Tuesday, July 28, 2009

The Importance of Gut Hunches in Trading

As background for this post, I recommend you take a look at this post on the role of somatic markers in trading decisions and this post on the role of intuition in trading.

What cognitive neuroscientists are finding is that emotion--those gut hunches--plays a critically important role in decision making. That is especially true of rapid decision making in the face of risk and uncertainty. A fantastic recent New York Times article captures how gut hunches are crucial in military battle. The article makes clear that the body often senses danger before the mind makes the identification.

One fundamental fact keeps psychologists busy in the world of finance: the emotions associated with performance pressures--that legendary fear and greed that traders and investors know well--are stronger than the emotional cues from our gut hunches. When we are frustrated or overconfident, we unwittingly override the more subtle signals from our body's pattern recognition of danger or opportunity.

An important implication is that experienced traders--like experienced soldiers--generally know more than they know they know. Their implicit knowledge can only be accessed, however, if they are in a receptive state. This is why techniques for enhancing a calm state of focus can be so helpful for trading performance.

All too often, our self-talk submerges our gut hunches. In other words, we talk to ourselves when we should be listening.