Essence of Trading: Emotional Imbalance Can Impact Your Trading Decisions (and Profitability)By on 2012 Apr 3 Tue 15:14:46
What I am going to talk about is not the kind of emotional roller coasters from life-altering events that we know for sure can cloud your judgement. It is something more subtle and will surprise a lot of people.
A Good Read
First, I have to mention the book Risk by Dan Gardner as one of the influences that drive me to write this article. I have the book for a long time. A reread of the book lately reminded me how easy people are affected by the environment they are put into. The implications of such influence on traders are profound and can affect their bottom line without them knowing the reasons at all.
There are two main points delivered by the book. First human mind functions with a 2-tier system – one by gut, and another one by our head. Examples after examples presented in the book on real-life events and experiments done by academics prove that humans can be conditioned by the information they get in touch with, without really reading or listening to them at all. Second is that once human gut is overwhelmed by a strong feeling, it in turn influence the opinion formed by the person in other issues as the logical part, the head, is suppressed.
All it takes is that a person is exposed to words / sound / visual that they can associate with a specific feeling or bias. Then the gut side of that person takes over. Opinions will then be biased disregarding the actual content of the news reports or articles these people that are going to read or listen to. The changes is subtle. Most of the time the opinion is just nudged a bit more towards the opposite end.
In normal situation, that is not likely going to affect people greatly because they can keep their opinions to themselves.
But the book shows us that when the biased opinions somehow formed right before decision making on important issues, it becomes a problem. From survey results, penalties given out to a sports team, emergency policy making, to people voting for their government officials , the biased opinions can really mess up the world.
The Sources can be Trading Related
Think about the news that people read in the morning – economic reports, earning results, overseas markets performances, etc.
All these reports are not written with plain wording. Instead, we see "strong economic data", "disappointing results", "overseas markets very bullish", "spectacular earning", etc.
All these words that one can associate with some kind of feelings, some we recognize consciously, some we don’t. Depending on the stories that a person read, it will shape this person’s mood without him/her knowing.
My guess is that if a person is conditioned in an aggressive or irritated mood, that can easily push the person to take on countertrend trades, oversized trades, or refused to cut losses. If a person is conditioned in a depressed or frightened state, the person will have difficulties pulling trigger or managing an existing position.
The Sources can also be Non-Trading Related
There are other news that are not related to the markets but you read them, heard them, listen them anyway. Keywords like "upsetting tragedy", "happy ending", etc.
The conditioning can also come from sound, visual images and physical contacts.
It can also be incidents like a prank done on you by co-workers, could not get a parking spot in 20 minutes, being reminded to exercise more by family members, etc.
It does not happen all the time, but occasionally the accumulated effect can be pretty one sided, and you will be conditioned without knowing.
Some Useful Techniques Known to be Helpful in Restoring a Balance Mindset
So many things can affect us, is there something we can do about it?
There are well known techniques people use to clear their minds. It can be simple and easy to do.
Techniques often used to clear the mind, empty your thoughts, or giving you the inter-peace:
- a walk
- a swim
- breathing exercise
Many people find that in order for a technique to be effective, you need to do that consistently.
The important thing here is to clear your mind from thoughts you are stimulated earlier in the day by media, email you read, website you browsed, etc. or emotional swings from major issues in your life. Given enough practise of the same routine everyday, even if your mind was clouded, you would still gain a small window of time that your mind is not filled with prejudice.
That moment of a balanced mind would allow you to make an assessment of yourself whether you are fit to trade for the day.
A balanced mindset is not one without an opinion. It is one that is flexible enough to see other possibilities.
i.e. You can be very bullish as long as you have an exit plan that you are going to honour.
Some People Find It Difficult to Read Charts All the Time
I have seen many people, given enough training in basic chart reading techniques, produce inconsistent results in their chart reading analysis most of the time. The idea that external influence affecting a person is a plausible explanation.
Some people are just affected by other people’s opinions more easily.
Some are just more pessimistic overall comparing to others.
Some are more optimistic than others.
Almost all of us, one way or the other, would be affected by our emotion in making a trade. But some people are just affected by emotions more often than the others. For these individuals, it is very difficult to separate their objective analysis and emotional bias.
I am not sure to what extend the techniques mentioned above can do for these more emotional individuals.
The Goal – A Detached Mindset
Without a balanced view, the basic rule of letting the chart telling you the story is violated. The rest of the decision making process is no longer applicable. This is effectively turning trading into gambling and we know it is not a good thing. Worst yet, if the ability to accept a loss and move on is shutdown from the analytical process, a small loss is likely going to turn into a disastrous one.
If you find yourself struggling with trading from time to time and that it seems like the bad days coming from nowhere. Take some time to reflect on yourself to see if it fits the symptoms described here. If so, you should give the mind clearing techniques listed above a try.
The goal is to eventually detach your emotional side from your trading decisions. It sounds easy but it is quite difficult for most people.
Think of a physician – before qualifying as one, the rigorous training required is a process to enforce diagnoses done with professional knowledge and opinions with the goal to minimizing the impact of judgement affected by outside influence. Even with intensive training and actual experience, it is not possible to eliminate all the errors made.
Surgeons are generally recommended not to operate on their close relatives for a good reason – the emotional aspect of a person can affect his/her professional judgements.
After all we traders are just humans.