Sooner or later, it is bound to happen. The markets conspire to converge in a way that fits your optimal trading strategy. You see it, you know it and then at the same moment, the phone rings, or the boss yells or the ….. Something happens that interrupts your ability to execute as you planned and you miss the trade. In those moments, it seems that you are cursed. It seems that all of the time, energy, effort and money spent learning to read the markets is for naught. The whole endeavor is doomed.

And what do you want to do?

Dollars to donuts, the urge is to take another trade. The feeling of needing to do something… anything… is totally consuming. Chances are you have already done something before you even realized how consumed by the energy you are/were.

It so happens that a version of this is happening to me the author right at this very moment. For months, the CME Group and Trader Psyches have been working on an event in New York wherein I am the featured speaker talking about how the brain perceives uncertainty and unknowable probabilities. I have been working on reading all the latest research to put a really stellar, worthwhile talk together… and just now I get an invite from a woman who told me she would promote it, who is holding a competing event! Besides flabbergasted, I am infuriated.

And the ONE thing I know NOT to do is trade or even look at the markets!!!

See the markets are very deceiving because we can always act. We can reduce our annoyance, frustration or anger by substituting the feeling that we are doing something. And yes we are, we are taking a risk that will either make money or not. Most likely, if the trade is perceived and conceived within the feeling of wanting to reduce the frustration (DO SOMETHING god damn it!), the odds of the perception being accurate are just about zero.

What does this get us? For a moment we feel better. We took control of our situation and made something happen. Then the price starts to move. It may even tick in our direction for a minute. If we are lucky.

The next feeling is “Oh S***”, the D*** trade isn’t working!” At which point, we either stop ourselves out and feel doubly worse than we did at the beginning of the blog post (only to watch it turn back) OR we insist we have power and take the stop out altogether. “It will come back we tell ourselves.”

The hardest part about this whole scenario is it is SO natural to want to take action when we are frustrated. It is particularly natural to want to take action in the arena that frustrated us. In the markets, that never works. But knowing that intellectually won’t help you. Otherwise, Trader Psyches would never exist because everyone knows this intellectually.

Doing it is hard because it is about allowing yourself the feeling but also the capacity to think about the feeling in order to find the best course of action.

Anger always has an instructive message buried deep within. We have unfortunately been brain-washed to believe otherwise because we have confused feeling with acting. Maybe it is telling you, you need a trading bubble where people can’t get to you. Maybe it is telling you to find another way to focus.

In the meantime, punch a bag, pillow, chair, even your desk. Pound on the wall. Write a comment on this blog. Just DO NOT take a trade – at least until you know what the real lesson is.

Finding that lesson hidden within the fury is the action you need to take!

Conventional wisdom (and even academic research) says/said that we have basically three parts of our brain – the old lowest brain that helps us breathe and makes our heart beat, the “mid-brain” where emotions occur and the frontal cortex or higher brain where our more highly developed, analytical and linear thinking occurs. A second way of categorizing the brain is right to left with the right being generally speaking more artisitic and the left being more scientific.

At least the former, the old “triune” brain idea is now, well how can I put this delicately, WRONG. It began with Damasio in 1994 and Descartes’ Error and continues at an exponential pace today with researchers like Tor Wager and Lisa Feldman Barrett but the tsunami of evidence that we can’t make a single decision without a functioning foundation of feelings is just that – a tsunami. For example, Damasio, now at USC, has provided experimental evidence wherein the lack of healthy emotional circuits prevents an otherwise normally functioning human to be unable to choose between two outfits of clothing. Colin Camerer of Cal-tech, noted game theory expert, said in his 2005 summary article with Lowenstein and Prelec of Carnegie-Mellon and MIT respectively, in the Journal of Economic Literature “It is not enough to know what should be done, one must also feel it.” Barrett just did a summary article on all of the MRI pictures of emotion acting in the brain and concluded that neural networks facilitating emotion infiltrate areas within the frontal cortex. There is even evidence that we can’t identify an object, i.e. our sense of sight won’t work without an emotion firing first.

