Market ambiguity compels you to make impulsive judgments … . Not enough sleep… . I can go on and on and on… and talk to you about your emotional architectures and using emotion analytics to better manage your risk as well as better deduce opportunity.

But here is a little “emotion analytics” trick -

Ask yourself – as you are contemplating entering or exiting a position “How will I feel if…. ?” … and then play out the scenarios, #1) the trade continues in my direction, #2) it pulls back and takes away some of my money, #3) it ….

By putting yourself into your potential future emotional contexts, you can make better “risk” judgments in the here and now.

(And oh yes, I know to some of you this sounds absurd…that is OK. Everyone that I have taught to do it, makes more money than when they just tried to use so-called discipline to intellectually overpower their desires to get in or out or… in and out … or ….)

The two areas in trading that separate the men from the boys (so to speak) are:

1.) The ability to divide environmental perceptions in half and process them separately. First I ask myself what I am feeling and in doing so I acknowledge and honor the feelings so that they don’t cry out for expression on the chart. Then and only then I ask the market what it is telling me. (I used to combine these two observations; I used to subconsciously deny how I was feeling because I knew it was wrong to let my feelings dictate a trade and so the feelings were bleeding into my technical observations because I had not acknowledged them and honored them.)

2.) The ability to execute according to #1 as if I am even or in the black when I am in the red. If during my 90 minutes of trading (09:30 -
11:00), I’m in the red, usually the feeling is something like “I’m afraid! I want to be in the market! I want to be in a trade!”

re A.N.N.A.:

I realized it’s not enough to intellectually understand ANNA. I had to write my own version of the ANNA software for my own internal hardware. When I learned to ride a bike, even though I’d observed someone else doing it and they told me how, I still had to write the program in my own head about how to balance and pedal. It couldn’t be just an intellectual understanding.

re trading plan rules:

I think that if you need strict rules, you’re not ready to trade cash. Strict rules mean that you’re not in control of your emotional feedback
in a live market. I’m not tape reading and I have general ideas about where I get in a trade (ideally the pullback at the end of a trend) but
I don’t have strict rules because it seems trading is an art not a science.

-Trader Diagnosis

So, I found your website and purchased Access Your Psychological Capital, which then led me to devour books on emotional intelligence, mindfulness, neuroscience, and sports psychology. During this time of self-reflection, I combined my life experiences, education (Masters of Divinity in Biblical Theology), your workshop and group meetings, and many other resources, and applied them to arrive at a greater self-awareness. I’d like to share the journey of becoming acquainted with my echo with you—a journey that has led me to greater emotional understanding, less impulse trades, and no more door punching.

Your E-Learning Course introduced me to another stage of trading development: what is going on inside of me. For the first time I took responsibility for what was happening while I was trading. I realized who the enemy was—me. Why do I do the things I do? I’m a mess. Where do I start according to what Denise teaches?

I began by focusing on my body before, during, and after a trade with no self-judgment. Before getting in a trade I felt anxious, sat on the edge of my chair, and breathed heavily. After I finally pulled the trigger, I was in the trade at a less than ideal location and trying desperately to seek new information to reassess the trade. During the trade, my chest felt heavy, I clenched my thumbs, making a fist, and prayed I wouldn’t get stopped out. At this point I had no idea what other traders were doing—I was completely consumed with myself. Then, sure enough, I would get stopped out on a pull back or exit after only a couple of ticks, afraid that it would come back and I would lose what little profit I had. Even two ticks profit felt like a loss to me especially after watching it march on without me, reminding me with every tick that I just lost an opportunity. . . DAMN IT, SHIT, I lost!

I was so angry that I got upset at a simple question from my wife or the noises my kids were making, blaming them for my bad trade—as if I had lost because they were distracting me. Well, after experiencing this a number of times, I knew I had issues. It was not my wife’s or my kids’ fault, and after apologizing to them, I admitted to myself that I was afraid to lose, and didn’t want my family to think I was a failure.

But I noticed my fear of failure was just as strong when I risked only $50 as when I risked $200. So I asked myself: “What do I feel and believe about myself when facing risk?” I turned my focus from my physical response to my emotional response, for emotions reveal my true beliefs about who I am and how I relate to the world around me and, in particular, how I relate to the market.

