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

JUST before the hovering finger clicks the mouse to trade, there is one thing that online investors of the future might want to check: their “Rationalizer”. The device, a prototype of which was unveiled this week, is an emotion-sensing system designed to help investors keep a cool head when buying and selling. [...]

The Rationalizer, which is still under development, consists of a bracelet that measures something called a galvanic skin response. This is a change in the electrical resistance of the skin which can be caused by various stimuli, like anger or elation. It cannot determine if the emotional arousal is negative or positive, only that it is happening.

ABN’s interest reportedly stemmed from a study by Andrew Lo and Dimitri Repin, “Psychophysiology of real-Time Financial Risk Processing” (Journal of Cognitive Neuroscience, 14(3), pp, 323 – 339,  2002), showing that day-traders who exhibit more intense emotional reactions also have significantly worse trading results.

One may question the efficiency of using this new device, trading performance wise. My guess is that this kind of practice is based on a somewhat misguided view on emotions. This view emphasizes the negative effect of emotions on behavior, the idea being that emotions vitiate rational decision-making. Here “emotions” stands for “passions.” Automatic emotional responses mediated by structures such as the anterior insula or the amygdala – see Joseph LeDoux’s beautiful book “Emotion, Memory, and the Brain” (1994) for the functions of the amygdala in fear conditioning – would trump higher-level responses mediated by the prefrontal cortex. Very Platonic stance, sometimes referred to as “dual process theory.”

This is not to say that emotions never prompt us into the wrong direction, they surely do, often “short-circuiting” logical reasoning and long term planning that are essential to efficient trading (Cf Andrew Lo and collaagues, “Fear and greed in financial markets : A clinical study of day-traders” American Economic Review, 95(2), pp. 352-359, 2005). The dual process theory is thus heuristic in that it highlights such phenomenon. However, it may lead to a hyperemphasis on emotions as sources of mistakes. Such hyperemphasis is wrong-headed. Because in many domains, nonconscious emotional biases drive behavior before conscious knowledge does; without such emotional inputs, overt knowledge is in effect insufficient to ensure rational behavior.

Antoine Bechara, Antonio Damasio and colleagues highlighted this role of emotions in implementing rational decisions (”Deciding advantageously before knowing the advantageous strategy“, Science, 275, pp.293 – 1295, 1997). Further, John Allman, an eminent neurobiologist from Caltech, has been pinning down the role of the Von Economo Neurons (VENs) of the anterior cingulate cortex in providing humans with a system for quick and intuitive behavior in the face of uncertain ever-changing conditions. This work stresses that in complex situations involving fast intuitive assessments, such as day-trading, fast intuitions are melded with slower, deliberative judgments (e.g. “Intuition and autism: a possible role for Von Economo neurons“, Trends in Cognitive Sciences, Volume 9, Issue 8, pp. 367-373, 2005), whereby emotions are best viewed as informational inputs serving deliberative processes. Consistent with this view, recent studies on decision making under uncertainty has revealed the amygdala and the anterior insula to provide uncertainty signals. See, e.g., the paper by Wofram Schultz and colleagues “Explicit neural signals reflecting reward uncertainty” in Philosophical transactions of the Royal Society of London. Series B, Biological sciences, 363(1511), pp. 3801-11 (2008); or the one by Tania Singer and colleagues “A common role of insula in feelings, empathy and uncertainty” in Trends in Cognitive Neurosocience, 13: pp. 334-340 (2009). A famous paper by J Coates and J Herbert, “Endogenous steroids and financial risk taking on a London trading floor” (PNAS, 105(16) pp. 6167–6172, 2008), helps pinning down the nature of these uncertainty signals: these may be relayed to the neural structures involved in decision making through neuropharmacological signals. For instance cortisol, which has receptors in the insula and the amygdala, would signal market risk in the brain.

All this suggests that emotions are key information providers when deciding under uncertainty. They make us tuned to our environment. Actually, in some contexts of fast and intuitive decision-making in the face of unstable (high vol) conditions, one expects that the stronger the emotional uncertainty signals of the day-trader, the higher the performance. To be more specific, I would not be surprised that for a trader “in the zone” at a particular point in time, the light pattern of  “EmoBow” (the object displaying a moving light pattern to illustrate the user’s mood) reach a deep red. Shall one conclude that the trader is too aroused emotionally at that moment, and hence should take a deep breath? Or merely that he has achieved a state of focus that intense, that all the relevant stimuli in his environment are integrated as emotional inputs? In the second scenario, stopping the decision process is like stopping a high-speed driver in the middle of the race.