It is ironic because on one hand the book blink has been a huge hit and its message is to use “gut-feel” much more often. Simultaneously, the vast majority of us still believe that feelings are detrimental to good decision making. The answer lies in each individual learning a whole lot more abut their own feelings. There are impulsive feelings and there are intuitive, unconscious pattern recognition feelings – one is helpful and the other is deceptive.

It is indeed possible to learn the difference … and it is even more indeed, profitable. After all, isn’t the ping pong between confidence and fear what drives markets anyway? Markowitz said in one of his first treatise’s on Modern Portfolio Theory that it all hinged on confidence but that confidence was something that he didn’t understand much of anything about. Today’s neuroeconomists are starting to fill in that open question.

What is this blog about anyway?

In short, it is supposed to be immersion in thinking about trading and behavior from a totally radical perspective – one where your emotions and feelings matter more than anything else. They will influence your perception of risk and in turn influence your decision making and the trades you take.

We get a little zealous about it because we see how powerful this realization is to so many traders. It also applies to all traders – from the newbie to the quant in Greenwich. How can that be? Well the underlying idea of you can’t make any decision without emotion is a human reality. The idea that we like to rely on numbers and probabilities MORE than we like to rely on squishy mushy feelings is well proven.

Why? Well for one – and it is a big one – it is easier. We know what to do with numbers while the qualitative aspects of feelings are something we have assiduously and theoretically wisely avoided for as long as we can remember.

That fact doesn’t change the real fact that without those feelings you can’t decide what to wear. It doesn’t change the fact that there is emotional motivation in every trade. It doesn’t change the fact that there is impulsive emotional energy in every deviation from the plan.

What it does do is mean that if you really want to make it in this business – regardless if you recently started or if you were laid off from JPM or even if you are at one of my friendly funds in NYC, the key to more effectively assessing risk is to get in line with your psychological capital. Or better put, get your psychological capital in line – front and center – and always the thing to be managed alongside of the probabilistic or mathematical risk.

ALWAYS.

When you feel confident, presuming you do sometimes feel confident, where do you feel it? Can you feel it in your brain or is it in your thorax (i.e. middle part of your body)? Better yet, why do I ask?

Well if you think about it, part of our mission here at Trader Psyches is to teach traders of all stripes how to use the message in Gladwell’s blink to assist in the d/m (that is decision making) process. The zillion copies it has sold prove the interest in it but the practical parts about what I read – sort of the “just do it” related to using your instantaneous impressions seem frankly impossible.

And I honestly still feel that most traders are for good reason, stuck in their heads. So, I ask this simple question – when you feel confident where does it hurt?

It is all too easy to forget that trading (not to mention life) is a physical experience. (See Descartes’ Error “I feel, therefore I Am” by Damasio) The path of least resistance is believing that risk decisions are mainly, if not exclusively, cognitive (thinking) events.

My just-ended golf weekend in Amelia Island reminded me how true this is. On certain chip shots I thought about things like ball placement and whether I wanted a full-swing or not. On others I “thought about” what felt right. I looked at the distance to the hole and just focused on the physical experience. Ditto for putting. Which do you suppose led to better shots?

If you said “thinking shots”, you are wrong with one exception.

I tried a whole new way to hit a sand shot and it required that I consciously execute each step. I couldn’t do it by feel because I had none. And true to the intent of this letter, the response of the much better golfers I was playing with was “great, now you have the FEEL of it.”

Trading is like this. At first you have to intellectualize a risk situation. But the best results come when you arrive at the place where on top of that cognitive activity you can effectively layer an awareness and integration of the physical experience – the data that exists in your body not your head.

This is what is meant by the term “art and science”. Trading by definition cannot be a science as it is only the sum total of all human risk decisions but its numerical nature allows it to pass as a reasonable facsimile. The idea of financial engineering btw is kind of an over-statement. There is no engineering of markets. Anyway, as for the art part, the thing that is missing from almost all trading advice is how to research and interpret data that isn’t presented in statistical form. Or put another way, how to leverage the qualitative along with the quantitative.

The vast majority of experts will still tell you not to try.