I realized that when facing risk, I feel fear, and my earliest memory of fear happened at four years old. I was sitting on my Mom’s lap in the front seat of the car while my Dad clutched the steering wheel and peered through windshield wipers that were frantically trying to clear the window of the indefatigable rain. Lighting bolts were everywhere. Thunder crashed around us. I cried and held my blankie tight. My Dad yelled some disparaging remark about my being a baby. I felt embarrassed and ashamed.

Sitting with this memory and the emotions of it, I realize I have heretofore associated fear with being a baby and losing the affection of my dad. Looking back, I see that whenever I hurt physically or emotionally, I tried to prove to myself that I wasn’t a “baby” by rebelling against my instinct to cry and instead doing dare-devilish stunts on four-wheelers and snowmobiles, tight narrowly escaping paralysis and even death a number of times. I now know I was trying to prove to myself and others that I was fearless. Early in my trading days, I took some crazy, risky trades. I won a few and lost a bunch. It didn’t take long before the losing trades hurt, and I knew I couldn’t control the market like a motor vehicle. In front of my computer screen, I started to experience real fear, and I was angry because it reminded me of feeling like a baby, as if the market was my dad saying: “What’s wrong? Are you scared? You must be a baby!” My response didn’t help; I’d make another impulse trade, another trade out of regret and another loss. Another failed attempt to prove, to my father or myself or whomever, I’m somebody.

I realized then that part of my echo was, “I can’t have what I want because I’m not as talented or strong as everyone else”—I’m just a scared baby. I was afraid of screwing up a trade because losing meant I wasn’t strong enough or talented enough to deserve acceptance or love from those closest to me. When trading, I felt like a timid kid playing against confident giants, so I had a tendency to get out after only a couple ticks because I felt as though it wouldn’t work out. I was sure I wasn’t going to get what I want, so I better get out NOW.

This feeling of “I can’t have what I want,” was further reinforced by 1) my parents pessimistic view of adversity in life—you will never win, everyone else will come out on top, because they are stronger/more talented than you are—and 2) my parents frequently complimented other kids who were talented musically or academically, yet rarely paid me compliments about my talent in sports. Since I felt my parents were always comparing me with others and there was an absence of affirmation towards me, I felt that I had to perform in order for them to be proud of me.

I think my fear of not gaining the affirmation of my parents was most strongly imprinted on my mind when I quit taking piano lessons in 9th grade. I hated piano and, as my wife will testify, I am basically tone deaf. Yet, because the children of my mom’s friends were talented musicians, I HAD to take piano. The day I told her “I quit,” my mom blew up, cried and then tried to convince me that playing piano was “good for me,” regardless of the fact that I hated it and wanted to put my time into athletics. Her reaction communicated to me that in order to gain her acceptance and love, I had to do what SHE wanted me to do. I was only acceptable if I played piano, which was pure misery for me; therefore, I believed I couldn’t have what I wanted—success, love and acceptance in something that I wanted.

From that moment on, I feared that pursing things I enjoyed meant risking my parents’ acceptance and approval. So, I put pressure on myself to perform perfectly in basketball and football, thinking that maybe then they would accept and love me for me. I thought: “if they see how good I am at sports, piano [or whatever else] won’t matter so much.” Then when my performance wasn’t perfect, I blamed myself for BOTH my poor performance AND the fact that my parents didn’t love or accept me. This line of thinking led me to believe that their lack of love and acceptance was “my fault.”

Interestingly enough, any time I pursued something, my parents said, “Well, if it doesn’t work out. . . . ” As a kid, I interpreted that statement to mean my pursuit will fail because I’m not good enough, which will result in failing to gain my parents’ acceptance. Consequently, the fact that they don’t accept me is MY fault. . . . If only I’d just worked a little bit harder. . . .

So, when I trade, my self-worth is dependent on whether I make it or not. When I take a bad trade, I realize my full echo is, “I can’t have what I want because I’m not as talented or strong as all the other traders out there, and, the fact that I’m not as talented and strong is ALL MY FAULT!” If I don’t make it, I risk losing the love and acceptance of those I care about because I project my parents’ line of thinking onto them. The greatest revelation came one day, when after three bad trades, I just started saying, “I’m sorry, I’m sorry.” At first, I had no idea to whom I was apologizing. I was apologizing for having failed and disappointed everyone important to me. I was telling them that I was sorry for not being “good enough” and, ultimately for not making it as a trader. That is a reality I dread.

