Sunday, January 29, 2017

What Is Your Explanatory Style as a Trader?

We are wired to make sense of our experience.  We look for reasons that events occur, developing explanations that make the world understandable for us.

Imagine that the same event occurs for two people:  They lose their job.

The first person blames the job loss on his bad luck, lamenting that nothing goes right in his life.  He tells himself that he lost his previous position and this job loss will be just as devastating for his future.  He views future career opportunities as equally insurmountable, doubting his vocational future.

The second person sees the job loss as an unfortunate byproduct of the company's retrenchment in a weak economy.  She tells herself that this won't be the case in all industries and that the economy will soon improve.  She sees the weakness in the industry she had been working in and considers applying her skills to a different industry with greater growth prospects.

The first person has an explanatory style that is internal (self-focused), stable (situation not amenable to change), and global (apt to occur in all situations).  That explanatory style easily leads to a pessimistic, depressed mood.

The second person has an explanatory style that is external (situationally focused), unstable (situations can change), and specific (unique to this particular occurrence).  That explanatory style easily leads to a more optimistic, energized mood.

The first person's explanatory style leads to blame; the second's style leads to adaptation.  The first style is disempowering; the second is empowering.  If I have an external, stable, global perception that markets are manipulated by shadowy forces beyond my control, I will not feel competent to succeed.  If I have an internal, unstable, situational perception that markets offer different opportunities at different times and that I can adjust to detect patterns in various regimes, I will feel in control of my success.

The term explanatory style suggests that each of us develops a characteristic way of viewing self and world.  Sometimes we can impose that style onto events inaccurately, coloring our perceptions and reactions.  Pessimistic explanatory styles tend to rob us of energy; optimistic styles tend to energize us.

How we talk to ourselves after successes and failures colors our emotional reactions to those market outcomes.  Many times traders can oscillate wildly from overly optimistic explanations ("I've finally figured these markets out!") to overly pessimistic ones ("I'll never be able to succeed.").  That instability makes it difficult to sustain a consistent quality of preparation and effort.  On other occasions, traders will pass off failure as a function of bad luck and "algos", thus preventing themselves from truly learning from their experience.  The perfectionistic trader implicitly assumes all trades should be successful, thereby experiencing random, expectable losses as failures.  That takes a heavy toll on morale.

How do you explain your outcomes in markets?  How do your explanations impact how you subsequently think and feel?  How you learn?  If you review your trading journal entries and reflect on your self-talk, you can identify your own explanatory styles and how they might be impacting your experience during and between market hours.

Further Reading:  We Gravitate Toward Our Self-Talk