Tuesday, May 06, 2014

Why Emotions are Key to Trading Performance

The first post in this series took a look at how emotional experience impacts risk-taking and decision-making.  As the above quote suggests, discussions of emotions and trading often focus on fear and greed.  Two important, but lesser appreciated emotions that impact trading are frustration and fulfillment.  The frequency with which you are in a flow state--a state in which you are wholly absorbed in what you are doing--is probably the best psychological test of all.  The reason for this is that we are more open to experience when we are in the flow state; it is a mode of enhanced information processing.  

The flow experience occurs when there is an optimal balance between the challenges we face and our level of talent and skill.  When challenges overwhelm our abilities, we experience frustration.  When we are insufficiently challenged, we experience boredom.  Both frustration and boredom keep us outside of our doing.  In the flow state, we are immersed in the doing, so much so that time can pass without our notice.  As the diagram above indicates, much of what we experience in performance situations can be explained by the match or mismatch between skills and challenges.

The British novelist and philosopher Colin Wilson observed that acts of will--often brought on by crisis--can overcome frustration and boredom and transport us to a flow state.  "We spend most of our lives in monoconsciousness," Wilson writes, "a narrow state in which we are only aware of the present moment.  It could be compared to being in a picture gallery but being forced to stand with your nose within an inch of the canvas."  When we can stand back from the picture and truly apprehend its beauty, our narrow state is expanded: the petty worries and concerns of the present no longer matter.  This can only occur, however, if the picture absorbs our attention.  It is the act of focusing--and sustaining a focus--that turns mere seeing into perceiving.

It turns out that there are physiological factors that account for Wilson's observation and the flow state.  Our attentional focus is improved when our brain's prefrontal cortex receives a jolt of dopamine.  When we experience something as intrinsically interesting, fun, and/or challenging, that jolt keeps us engaged in what we are doing.  In an important sense, highly productive, creative people who have cultivated the ability to sustain flow states do so because of positive addictions.

A recent post by Abnormal Returns offers trading rules for new retail traders.  Tadas makes the excellent point that there are many opportunity costs associated with developing trading mastery.  The time and effort required necessarily eat into other potential productive and rewarding activities.  It only makes sense to forgo those opportunities if one can find in trading the quality of emotional experience that comes from the flow state.

We can best learn and master markets if we are absorbed in them and their patterns.  We can best sustain absorption if we structure our learning so that tackling challenges provides us with shots of dopamine, not frustration.  It's not just about fear and greed:  emotional experience is essential to trading mastery because it provides the conditions under which we best learn and perform.

Further Reading:  What We Can Learn From Sport Psychology