The irony of that is your brain is going to interpret market data via pattern matching regardless if you want to use that input or not. Most importantly, the holistic system communicates the result of the pattern match through the physical feeling-sensory-dimension of our existence. The reason the conventional wisdom is so wrong is that it never learned to distinguish between the feeling of an impulse and the feeling of an intuition or what comes to feel like instinct. That however isn’t a good enough reason to stick with the old earth is flat/intellect is all approach.

The way we see it, the brain will always win in the end so why not get started as soon as possible on working in concert with a brain and a body that work together to assess and address uncertain situations – price movement or sand traps. The job might be as hard as learning to shoot a 90 but did you really think other traders or money managers were going to let you take their money without a fight?

Bring all your faculties to the game!

Lisa Feldman Barrett along with others such as Tor Wager lead the world in the science of emotion. Last year she published a meta-analysis of all of the neuroimaging (brain pictures) studies on emotion. While to a researcher, the work certainly generates more questions than it resolves, to us laypeople trader types there is one salient point – emotion and cognition or feeling and thinking DO NOT happen in two separate parts of the brain. In fact, it is fair to say that what are known as sub-cortical and cortical (cortex) regions work together in all sorts of emotional experiences.

Why does it matter to trading success? Two reasons – just more proof that any effort at controlling emotions is wasted and more importantly, just more proof that learning how to leverage emotional data – both as a risk management tool and as a tactical judgment factor is an investment that will pay off in spades (and trades).

See “Kober et.al. 2008 Functional Networks ….” (hey it is my blog, I don’t have to follow the science reference syntax!)

Everyone thinks the market is a game of numbers. We use complex models, umpteen oscillators or retracement calculations and even a fundamental analysis of supply and demand – all based in numbers and about numbers.

But in reality, the numbers of the market are but an illusion.

Markets are only the vacillating prices that other human beings, using the same mathematically based tools, are willing to pay. For example, what can be expensive one day can be very cheap the next if a trend has ensued.

It is only a matter of perspective. And perspective is a matter of the judgments you make.

Judgments on the other hand will be influenced by both impulsive feelings and by intuitive feelings – or pattern recognition. The trick is to have all the data on the table so you can tell the difference.

In order to do this, us market participants need to do a couple of things – give up the notion of a iron-clad trading plan based purely on historical probabilities and replace it with a trading plan based on historical probabilities (yes you read that right) AND a systematic way to leverage your judgment under uncertainty. This way you can make a decision about factors that may now be in play for the future probabilities. I mean who thought the VIX could stay over 30 for 6 months? … I am just askin.

Now in order to do this successfully, you have got to learn to optimize your judgments – which means spending more time focused on deciphering and understanding them than you spend on deciphering and understanding the charts.

This is revolutionary trading psychology – and it works.

“I return from holiday rested and relaxed, to quote Ben Lichtenstein, “I have tasted the sweetest Mediterranean tomatoes brought to me by dusky maidens and washed down with oaky red wine in the shade of orange trees, I have felt real warmth from the sun on my skin again.” Pulling up a chart once more, and looking at the comments to my previous post, I am full of good will. I have set aside my weapons of war and my heart has turned to love.

I do not quite, however, see trading as some kind of sixties group hug, where there’s plenty of weed for everyone. The money has to come from somewhere after all. So where’s the love? There are so many beautiful trades, so little time. How to choose? I should explain that I am truly a romantic. I long for commitment, for a lasting relationship. I enter each trade with the same hopes, the same fervour, the same simple faith that our love might last forever, that we will trend and trend and never look back. Once the first flush of my passion is over and my first target filled, my second half is there for as long as my lovely companion continues to show interest. And I am quick to forget the sins of the past: if I have been hurt by Cupid’s arrows before, I myself have wounded too, and will happily embrace again yesterday’s lover.

On my return, I found that the languid Euro (I always see her as French don’t you?), has invited me to join her for the afternoon. Charmed, I accept her invitation, but find her at first quarrelsome then sleepy. I take what pleasure I can, but as she dozes, I notice the door push open and her pretty blond cousin from Switzerland winking at me and beckoning to join her. Perhaps all that mountain air gives her more energy, but I am pleasantly surprised by her enthusiasm while Euro sleeps, and even more so when she introduces me to a young American friend she has made, a certain Mini Dow from Chicago, who is eager for me to help her with her extraordinarily tight shorts. Naturally, we have met before. From the window I see that the fickle Miss Soy Bean has made other friends while I was away, and seems to have had a fine old time after kicking me out of her bed just before I left for my holiday. But I forgive her already. I love them all, and I know that despite our occasional tiffs, we will always make up.

