier than he was prior to the award;

* A person eagerly awaits retirement, but after being out of work for a while, feels no happier than when she was working;

* A person is quite happy to make his first six figure year as a trader, but the next year is frustrated at the same income level;

All of these are examples of what psychologists call hedonic adaptation. We quickly adapt to increases in our happiness, so that what initially brought joy now becomes the psychological norm.

This is quite relevant for traders, who may experience initial pleasure over gains in the markets, only to see the glow of the winnings fade. To recapture this glow, a trader may seek out further trades, much as a drug-dependent person might seek out subsequent highs after initial use.

An interesting study suggests that, when consumption is interrupted, people are less likely to experience adaptation, which in turn enhances the consumption experience. For instance, taking a break during a massage prevents a person from adapting to the pleasurable experience, heightening pleasure when the massage resumes. It appears that, during such a break, people recalibrate their emotional experience, coming back to a pleasurable event with a fresh perspective--much as a diner might freshen his or her palate between courses.

Indeed, the very experience of savoring an event may be a way of holding off hedonic adaptation and maximizing positive emotional experience.

This leads to the paradoxical conclusion that traders should consider taking breaks from trading when they're making money--not just when they're losing. By adjusting to the experience of making money, traders are likely to lose a sense of satisfaction and instead seek further (and possibly imprudent) gains through more (i.e., over) trading.

By taking a break during a winning period, a trader has the opportunity to savor the experience and reset his or her emotional barometer. Such a break does not necessarily mean stopping trading altogether during a period of high opportunity; that would be foolish. Rather, it means that fully experiencing the pleasure of gain might be the best way to mentally--and emotionally-- prepare for the next victory.