Friday, January 11, 2008

Emotional Intelligence and Trading - Part One

Emotional intelligence is a term that has been popularized and, perhaps as a result, widely misunderstood. In point of fact, emotional intelligence is an active field of psychological research with strong underpinnings. It also conforms with our standard understandings of intelligence, as it describes a set of related abilities that develop over time. In the work of Mayer, Caruso, and Salovey, emotional intelligence is distinguished by four "branches":

1) The ability to perceive emotion;
2) The ability to use emotion to facilitate thought;
3) The ability to understand emotion;
4) The ability to manage emotion.

Discussions of the role of emotion in trading frequently emphasize the fourth of these branches, with "controlling" emotion or even minimizing/eliminating it a frequent goal. The risk of this approach is that it leaves traders emotionally unintelligent, without the ability to accurately perceive and understand emotion and utilize it to facilitate thinking.

Indeed, in this series of posts, I will suggest that it is not a lack of intelligence--but a lack of emotional intelligence--that frequently bedevils traders.

Research suggests that individuals who are emotionally intelligent tend to be more successful socially than their less emotionally intelligent counterparts. They are also less likely to engage in self-destructive behaviors, such as addictions. An emotionally intelligent person is more capable of reading the feelings of others and responding to them constructively. Might it be the case that emotional intelligence also mediates the ability to read sentiment changes in markets?

Many accounts of trading success--my own included--have emphasized cognitive skills (such as pattern recognition and reasoning) are essential ingredients. These are important to be sure, but perhaps it's the sensitivity to market shifts--the capacity to read these and respond appropriately, as one does in social situations--that also distinguishes the successful trader.

Psychological research finds that emotional intelligence is related to both understanding oneself and others. It is also involved in pattern recognition--the ability to detect when situations "feel right"--as well as the channeling of motivation. Indeed, much of what we call "discipline" in trading may be an expression of emotional intelligence as it relates to understanding, utilizing, and managing one's reactions under conditions of risk and uncertainty.

In short, the problem might not be that traders get emotional. The problem is that they can be emotionally unintelligent.


Controlling Emotion is Not the Goal of Trading Psychology

Personality Questionnaire for Traders

Emotion and Perceptual Bias in Trading