Trading With EmotionsPosted on Nov 01,2012
Before you can manage your emotions it helps to understand what causes them. Our brains and endocrine system are a veritable narcotics factory, producing an array of natural chemicals that act as stimulants, depressants or pain-killers:
- adrenaline prepares the body for fight or flight: your heart starts pounding, your pupils dilate, you start to sweat and get “butterflies” as your digestive system switches off;
- endorphins, natural pain-killers many times stronger than morphine, are released by the pituitary gland;
- dopamine, released in the middle area of the brain, is chiefly responsible for pleasurable sensations;
- anandoline, a canabinoid, stimulates the appetite;
- PEA, a natural stimulant, performs in a similar manner to amphetamines such as speed;
- melatonin controls your sleeping patterns and stimulates the immune system; and
- serotonin is believed to play important roles in a number of areas: sexuality, anxiety and depression.
More than 30 different neurotransmitters have been identified, some very specialized; some performing a wide range of functions. Others work in groups, while some, such as serotonin, control or moderate the affect of other neurotransmitters. Lurking below our rational consciousness is a vast array of mood-altering chemicals, and it is virtually impossible to suppress them. The more we try to suppress our emotions, the more our performance is likely to suffer. Consider someone who experiences a fear of heights, stage-fright, or any other phobia; the more that they focus on fighting against their emotions, the more paralyzed they become.
It is far more effective to manage our emotions and use them in a positive way: to enhance rather than inhibit our performance. To do so, we need to be able to recognize our emotions and, having identified them, channel them or use them to our advantage, rather than try to block them.
This page will attempt to identify the emotions that you are likely to experience while trading. The reader will need to reflect on his/her own experiences.
The most common emotions discussed by traders are greed and fear. In fact, some maintain that the only emotion that they contend with is fear: fear of suffering a loss, and fear of missing out on an opportunity. The actual array of emotions is far more complex than that. How many of the following do you recognize?
Early man probably experienced an adrenaline rush while hunting: stalking his prey or a member of an opposing tribe. Nowadays we are more likely to experience excitement when dealt a straight flush in a game of poker; or when our latest trade starts trending upwards on big volume.
Recognize Tiger Woods’ fist pump when he holes a 20 meter putt? Or the roar of the crowd when the home side scores a touchdown? Or when your trade has jumped almost 100 per cent inside 2 weeks.
Fear of Losing Out
The crowd behavior at a closing down sale: “Grab as much as you can”.
Or buyers when stocks are gapping up in a strong bull market: “I don’t care what the price is, just get me in”.
Fear of Failure
The trepidation a weekend golfer feels when standing in a deep sand bunker; or the uncertainty and indecision you face when placing a trade after a string of losses.
Fear of Impending Threat
When you see a police car in your rear-view mirror; or when the dentist says: “This isn’t going to hurt much.” Or when your stock posts three large red candles.
When price gaps down through your stop level: “This is not happening to me — there must be some mistake.”
Victor Sporandeo describes this well: When we confuse our wishes with reality. Denial is forlorn hope; a refusal to accept the situation:
- “This is just a temporary aberration — everything else is still going up.”
- “I am sure that it will bounce at the low — I’ll move my stop down to below there.”
- “The fundamentals are still good — I’ll hold for longer term.”
The attack response triggered when someone cuts you off on the highway; or steals your parking space; or when a trade just won’t go your way:
- “I’ve been cheated.”
- “Brokers are a bunch of thieves.”
- “It’s the government’s fault – they should protect us.”
Inward-directed aggression. Irritability. Negative self-talk: “You idiot — how could you have missed that.”
An inability to concentrate or make decisions. You review more than twenty different indicators, many of which you have not used in the past two years, in an attempt to arrive at a decision — while price ticks inexorably downwards.
As soon as you get to the point: “I don’t care what the price is, just get me out.”
Feelings of loss, sadness, worthlessness or helplessness. Loss of confidence.
Resolution of the whole process. Recognition of past mistakes. Acceptance that you have to incur losses if you want to make profits. The inner calm that comes from having “let go”. A feeling of having gained from the experience. An expectation that you will do better the next time. Confidence restored.
Each of the above emotional states is triggered by a different chemical cocktail released by your endocrine system. Most severely impact on your ability to make rational decisions while trading. Later pages will discuss strategies for managing your emotions in order to enhance your trading.