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!

Bear markets mean lower lows and lower highs … and we are in a bear market until we get higher lows. and higher highs … which is decidedly NOT today.

At least Charles Payne on Fox Biz talked about SDS – one of the short ETF funds.

On one hand the world gives credence to “you can’t market time” (well what do they know) and on the other they all do the same thing us short-term, high frequency traders do which is go nuts over “missing out.” Yet missing out on the bottom is a great thing – regardless of your timeframe. The market has this funny tendency to trade at a price, reverse from it and then go back and take a look – kind of like a criminal goes back to the scene. Everyone gets a second chance to get in at a safer spot – after the market has shown its hand – and this is true in ANY timeframe.

But back to rocket surgery Mario and all of the other experts who want to tell people what to buy – this is a bear market. How can you sleep at night knowing that people will listen to you and buy what you say – maybe even today?

Not surprisingly, the hero pilot of flight 1549 unconsciously used a technique that works – his feelings were put into words – even if only in his head. This kind of acknowledgement of anxiety actually helps the brain to focus because it isn’t wasting energy on trying to suppress a feeling that is a very real reflection of the situation.

This works in much less dire circumstances where the only risk is a loss of capital. Giving voice – verbally or internally – to one’s acutal feelings – without edit or judgment – allows one to much more easily see (and execute on) what needs to be done. I have said it before and will say it again, FDR was wrong. It is not that the only thing we have to fear is fear itself, the only thing we have to fear is no fear at all.

Madoff’s investors “felt confident” in his long-time consistent returns. Yet every article indicates there were multiple red flags. No investment fees? Not even a 1% management fee when most charge 2%? As Joe Aaron was quoted, “why would a good hedge fund guy work for pennies?” Conflicts of interest, no independent custodian, not even registered with the SEC before 2006 – why didn’t at least the other supposedly sophisticated hedge funds notice that stuff?

Because people want to believe. Read that again – want to believe. It means people have a feeling about having a feeling. Madoff’s spectacular Ponzi scheme only underscores what neuroeconomists are seeing in their pictures of our brains - that we base all our analysis (or lack thereof) and hence our decisions, on our feelings – no matter how much we want to believe (there is that word again) otherwise.

Famed economist Robert Schiller writes in today’s NY Times that if Obama could set a goal of full employment and if people would believe it, then confidence could be restored to the economy. I have met Bob. I like Bob. But.. Bob, c’mon – while you are technically and totally correct about the relationship between beliefs, the feeling of confidence and what people do, I seriously doubt any politician (even the almost-deity President-Elect) can inspire that kind of belief!

Nevertheless the real point is that the X factor here is the criticality of the physical experience (i.e. feeling) of confidence. …. feelings, feelings, feelings. Or take another New York Times columnist Ben Stein, “All that Fear” -? … “there is a new feeling in the land – fear – on a scale that I have never experienced. Chilling right to the bone fear. Fear that there is no bottom to our problems, that we got into this mess in some way we don’t understand, and that no one knows how to get out.”

“IN SOME WAY WE DON’T UNDERSTAND” - truer words have never been spoken! Underneath this entire great recession in the making is the problem that we don’t use our brains in the way they are designed. We simply don’t understand them – or at least most of us don’t.

We got into this mess because we all believe (there it goes again) in numbers and logic. We dismiss, discount and deny our feelings. Yet ironically if “they” had listened to the feeling of fear that the oddities about Madoff induced or the feelings of fear that Mathew Tannin of the Bear Stearns hedge funds wrote in his infamous email that has unfortunately earned him an indictment, we would not be where we are now.

NO! Skip the damn “maybe”. Us sophisticated financial types think that numbers, math and rational logic are the answer to everything. This belief couldn’t be further from the truth and it exactly what got us into this mess.

A group of the world’s leading neuroscientists, Camerer, Lowenstein and Prelec, call it Radical Neuroeconomics and it means that we can neither analyze, decide nor act without feeling. Invert that and it means that we do not analyze, decide nor act without feelings.

Therefore, it is always the feeling that counts – fear of the unknown matters now but while the bubble was blowing itself up, it was fear of missing out and fear of finding out your guy wasn’t making the 12%/year you were counting on.

In both cases, feeling the fear – analyzing and understanding it – would have saved you. It might possibly have saved Bear Stearns… and if BSC had been saved, then where would we be with Lehman, Citi, and the whole debacle of a credit crisis? it wouldn’t have felt good then but it sure would have been a lot less painful then what we have.

