As we get ready to watch markets on the other side of the globe open, it might be helpful to think about how we think. Our brains use both the social and emotional context of a situation to decipher its true meaning. But what happens when something completely new happens?

For all practical purposes, no one really knows what a downgrade of US debt means. We might be able to say it means higher interest payments or certain entities having to sell US debt but in reality, because this hasn’t happened before (at least not in any recent institutional memory), we can’t have that context that is so important to judgment calls under uncertainty. This might mean that nothing much will happen on the opening in a few hours – everyone will be looking around to see how other people perceive it.

Of course, the knee jerk reaction is to think the markets will sell-off. I hate to go out on a limb …. but …. I suspect that at first at least (i.e. the first 12-24 hours) won’t be /that/ clear. The context – both social and emotional – has yet to be created.

How many traders realize that the better models of decision making rely on a foundation of subjectivity? In other words, don’t most of us on or around Wall St. think that we are supposed to be trading via a maximum value, maximum utility or “rational man” model? I mean that surely is what I thought when I heard trading teachers talk. Now maybe this is because I came to trading from The University of Chicago but I don’t think so – I didn’t take that many courses in the business school.

As it turns out, people who spend all of their time thinking about the right model of human decision making think in terms of subjective or even personal probabilites. This means that you make a judgment including the context of what it means to you.

So for example, you might choose to skip a trade because even though it fits your scenarios you know you aren’t in a position – for whatever reason – to manage it. In this case you know the subjective or personal probabilites of it working out are slim – regardless of the market itself.  This is the real world.

Now we even have to go one step further and add regret into these subjective probabilities – will I feel regretful or joyful if I do or don’t take this option? Why? Aren’t we supposed to be over regret?

Some research shows regret to be the most powerful motivator. I know it certainly is the one I hear on the phone.

Adding subjectivity – how much you believe in something or the personal context you are in (won’t be here to manage the trade maybe) and then adding regret or potential regret AND MAKING IT EXPLICIT and known… will help you make better decisions under uncertainty.

Generally traders, analysts and expert commentators focus purely on numbers when it comes to markets. Rarely do they /really/ look at why they do. Take the news numbers – like consumer sentiment or housing starts… why does anyone care? Well because it gives a glimpse into what people are feeling or doing right?

What if we stopped and asked ourselves the people question first? What if we said, what will different time frame players be feeling/doing today? Next month? What if instead going straight to the numbers we started with the over-arching question we really wanted to know – will someone sell this asset for less in the future if I short it now.

Why bother you might say? Aren’t the numbers enough?

Well no – first of all does any number in the market really have any meaning? Aren’t they all relative to the numbers that came before? So in other words, all market numbers have meaning only in context.

Well that is a funny thing because the latest neuroscience shows that /everything/ we do only has any meaning in context. Particularly when we have to judge uncertainty – which is about all of life except algebra – we use context. We pull data that we aren’t even conscious of ….

What could happen if we consciously set out to put our brain to work in the context that it is really working – predicting other people (theory of mind) and using numbers just a tool – understanding them only as the language being communicated across the electrons?

Having had the privilege to coach hundreds if not thousands of traders in my roles as first a trading desk manager and then as a mental trading coach, I can promise you that not matter how much capital someone is trading – $10,000 or over a billion dollars – everyone regularly asks “why the H*() did I do /that/ again? Traders at all levels are often mystified at their behavior. More importantly, they are frustrated and often disappointed in themselves.

The solution to this isn’t to think harder, find another system or add something to a series of charts. The answer lies within each trader. It first demands understanding the basics of psychological capital – managing yourself with more care than you monitor your charts – but beyond that, the real way to reduce the number of times you have to ask yourself that “wtf” question is to understand the sequence and more importantly the unconscious meaning to your actions.

We all know that actions speak louder than words so it is possible to work backwards from what you do to what it means. Armed with what it means, you have the first step towards changing the behavior.

