Sunday, March 13, 2016

The True Reason Psychology Is Central To Trading

Traders have an enduring interest in psychology because they recognize the degree to which success requires change.  This occurs at two levels.  First, most fundamentally, markets behave in ways that run counter to normal human biases and tendencies.  If we simply follow our feelings and sell when markets look scariest and buy when they are most euphoric, we will lose money with alarming consistency.  If we seek the comfort of the herd and buy when others are optimistic and sell when they are pessimistic, we similarly court negative returns.  To trade markets successfully, we must wire ourselves as markets are wired--and that requires changes in how we think and feel.

A second level at which change is central to trading is that markets themselves are always changing.  Sometimes we observe momentum in markets; other times we experience mean reversion within trading ranges.  Sometimes markets are volatile and we can harvest large moves.  Other times, volatility is low and we must take what markets give us.  If we simply had to rewire ourselves to fit markets once and for all, that would be challenging enough.  To rewire ourselves as markets continually change requires unusual flexibility--and a capacity for continuous change.

This, most fundamentally, is why psychology is important to trading.  In adapting to markets, we must continually adapt.  We must change at a pace no slower than markets themselves change--or we will be left behind.

Once we realize the importance of change to trading success--and the need for relatively rapid and continuous change--the crucial question becomes, "How do we effect change?  How do we adapt ourselves to ever-changing environments?"

I address this issue in my most recent posting for Forbes.  It is little appreciated that there is a deep research literature on human change processes.  It goes relatively unnoticed to the general public because it has been conducted under the umbrella of outcome research in psychotherapy and counseling.  The study of how people make changes in therapy--and how they sustain those changes--has become a central theme of that outcome literature.  As the Forbes article makes clear, we change, not by motivating ourselves or trying to talk ourselves into thinking or behaving differently, but by absorbing new life experience.  

Do you wish to become a more patient trader?  You can write in your journal, and you can attach sticky-note reminders to your screen, but ultimately you will become a patient trader when you experience yourself as a patient person.  That means using your non-trading life to cultivate patience, placing yourself in roles that push you to be the patient person you wish to become.  Perhaps your child is having trouble with math in school and you can act as a patient tutor.  Perhaps your home needs curb appeal and you can grow and maintain a garden.  Doing things with patience, one small step at a time, builds the patient identity.  So it is with all the changes we seek to make.

We will never become greater risk-takers in markets if we approach life with risk aversion.  We will never be organized and disciplined in trading if we are scattered in our daily lives.  Everything in life, approached properly, is an opportunity to exercise the capacities we most require in our trading.  This is how becoming a better trader is a path to becoming a better person.

If we can move one stone at a time, make one small change here and now and another one the next day and yet another the next, before long we will have moved a mountain.  What the research on change tells us unequivocally is that we change when we internalize new ways of doing and viewing and we internalize those new ways through repeated, fresh experience.  Every day is an opportunity to move a stone, in our trading, in our relationships, in our lives.  We can become the best traders possible by cultivating trading strengths in our personal lives.

Further Reading:  The Most Powerful Change Technique Of All