After walking, wallowing, and writing, I am finally able to name my hindering emotions: fear that I can’t have what I want because I’m “a baby,” anger and regret over the fact that I’m not “good enough,” and despair over the fact that this is all my fault. Now that I’ve named my emotions and beliefs, I’m free to channel my psychological capital towards what other traders are doing by using market profile and order flow. I have finally given myself permission to succeed and I am confident when I trade.

But what is simple to me… doesn’t necessarily come easily to people who are much better at differential equations than I am. In fact, it came to my attention that a listener to a recent talk I gave on DEALING WITH UNCERTAINTY, kept typing into the chat “this is really confusing for a numbers guy”.

Well first I am literally talking about CONSCIOUSNESS. Second – I am talking about PERCEPTION. Now both topics have been debated at least since the days of the Romans and I feel fairly comfortable betting on the subjects being discussed for as long as man has had language… So granted, it isn’t easy.

But is there any game in the whole world that is more a game of perception than markets? I honestly don’t so …

Therefore, it would seem that be best way to play this game better is to get better at understanding our own perceptions.

Last week an author named Fowler made the comment “Almost everything we think, do or feel is a result of our social networks”. He is a professed at UC-San Diego and he has a point. We here call it the “social/emotional context”. To make the social emotional context explicit – even in trading (hec always in trading) sets us up to make better decisions.

Call it the human condition – under risk.

1. You need to know what you are looking for – both to enter the market and to exit.

2. You need to know what the variations on #1 are – and what they are not!

3. You need to know what is imprecise about what you are looking for – it is more than you think.

4. You need to have thought about the imprecision long before you sit in front of the screen and certainly not just as you push the button.

5. You need to know what it will feel like if you turn out to be wrong.

6. You need to know how you will handle, manage, learn from and deal with that feeling.

7. You need to know what it will feel like if you are right – and again, how you will handle, manage, learn from and deal with it.

8. You need to know how to operate on the premise that “perfect is the enemy of the good”.

Okay then… can someone explain to me how the game, and particularly the QB’s job, is any different than being a trader or a portfolio manager? I mean sure they have a plan and they have studiously developed and trained-for expectations but don’t they still have to think “on their feet”? Don’t they have to assess the situation and make nanosecond judgments?

Why does everyone buy the widespread idea that traders have to come up with “plays” and then in turn execute them in a robotic fashion in the game of the markets? What happens to the need for judgment when faced with changing volatility? What happens to the need to use your brain in the toughest game on the planet?

Yep it is easier to NOT to have to use judgment… but is it realistic? I mean should stops and targets always be the same? Does that idea make ANY logical sense in as fluid environment as the markets present?

And in fact – worse, what is the downside to believing in the myth of the robot following the plan? There is one you know… and I submit to you that it accounts for some large % of the fact the vast majority of traders can’t consistently and reliably take money out of the markets.

And if it isn’t quite a robot – the isn’t it judgment? And if you have to use judgment at all … then what do you have to do to improve it? What do you have to do to capitalize on the fact that it is an asset?

This is a thought experiment… it is meant to help those who try it learn something… or at least stretch our minds to the point that we see the situation more as it really is.

Reflecting now – two plus weeks post – I realize I haven’t drastically changed my long-standing opinion regarding the difference in content and value between the field of behavioral finance and neuroeconomics. BF (for short) describes and documents the inordinately probable likelihood of not seeing all the data, of seeing only yesterday’s data and of making so called “irrational decisions”. In fact, at Harvard in November, BF even demonstrates that a room full of 75 portfolio managers fall prey to the exact same perceptional “deficits” as the general population. Neuroeconomics on the other hand is attempting to reveal exactly what is happening in our brain (or at least where it is happening) as we make these well-known errors in judgment.

Anyone who has followed our thinking for any period of time knows that we explain these behavioral tendencies under the general rubric of acting out unconscious emotions and I didn’t hear a single word that dissuaded me from that position. What I did however hear and realize is  that BF as a body of work gives us a list of cognitive/intellectual strategies we all can use simultaneously alongside the pursuit of greater emotional awareness and skill to help us make better decisions.