Now this culture is still under the spell of the superiority of the intellect (which by definition means the inferiority of non-cognitive dimensions like senses, feelings and emotions) but that is changing rapidly. Neuroscience now compels us to look at what is going on below the level of consciousness. There are literally hundreds of studies now showing the power of what we are NOT conscious of.

Now many people are afraid of knowing their unconscious. The good news about that is for anyone who is willing to get to know themselves and the meaning behind what they do, there is a built-in edge (that you can control) over every trader who won’t or can’t do that work.

The markets work in psyches as authority figures because indeed they are – no amount of arguing, imploring or pleading will change what they do. The are the ultimate implacable listener. This brings up many issues – need to be right, habit of rebelling, desire to be perfect and get “their” approval – all of which will coalesce into a pattern of behavior that will NEVER be changed by the intellect alone. It begins with simple fractals of experience from early in life and as adults, those simple fractals combine and recombine to create our perceptions, decisions, context of feelings and “baggage” that fuels that never-ending “Why did I do that ?”

Solving it is indeed possible. It just requires giving up the resistance to knowing the unconscious meanings – and being open to having and creating new emotional experiences. For each time you do it, it is a risk well-managed or a trade better executed. What will that do to your year-end results?

As I go about proselytizing about the value of being aware of one’s state of physical, mental and psychological capital, I routinely get the same questions -

1. Exactly how to be self-aware

2. How long will it take?

Let’s assume you believe that it is as important for your trading to be self-aware as it is to be market aware… (that is a big leap you know because it is SO easy to focus on the intellectual cognitive dimension and miss everything else). Get started this way -

1. Organize your life with the priority of getting enough sleep – this will automatically improve your perception about risk but also about opportunity.

2. Aim to always know how you feel phsycially and emotionally.

3. If you are frustrated, angry or fearful … write it down! Keep writing until the intensity lifts. (No you won’t miss the single best trade of the year!)

4. If you want more immediate help, tell someone who is a very good listener about those feelings. (If they say “ah don’t feel that way – they are not being a good listener).

5. Repeat.

Now, what this list doesn’t say is what will happen if you make this approach a standard part of what you do.

The most important part is that for every time you actually feel a feeling and put it into words you will be granted a time when you see your positions more clearly, make a better decision and risk less. Let’s suppose you did that once a week for 3 months (not making the bar TOO high here) … what would be the difference? Better yet, let’s suppose you did it after an annoying losing trade. How would that scenario turn out differently? Could you avoid the flurry of stupid trades that only waste money and “annoy the pig” (as in teach a pig to sing).

How long will it take to do this? Well… it depends

a. Do you believe it will help you? If you don’t really believe it… well you won’t be able to do it.

b. Do you commit to doing it – or would just watching the markets be more interesting?

c. What level are you starting from?

Dr. Brett Steenbarger once said he preferred to coach only professionals because lots of independent traders wouldn’t do this work. Coaching both groups currently I am coming to see what he meant. If you want to jump ahead of the pack, take this edge – it really is there for the taking.

Day in and day out I hear it over and over and over – thinking over feeling. Emotions are bad. Emotions are old. Control your emotions.

And some days I just can’t take it anymore. The avalanche of human brain research proves beyond any shadow of a doubt that feelings are more powerful than thoughts. (This doesn’t make thoughts useless just way less important that we think – hence our tag-line ReThink Thinking!). The very latest research strongly suggests that even our eyes, our eyesight, our visual cortex – will NOT work without the proper “dose” of emotional neuronal activity.

But take it from another angle. Remember the old and not-so-old saying “Actions speak louder than words”? Well we all know it is true right? But why is it? Words are cognitive, they are intellectual. Actions demonstrate how we really feel – regardless of what we say.

But this leaves the big question to be – how do you move through from feeling bad when feeling bad about something – anything – feels bad?

#1 Allow yourself to actually physically feel bad for a little bit. Believe me, it won’t kill you.