Let’s suppose anyone who was in on the chain two years ago – the group formerly known as investment banks, the ratings agencies, the mortgage brokers and yes even the home buyers had paid attention to that voice that was there. “Something about this doesn’t feel right.” Then let’s get really imaginative and suppose that the rest of the group would have accepted that kind of data…what might have happened? Would we have had one less risky loan, one more B- rating, maybe even an exchange for those weapons of mass financial destruction the CDO’s and CDS’s (exchanges keep things trading and it is the lack of trading that sent the credit market into the nosedive that our government is still trying to find a? parachute for).

FDR got it totally wrong. The only thing we have to fear is NO fear!

We just have to learn to systemically feel it, listen to it, understand and analyze it – just like we do with the numbers. Doing so would have saved billions – if not trillions – in worldwide market cap, global GDP and yes, ironically in the most important measure of all – that elusive X-factor confidence.

Madoff’s investors “felt confident” in his long-time consistent returns. Yet every article indicates there were multiple red flags. No investment fees? Not even a 1% management fee when most charge 2%? As Joe Aaron was quoted, “why would a good hedge fund guy work for pennies?” Conflicts of interest, no independent custodian, not even registered with the SEC before 2006 – why didn’t at least the other supposedly sophisticated hedge funds notice that stuff?

Because people want to believe. Read that again – want to believe. It means people have a feeling about having a feeling. Madoff’s spectacular Ponzi scheme only underscores what neuroeconomists are seeing in their pictures of our brains - that we base all our analysis (or lack thereof) and hence our decisions, on our feelings – no matter how much we want to believe (there is that word again) otherwise.

Famed economist Robert Schiller writes in today’s NY Times that if Obama could set a goal of full employment and if people would believe it, then confidence could be restored to the economy. I have met Bob. I like Bob. But.. Bob, c’mon – while you are technically and totally correct about the relationship between beliefs, the feeling of confidence and what people do, I seriously doubt any politician (even the almost-deity President-Elect) can inspire that kind of belief!

Nevertheless the real point is that the X factor here is the criticality of the physical experience (i.e. feeling) of confidence. …. feelings, feelings, feelings. Or take another New York Times columnist Ben Stein, “All that Fear” -? … “there is a new feeling in the land – fear – on a scale that I have never experienced. Chilling right to the bone fear. Fear that there is no bottom to our problems, that we got into this mess in some way we don’t understand, and that no one knows how to get out.”

“IN SOME WAY WE DON’T UNDERSTAND” - truer words have never been spoken! Underneath this entire great recession in the making is the problem that we don’t use our brains in the way they are designed. We simply don’t understand them – or at least most of us don’t.

We got into this mess because we all believe (there it goes again) in numbers and logic. We dismiss, discount and deny our feelings. Yet ironically if “they” had listened to the feeling of fear that the oddities about Madoff induced or the feelings of fear that Mathew Tannin of the Bear Stearns hedge funds wrote in his infamous email that has unfortunately earned him an indictment, we would not be where we are now.

NO! Skip the damn “maybe”. Us sophisticated financial types think that numbers, math and rational logic are the answer to everything. This belief couldn’t be further from the truth and it exactly what got us into this mess.

A group of the world’s leading neuroscientists, Camerer, Lowenstein and Prelec, call it Radical Neuroeconomics and it means that we can neither analyze, decide nor act without feeling. Invert that and it means that we do not analyze, decide nor act without feelings.

Therefore, it is always the feeling that counts – fear of the unknown matters now but while the bubble was blowing itself up, it was fear of missing out and fear of finding out your guy wasn’t making the 12%/year you were counting on.

In both cases, feeling the fear – analyzing and understanding it – would have saved you. It might possibly have saved Bear Stearns… and if BSC had been saved, then where would we be with Lehman, Citi, and the whole debacle of a credit crisis? it wouldn’t have felt good then but it sure would have been a lot less painful then what we have.

Let’s suppose anyone who was in on the chain two years ago – the group formerly known as investment banks, the ratings agencies, the mortgage brokers and yes even the home buyers had paid attention to that voice that was there. “Something about this doesn’t feel right.” Then let’s get really imaginative and suppose that the rest of the group would have accepted that kind of data…what might have happened? Would we have had one less risky loan, one more B- rating, maybe even an exchange for those weapons of mass financial destruction the CDO’s and CDS’s (exchanges keep things trading and it is the lack of trading that sent the credit market into the nosedive that our government is still trying to find a? parachute for).