Before I let my imagination go too far, or grossly offend anyone, I should perhaps say two things: first, I would like to assure you that I am neither a psychopathic killer nor a serial philanderer. This is all part of a game to engage the psyche with the human side of trading, to connect the flickering numbers and bouncing price bars with some of the real human feeling that this strange activity has such a capacity to generate. And yes, perhaps trading does touch on the darker side of our psyches. By acknowledging this I believe there is a chance we will become better traders.

Secondly, there are of course many metaphors for trading, and I certainly don’t see combat as the only one. I have found helpful comparisons with sailing (attention to currents, the tide, the strength of the wind etc), viticulture (trading is like harvesting a crop, a stroll through a vineyard in search of the ripest and juiciest grapes, much is wasted, but the wine at the end is worth it), skiing, paragliding, the list goes on. I am sure there are many ways of visualising the process, and each trader must find what rings his or her bell. Ultimately, trading is the Lottery of Babylon in Borges’s story – it is like life itself, filled with perverse rewards and punishments, a labyrinth of both startling simplicity and complexity. Recently, though, with Denise’s help, I have come to see a particular reality in metaphors that recognise the traders on the other side of my trade, and my attention to detail, my ability to use judgement to enter or exit a trade at the right moment is linked to that sense of my enemy’s strength or weakness, or of my lover’s enthusiasm or languor.

Now, you’ll have to excuse me, but I must go and get some flowers for Euro before she wakes up.”

Trader K

April 7, 3:23 PM

Dear Denise,

I feel like I have stepped into a new area of understanding. Tracking my emotions by writing down what I am feeling during trading, is making a huge difference for me! I mean, it is FANTASTIC! I am amazed at how many emotional adjustments I do (or desire to do) to my trading. Things I never even realized, except that now I am making a conscious effort to write it down. Like realizing this morning, after I was short YM from 7807… that I had went to “deactivate” the trade as the market jumped back up, but it filled me before I could do that… literally as I was moving the mouse. At the time, I completely forgot the “impulsive” because I was so elated to be short from that area, as it immediately started going my direction… However, had I acted on that impulse, I wouldn’t have been in a beautiful trade as it tumbled 50 plus points.

But now, I realize what was happening to me. My emotions were dictating my trading in ways I never even knew. Especially in high frequency trading. Reading your work, applying it, monitoring myself, writing down my feelings, is really paying off. I am trading less, and making more money. This week and last week have been incredible.

I feel like the light just went on, the eureka moment has happened, and that I am learning to listen to my emotions, instead of trying to be the “Iron Man Trader” with cold, disciplined psyche. Am I emotional, as I write this? You better believe it! I am pumped at what I am learning.

Thanks, thanks, THANKS!

#1 (Wed, April 1): There surely can’t be anything worse in trading, than setting up a trade… entering it…. but then getting psyched out to close it with a small loss… minutes before it drops 60 pts and does exactly what you forecast. Like shorting YM at 7706. (Always enjoy your blogs)

ME: Would you like me to post this to the blog?

#2 (Later, April 1): Would it need to include me yelling and beating the steering wheel of my truck as I drove away post 4:00 close?

ME: It would be more interesting if it did

#3 (Even later, April 1): Sure, I actually did that after I emailed you… LOL. But the reason I continued with it, was your teaching on “verbalizing the emotion”. I consciously remember thinking that…

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Point being? Counter-intuitively and certainly counter pop psychology is the power of being totally aware of what emotions are occurring. Putting them into words serves as the best risk management tool for derailing impulsive trades which are born out of acting out feelings that aren’t so conscious or are being purposely “controlled”.

To the Tpsyches way of unconventional thinking, this is the advanced trader psychology of managing psychological capital as carefully, if not more carefully, that you manage your cash capital. Addressing the first automatically takes care of the second.