#2 Pay attention to how it does feel – in your body and in your metaphorical heart.

#3 Ask yourself, what is causing the feeling … and keep asking that until you feel a wave of relief. Believe me, if you do this iteratively – and don’t settle for the much less powerful attempts to talk yourself out of (or anesthetize your way around) – sooner or later, you will realize “The REAL reason I feel (fill in the blank – angry, sad, frustrated …) is ________________ and wow! now that I know that A) I feel better B) I have a much better (and different idea) of what I need to do!

Feelings and emotions are information. Feeling tired tells you you need rest, hungry – need food. Angry – something is wrong. Afraid – something to consider. Every time we recast our feelings and emotions as this kind of data is one more time that we move further forward faster. Ironically, this feeling thing also clears the cognitive “thinking” part of your brain so that it can do its more linear work.

In many ways, many traders end up shrugging their shoulders to the tune of “oh well I will do better next time”. The question becomes /what exactly/ will make them perceive, decide and act “better” the next time? I mean it isn’t like there aren’t tons of methods and tools to help a trader with their decision making, their psychology and their emotions.

Maybe, could it be, that the tools have a fundamental flaw?

IMO it is – and that flaw is literally in understanding how the brain – when dealing with uncertainty – makes a decision. Based on my research for my upcoming book (McGraw Hill, 2011) MARKET MIND GAMES, the sequence is like this.

1. Contextual pattern matching – does what I am looking at look like something I have seen before? This step is to identify what it is you are looking at it. (i.e. is this my trade set-up?).

2. Application of a percentage of belief in what you think we you are seeing. How much confidence do I have in what I think is the pattern match? THIS IS THE KEY MENTAL STEP THAT HAPPENS MOSTLY UNCONSCIOUSLY AND COMMUNICATED TO YOU ON A VISCERAL FEELING LEVEL!

3. The emergence of a perception that underlies a decision and an action.

4. Acting – or the “behavioral expression” (Credit Kerry Ressler of Emory on Charlie Rose for that exact term) – of the feeling of confidence in the contextual analysis.

So…. how much “intellect” is involved? Well in the traditional sense of the word, the intellect is the historical learning that allows step one to take place. In the new paradigm of emotions, not all that much. Eric Kandel, the Nobel Laureate, said on Charlie Rose recently – “Everything we do MUST have an emotional charge”! (May 26, 2010, Brain Series #8).

Most traders spend all of their time on the pre-cursors to all of this – gaining the intellectual background. If they don’t have the results they want, they stay stuck in the pre-step 1. Instead I and my clients who have tried it, highly recommend getting analytical about steps 2 & 3. The context of confidence or context of feelings that one brings to the perceptual process is literally EVERYTHING! Without knowing that “fC” (and the U-fC for unconscious feeling context), the only choice you are left with is to act out feelings without knowing what is happening.

Get out ahead of it – and it will put you “in the zone” much more often!

We all like to talk about knowing the probabilities … and then just sticking to them. Most of us like to harangue other traders for not doing so while finding it not so easy to do ourselves.

It isn’t so easy for a number of reasons -

1. Whether you are conscious of it or not, your brain recognizes the ambiguity and uncertainty on your charts.

2. Your own level of beliefs and your confidence in those beliefs (the true “in your gut” feelings that need acknowledged) influences your view of the probabilities. This is more or less what the term “subjective probability” means.

Taleb and now Mr. Elie Aiyache, the author of The Blank Swan – the end of probability, like to say that the whole business of probability and markets is “for philistines”. They are really skipping the reality of how probabilities work inside a brain making a decision under uncertainty. It isn’t that the probabilities are worthless or non-existent, it is gaining a better understanding of how to use them for the tool they are.

Everyone knows what they /SHOULD/ do… and everyone has trouble doing it. Why? Lots of reasons -

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 ….)

Here are some of the things I’ve been thinking about:

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