Thursday, August 23, 2007

Stress, Coping, and Trading: The Role of Appraisal

The transactional model of stress and coping offers several important perspectives that are relevant for trading and investing:

1) The Role of Appraisal - Our stress (flight/fight) responses to life challenges are mediated by our appraisals of situations. It's how we think about situations that contributes to their stressfulness. I recently spoke with traders about perfectionism. A trader up for the week can make seven winning trades and three losing ones and still feel stressed out if he or she focuses on the losers. Conversely, traders can draw down but not be threatened by that, knowing that they have come back from similar setbacks. Stress, therefore, is a function of person/environment relationship: the interaction of situations and how we think about those situations.

2) Primary Appraisal - Our primary appraisals are ones in which we evaluate the danger of events: their threat value for us. This includes psychological as well as physical threat. For instance, one trader trading his own money might lose 3% on a trade and not worry at all: he has 97% of his capital remaining. Another trader might be working at a firm with tight risk guidelines and might fear being fired for such a bad trade. Many times, stress is mediated by primary appraisals that reflect the personal meanings of events for us. A trader might look to trading as a source of independence in life; not having to work for others. Losses may, therefore, be especially threatening, because they are perceived as a threat to that emotional life goal.

3) Secondary Appraisal - Our secondary appraisals reflect our assessment of our ability to handle challenging situations. We are more apt to respond with stress and distress when we perceive that we do not have the resources needed to meet our physical and emotional needs. Experienced traders who have weathered a number of drawdowns make the secondary appraisal that this is a normal occurrence and that they have the tools to effectively handle the situation. Newer traders may lack this experience and doubt that they can come back. This will make even relatively small losses feel quite threatening. Our stress responses thus reflect, not only evaluations of environmental threats, but assessments of our own abilities to deal with these.

Now here's an important idea: When we employ a coping strategy, we're coping not just with a situation, but with our primary and secondary appraisals of that situation. How we think about situations, in life and in markets, affects how we cope with them. Many times our coping responses are ineffective (i.e., they don't protect us from psychological pain) because our appraisals of situations are distorted.

Markets cannot stress us out unless we appraise them in ways that make them personal threats. Many times, it's our trading practices--our failure to control our trading size, frequency, and risk per trade--that contribute to those threatening appraisals. Other times, it's our unrealistic expectations that yield appraisals of threat.

We cannot control markets, but we can control our trading practices and our expectations. That is an important source of psychological edge in trading.

My next post in this series will outline different coping strategies and what these can tell us about our appraisal processes.


Bridging the Gap Between Hot and Cold Cognitive States

The Most Important Psychological Skill for Traders

The Most Important Psychological Skill for Traders - Part Two

Changing Your Self Talk