Sunday, August 07, 2016

Control Your Ego, Listen to Your Emotions

A commonly encountered view in writings on trading psychology is that good decisions require that we tame our emotions through discipline and self-control.  Many of those same writings talk about trusting your gut and not overthinking decisions.  How we are to be open to our feel for markets and yet trade in an emotionless, zen-like state is left unanswered.

In this post, I will propose something different.  Our task as effective traders is to tame the ego, not dampen our emotions.  Indeed, it is when we trade without the ego that we're most likely to be open to our feel for what markets are telling us.  

The recent post made an important distinction between understanding and prediction.  Discretionary traders seek to understand market behavior from the ground up, by listening to markets the way we listen to people when we seek to understand them.  When traders become uncomfortable with market uncertainty, they often seek false security in predictions.  They impose views from the top-down, and they stop listening to what markets are trying to tell us.

Why do traders become so enamored with prediction?  Perhaps it is because prediction is all about us.  We are the ones calling the moves and leading the markets.  In the dance with markets, the trader seeking understanding lets the market lead and takes their cues from the market's steps.  When we seek prediction, we seek to lead the dance with the market.  It becomes about us.

It occurred to me after writing the post that, when I've developed quant models of market behavior than anticipated a move, I've often heard kudos from others about my "good call."  When I'm a psychologist and listening to my clients, helping them make changes in their lives by accessing strengths they didn't realize they had, no one compliments me on good calls.  As a psychologist, it's not about me; my ego is placed as far to the side as possible.  It's about listening to others and discovering those hidden strengths.

Emotions become problems in trading when they follow from our ego involvement in decisions.  If we're making a market call and looking for self-validation by anticipating a market move, then it will be particularly frustrating if and when that move doesn't materialize.  We no longer feel validated.  If a trading decision is the result of listening and isn't about us, being wrong doesn't feel like being stupid.  Being wrong becomes information.  It tells us we have to listen harder, listen differently.

Imagine if I were to come into a session with a client with a clear conviction about what we needed to talk about that day.  Chances are good I'd miss what that other person had to say and might even create a frustration for them.  It's no different with markets.  Once it becomes about me, I can justify ignoring the messages of markets simply by calling myself a contrarian or a "mean-reversion" trader.  Very often, ego-involvement is the source of trading without emotional intelligence.

How ironic it is, then, that would-be trading coaches tell us to trade with confidence and double down on bets when we have our greatest conviction.  Listening to markets and following their lead requires the utmost of humility and open-mindedness.  The trader with supreme conviction is the one most likely to be blind as markets turn.

Once we put ego aside, we can pick up on market cues the way we pick up on the subtle nuances of tone and facial expression when we speak with those closest to us.  If I'm in a rush, focused on my needs to get to work, will I really be attentive to what my wife or children are trying to tell me?  We are wonderful pattern recognition machines if only we can learn to not superimpose our needs and views on what we're meant to process from the world.  It's when set the ego aside that we become most attuned to our feel for the world.

Perhaps the best trading strategy of all is to live a fulfilling life outside of trading.  If you don't need markets for your self-validation, you're less likely to seek those "good call" compliments, and you're less likely to make your profit/loss statement a barometer of your personal worth.  It's when we insist on leading the dance with markets that we're most likely to stumble as the music changes.

Further Reading:  Cultivating Emotional Creativity