I think however the problem is in categorizing the list of so called “biases”. To BF’s way of thinking, our sometimes funny, sometimes sad tendencies to not see information that is either right in front of us or glaringly obviously missing (and we should therefore realize we have to look for it) are called biases. For example, we have a confirmation bias – the tendency to see all data in a way to proves what we already belief. (If you can think political leanings here.)  We also have a tendency to research a problem in terms of data we already have and fail to look for data we don’t. Generally, this is considered the availability bias.

As the weeks go on, this blog (and our upcoming December online workshop) will outline the biases and how to work with them from an intellectual point of view.

Before we get started on that however I submit for your consideration the research that shows we update our beliefs, preferences and decisions in ways that keep us feeling good (Kuhnen and Knutson, 2008) and suggest that the real underlying cause, regardless of where it happens in the brain, is the emotional impact of finding, seeing, using new and possibly contradictory data.

One more thing for today – speaking of “where” in the brain … many a respected academic still talk about the triune model of the brain proposed by Maclean in 1990. Theoretically, we have a higher reasoning brain, a mid emotional brain and a lower “keep the heart” beating brain.

With NO disrespect meant, this idea is outdated. Beginning in the late 1990’s we started getting pictures of real live healthy brains and it is clear now that emotional neural networks infuse, integrate and work reciprocally with those ostensibly higher brain centers. In essence they are higher yes  – but only because they are at the top! The most recent research however shows they are non-functional without infiltrations from the emotional networks (Damaraju et. al., 2008) so I again submit the idea that understanding the reciprocity and sequencing between brain centers offers us our best possibility of defeating our otherwise seemingly entrenched “biases”.

See the real reason Trader Psyches exists (full disclosure here) is of course, like every student of any form of psychology or psychiatry, I wanted to understand my own thinking, decisions and actions – particularly in relationship to my ability to easily take gobs of money out of the market but almost just as easily – okay even more easily – give it back. (I have cured the second btw – and yes with my own methods).

Believe it or not, social and emotional (affective) neuroscience holds the key. Questions like how does the brain interpret symbols that represent other people’s intentions versus how does the brain interpret direct physical evidence of other people’s intentions (a raised fist or pointed gun for example), go directly to the heart of the matter of trading in a pit versus trading on a screen as well as in the case of the aforementioned, directly to chart reading.

Evidence is mounting that despite the widespread belief that markets are about numbers and probabilities in fact our brains are not fooled and know they are about predicting other traders and investors intentions and future motivations. In other words, maybe the reason so many people have such a hard time consistently thinking in terms of probability is that the brain knows that just because you have a hammer, a hammer isn’t necessarily the right tool for the job!

A couple of specific points – and names of researchers to ponder – (in many cases this data comes from what are called poster sessions where doctoral and post-doc explain their latest research so it isn’t published yet.)

1. Pranjal Mehta, Columbia University  “Neural Mechanisms of the testosterone-aggression relationship: the Role of the OrbitoFrontal Cortex” A couple of the salient points for trading here 1) any effects of testosterone were relevant within gender norms or in other words, women with relatively high testosterone compared to other women showed the same effects as men with relatively high testosterone. Take home for female traders – you know that news item a few years ago about traders in Europe and testosterone and lengths of fingers… don’t worry about it!

Ancillary points include the location of the actions (frontal cortex) and the complex interaction of testosterone and cortisol. Why do they matter? – more evidence that our higher brains aren’t just extraordinary computers and maybe the whole widely held assumption that our brains CAN work like ultimate computers needs revised!

2) Kateri McRae, Stanford, “Bottom-up vs. Top-down emotion generation: Implications for emotion regulation”. (Now as any regular follower of ours knows I think the whole emphasis on regulating emotions is mis-placed because the FACT OF THE MATTER IS, you only have to regulate actions! Nevertheless, the concept of modulating one’s own emotions still permeates lots of the science so my other attitude is let’s see what we can learn.)

The most salient point here – and I quote  – “Reappraisal paradoxically INCREASED amygdala activity during bottom-up generated emotion“. Okay I know that the meaning of that isn’t intuitively obvious to a trader (otherwise why would you even be reading this?) so let me explain. I think it is safe to say that the most widely held BELIEF regarding changing negative emotions centers around the ideas of re-framing or in layman’s terms, changing your perception about the meaning of something. All kinds of official and pop psychology strategies including NLP or “neuro-linguistic programming” rely on the idea that if you change how you think, it will change how you feel.

