Thursday, January 17, 2008

Emotionally Intelligent Trading - Part Three

In the two previous posts in this series, I advanced the notion that emotional intelligence—not the elimination or minimization of emotion—is essential to successful trading. Emotional intelligence, we have seen, requires attention to one’s feelings and clarity as to their nature and source. By understanding our experience, we are able to transcend it.

So how does emotional intelligence show up in trading practice? Below I offer pairs of behaviors contrasting emotionally intelligent and unintelligent trading.

Intelligent Trader: Notices frustration building and pulls back from the screen to figure out what’s going on in the market and what’s going on psychologically.

Unintelligent Trader: Becomes frustrated, does not attend to the feeling explicitly, and acts on the frustration by taking on too much risk.

Intelligent Trader: Has a strong degree of conviction in a trade idea, knows why that conviction is running so high, and acts decisively on the conviction.

Unintelligent Trader: Becomes overconfident after a winning streak and increases the frequency of trading, thereby changing what produced the streak in the first place.

Intelligent Trader: Feels fatigue or distraction, realizes that this could interfere with decision making, and does not make any major trading decisions.

Unintelligent Trader: Feels fatigue or distraction, tries to ignore or push past it, and makes poor decisions.

Intelligent Trader: Thinks through various market scenarios ahead of the open or ahead of economic reports and is prepared to act accordingly.

Unintelligent Trader: Does not think through market scenarios in advance and reacts impulsively to the market’s first move at the open or following a report.

Intelligent Trader: Is aware of subtle cognitive and emotional cues when a trade “feels right” and acts on the implicit pattern recognition.

Unintelligent Trader: Becomes so caught up in catching the exact high or low on entry that he misses entering the position on a good trade idea.

Intelligent Trader: Recognizes quickly when trade is wrong, accepts the disappointment, and channels attention toward learning from the failed trade and preparing for the next idea.

Unintelligent Trader: Perceives that the trade is wrong, cannot accept the disappointment and pushes it away, and turns the short-term losing position into a longer-term hold.

Intelligent Trader: Feels boredom, recognizes that nothing is happening in the market, stops trading for the day.

Unintelligent Trader: Feels boredom and tries to relieve it by putting on trades with a marginal risk/reward edge.

Intelligent Trader: Sees that the market is moving, feels eager to get in, recognizes that others are also feeling eager, so waits for a pullback to enter.

Unintelligent Trader: Sees that the market is moving, feels eager to get in, does not reflect on the feeling, and chases the market move.

Much of emotional intelligence boils down to a three-step process:

1) Pay attention to what you’re feeling
2) Figure out why you’re feeling that way
3) Use the information from your feelings to guide your next actions

The first step toward emotional intelligence is simply recognizing that feelings contain information, but that the information is not infallible. Only after recognizing and gaining clarity about our experience can we make wise decisions as to whether to trade, fade, or ignore those feelings.


Trading With Emotional Intelligence - Part Two

Trading With Emotional Intelligence - Part One