FDR got it totally wrong. The only thing we have to fear is NO fear!

We just have to learn to systemically feel it, listen to it, understand and analyze it – just like we do with the numbers. Doing so would have saved billions – if not trillions – in worldwide market cap, global GDP and yes, ironically in the most important measure of all – that elusive X-factor confidence.

Two things to know -

First, it tends to assume it will get the same result from the next
event as it got from the last event. In market terms, this means that
looking at losses predisposes all of us to expect more losses – the
timeframe is basically irrelevant – at least as far as the brain is
concerned.

Neuroeconomics research also indicates that the emotion resulting
from a “first” event also colors any? analysis of the next event -
without us knowing it and before we are conscious of what is happening.

Put the two together in today’s market and the third fact that fear
can easily spread from one person to the next and presto, feelings of
worry turn to fear turn to panic and then morph into limit down.

Interwoven into these human psychological realities, facts like
deleveraging (otherwise known as margin calls) force additional selling
which exacerbates the selling and creates more of the brain’s above
decision cycle.

This is where we are today and the “engineering” behind how the
markets tend to extract the most money out of most of the people.

The opportunity lies in interrupting YOUR brain from taking this trip.

The way to do that is to use what we call EMOTION ANALYTICS.
Researching and dissecting whatever feelings and expectations wash over
you – versus just taking action – gives anyone who tries it a window.
Windows give you the ability to see a more accurate picture to predict
what is really likely to happen next!

The weekend edition of the WSJ included Zweig’s column on fighting the herd mentality. In many ways it is good article… but it does what all articles and commentary seem to do… in the end it says “get rational”. The problem with this is when you feel terrified it is extremely hard to use your analytical mind to overcome that.

The trick is the counter-intuitive and ironic one of allowing yourself to feel what you feel.

Just remember that feeling afraid doesn’t dictate you take an action. If you listen to the panic it will actually allow you to think more clearly as the act of listening alone will calm what your psyche is doing to you.

I know it goes against conventional wisdom but let me ask you to try it. Try it with anything – something that makes you feel a little nervous. See what happens when you say “Okay Denise you are really nervous about…..”

… just sit there for a few minutes (or longer) and explore the feeling inside of you. Ask where it is coming from. You will find that using this approach is the fastest and most effective way to induce a greater sense of calm as you will realize that you are most likely unconsciously imagining total disaster and chances are that is not really the situation. Once you realize that, you have automatically got a more reasoned perspective on whatever is inducing the panic – public speaking or plunging markets.

and oh btw, this fits with what we know about emotions firing before thought… “anticipatory affect” is what they call it in the labs. Learning to use this tendency of the brain can be to your great advantage.

On the other hand, price moves directionally when many buyers or sellers (PEOPLE AGAIN) have a strong belief (FEELING) or desire (FEELING) or need (MOTIVATED? = feeling) that the price will keep going and either

1. they are afraid (feeling) they will miss out

2. they are afraid (feeling) they will lose money.

Another reason that prices move directionally (and fast) is that the majority of people either are or want to be (out of desire or need) to be on the same side of the trade. By definition, this leaves few people to be on the other side and a relative lack of liquidity.

This may all seem elementary but it is very germane to what we have been seeing lately – from either the global macro credit crisis viewpoint or the 1 minute average true range viewpoint. How can that be you say?

Well for starters, one of the pillars of the story of where we are in the big picture is the lack of liquidity in the complex structured debt contracts dreamdt up by trading desks around the world. Once Bear Stearns admitted to trouble in those privately traded contracts, all the other players went “no bid” and the cards started tumbling – because there was no one else to take the other side of the trade. This link speaks tangentially to the resolution of this problem – i.e. hedge funds declining to trade these “OTC” (read potentially very illiquid) contracts.

The other side of the trade

On the other side of the spectrum, the ranges we are seeing both intra-day and even in very short time-frames are the result of more market-players (people) wanting or needing (which makes them want) to be on the same side of the trade.

The point of all of this? Traders make money when they correctly ascertain where other players in their time-frame are and where they are likely to WANT to be in the near future (again according to their time-frame).

In other words, it isn’t just lines or bars or even a back-tested set of probabilities. It is the probability of what other people (even if they use computers to execute) are going to want or need to do in your time-frame.

Is it possible to think of the markets this way? It is a good idea?