What this study is saying is that process worked for certain processes like interpreting “words, statements or autobiographical memories” but it not only did not work for more basic interpretations like “phobic objects” (red on your P&L) but in fact, when tried with more survival (my word) type emotional reactions, it actually made it worse.

All I can say is Hallelujah! If I have answered a question about NLP or re-framing in a trading psych webinar once, I have answered it 1000 times. “Do you use, believe, recommend etc. NLP?” I am always adamant, militant and maybe even rude because I am so sure it doesn’t work when it comes to losing money (based on talking to 1000’s of traders and the a priori knowledge of the centrality of emotion to perception) and I know it tends to make it worse because when tried you have not only a negative trade but an additional experience of failure to deal with!

So… how to apply? If you have tried reappraisal or what most call reframing or even reprogramming and it didn’t work for  you, don’t waste one second wondering or worrying about why. The Darwinian nature of trading and the conscious and unconscious meaning of a red P&L is almost certainly a “bottom-up” emotion and behavioral & brain picture evidence says that strategy worsens the situation.  (As an aside – you’ll find more around the blog but in short try words instead – put the feelings into words. Write it out or talk it out – without judgment. No one at the conference will verify this technique but give it a try – and let me know.)

… I skipped the end of the meeting today (just to write this post but yesterday ended with David Brooks calling for  those who will create a revolution by bridging what science knows about how we think and the long held misunderstanding that we are single, isolated beings rationally maximizing our utility. I can only hope that Mr. Brooks will consider Trader Psyches and our new parent The ReThink Group an element of that revolution.

Thinking is germane to analysis and decisions and in turn confidence and beliefs are germane to implementing a decision. I still can think of no better way to say it than Colin Camerer of Cal-Tech and his co-authors Lowenstein and Prelec when they said “It is NOT ENOUGH (emphasis mine) to know what SHOULD be done, one must also FEEL it.” Well invert that and you get that all doing has a feeling associated with it.

Now Damasio and Bechara showed us this from The University of Iowa and USC starting in the early 1990’s but word really hasn’t hit Wall Street (or Washington either btw). Behavioral finance observations confirm that we indeed feel better when we rely purely on mathematical formulas but the real world doesn’t always fit into an equation.

And guess what – our brains (particularly on risk) know it! On the majority of days, it works fine to do it the old way. But doing well in the middle isn’t what makes you the real money or saves you from the black swans – that requires knowing what to do when things DO NOT go according to plan.

The solution lies in using our “maths” within the context of consciousness about the foundational and relevant qualitative data. Our brains are good at pattern recognition – call it implicit learning or intuition – it is the same. The problem is we don’t value that data – partially because we don’ t know how. In fact not all that long ao it wasn’t blink and Malcolm Gladwell getting $100K to talk about it, it was  only “feminine intuition.”

The key tenets to build an integrated decision making system for risk and the markets?

1. Never forget that you are betting on what other people will perceive about the same bet in the future

2. Know that they think a whole lot like you (whatever level you are at).

3. Ask yourself how your tools and formulas help you better understand their future perceptions. (Btw that is called Theory of Mind or Mentalizing in the scientific world).

4. Ask what can you do to improve your models and algorithms to better reflect the likely decisions of the competition. An example in the trading world is learning to use, read and interpret volume – particularly volume at price.

5. Next look inside – ask yourself what beliefs you bring to your risk decision. Get them out in the open because they have the amazing ability to create unrecognized biases.

6. Ask that question about your beliefs and the market and about your beliefs about your role right now in decision making. The latter will lead you to your own self-perception and its possible coloration by past experiences having nothing to do with trading or risk decisions. The latter is personality and life based.

Yeah you could call this the touchy-feeling approach to risk management (I suppose) but see the thing is, your brain is using context, pattern matching, probability judgments about the unknowable – and therefore so should you! Work with it – not against it.

1.    Realize that numbers reveal only ¾ of the picture.
2.    To see 99%, wrap all numbers in a cocoon of qualitative data.
3.    Elevate qualitative analyses to the level of quantitative analyses.
4.    Leverage how all human brains interpret uncertainty.
5.    Differentiate implicit learning from impulse.
5.    Never forget which game you are playing – poker or rugby.