Articles on Trader Psychology by Rande Howell, Trader Psychologist
Risking capital under pressure can be like a time bomb ticking away in your head. One moment everything is under control and then (in the blink of an eye) the thought or threat of losing capital pulses through you – creating an emotional avalanche that covers up rational thinking. It may be at an entry point, where you have to come to grips with the possibility that you could lose money – and a shudder runs through you. It could be when your position goes against you and you feel the money slipping through your fingers – and an urgency consumes you to get it back before it’s too late. Or it could be after your position has turned profitable and waves of anxiety pulse through you – and you regretfully get out way too early with a skinny profit. Or even worse, after a string of victories, you give it all back in a flush of over-confidence.
In theory, decision making in trading or actively managing positions looks so simple. Logically you know what to do and how to do it. It’s pretty straightforward. Then, in real time, you have to take action where you put your money at risk. Then all bets are off. Where a logical human being stood only moments before, now an emotional hostage is on the loose. And often you do not even notice it. What happens in the moments before or after you put capital at risk that transforms you from the rational Dr. Jekyll to the out of control Mr. Hyde?
The Collision of the Emotional and Thinking Brain
On the surface it appears that thinking is the king of the mountain. From the cradle you are taught to keep your emotions in check and be rational when making decisions. So ubiquitous is this line of reasoning, that it never occurs to you to examine the veracity of that assumption. Logically, you should be able to stay rational throughout a trade or while you are holding a position, giving you a tremendous edge in executing your plan. And by not letting emotions into the equation when capital is at risk, you should be able to stay cool and calm. You simply need to control your emotions by the force of logic, right? However, this is the thinking that leads you into emotional ambushes.
Unfortunately, thinking and emotions do not work that way. You may not notice the emotion behind thinking (which doesn’t matter in the overall scheme of things) but thinking follows emotions. We are taught that emotions follow thinking, but Emotional Intelligence theory holds that all thinking is emotional state dependent. The emotions are there, in the background, dictating what you think. You may have pushed the emotion out of your working awareness, but it is still operating waiting to be activated by any event that occurs that could negatively or positively impact your performance in the moment. Uncertainty while risking capital is such an event.
The reason you can appear to possess freedom from emotion is because you believe that you are in control – you are wired that way through adaptation. Reactive emotions do not need to activate when you believe you are in control of outcome or believe you are right (which is another way of saying that you are in control). The problem occurs when your belief conflicts with actual experience – as so often happens when risking capital. In active investing and in trading, no matter how much you BELIEVE you are in control through your logic – you discover constantly that what you thought was control was, in fact, only an illusion.
Your investment or trading account demonstrates clearly that you do not control outcome – no matter how much you want to believe otherwise. And, no matter how much you want to believe that you are in control of outcome, your trading account keeps reminding you that is not true. There is simply no place to hide from this reality. Then the experience of not having control activates the fight/flight response of the sympathetic nervous system, and you are on the short list for an emotional hijacking.
The emotional brain has just knocked out the rational brain in the first 30 seconds of the first round. In Emotional Intelligence work you quickly discover that not only is all thinking emotional state dependent, but also that the thinking brain is not rational – it is rationalizing in nature. The thinking brain makes up explanations to support what the emotional brain has already decided. The logical left brain likes to believe it is the horse that pulls the cart, while actually it is the cart that the emotional brain pulls – thinking follows emotion. The logical brain is not in control – it only appears to be. But in moments of stress, when the money counts, everything reverts back to the emotional brain. And unfortunately most active investors and traders are unprepared for this reality. This is where the survival instincts of the emotional brain take over and thinking becomes a slave to the primitive emotional responses to the threats inherent with an encounter with uncertainty. The old brain wins every time if you do not know how to work with it.
That is why traders and active investors fall apart at just the wrong time. Logic is hijacked. It feels so good to believe that, through logic, you can minimize the impact of emotions. And it really does appear that you can control emotions through the use of logic and reason. But this is true only when the money does not count. When capital risk enters the equation, the emotional brain wakes up from its slumber and feels either threatened or has an urgency to attack an opportunity. Logic is thrown out the back door in nano-seconds. Literally, sensorial information is reviewed by the thalamus complex in the limbic system (the emotional brain) and a quick and dirty decision is made to cut off communication with the thinking brain. Then an urgent signal is routed to the amygdala where the fight/flight response is activated. The elapsed time for this decision and action to be made is .003 seconds. The slowpoke, the thinking brain, never had a chance after the triggering of your most primitive beliefs about managing money in the midst of uncertainty.
There’s one last thing about the emotional brain you need to know. It is built for: short term survival (called survival instincts), controlling your environment, and believing it is right (no matter what). This is what gets the active investor in so much trouble. The trader or active investor needs a probability-based mind that calculates for the long term. But what he or she brings to the table is a brain that evolved to survive in the short term.
The emotional brain does not distinguish between biological threat and the psychological discomfort of feeling vulnerable when capital is at risk. So every time you put capital at risk, you are priming the emotional brain to look for danger to life itself. Literally, the brain is scanning for lions, tigers, and bears. Not a potential loss of money – but a potential loss of life. And it has to act immediately (no time for that slowpoke thinking brain) for survival’s sake. This is the situation you are summoning up every time you put capital at risk. The mind you brought to trading, based on survival instincts and short term survival, is not suitable for the rigors of active investing or trading.
What nature has done, you will need to re-do. Let’s look at how you might re-design the brain/mind from its original intent of surviving in the short term and re-build it for success in the long term with capital at risk. Understand that this is a very different brain than the one you brought with you.
How Do You Fix this Problem?
The brain/mind you brought to trading and active investing was built for another time and place. It would not be configured the way it is (based on lightning fast survival instincts) if it did not serve short term survival. The problem is that a very different brain/mind is needed to work with probability, rather than certainty. Your ancient emotional responses to uncertainty have to be re-wired from how you evolved as a result of natural selection and adaptation. Then the very beliefs you harbor about your capacity to engage uncertainty successfully have to be examined and changed. Not an easy task, but for the motivated this is a do-able task.
The very first thing that you need to do is to cool down the hotwired emotional circuits that fire when you experience stress coming in the form of a perceived threat or opportunity. In my work I teach a combination of emotional regulation skills (bellows breathing and muscle relaxation) that is applied at the moment of exposure to uncertainty. You learn to literally cool the emotion down so that it builds up enough intensity to hijack the thinking brain. Why breathing and muscle relaxation? Because emotions are biological and take over psychology under the stress of risking capital. Since they are biological, emotions will have a biological signature (including breath style and muscle tension) as they amp up for action.
Skillful use of bellows breathing and muscle relaxation will interrupt this process. This is critical. By interrupting the buildup of the emotion before it can take over thinking – and then replacing it with breathing and relaxation that support calmer emotional states – you can exert an enormous influence over the manifestation of the emotion. You can literally change the stress response from fear to relaxed confidence. A powerful skill is honed for managing the brain and mind that engages uncertainty. But it is not enough.
Re-building the Trading Mind
Evolution and adaptation built the brain/mind for short term survival, to believe that outcome could be controlled, and with a bias to win and not lose. And for the environment in which early humans lived, these adaptations led to triumph and the survival of the species. However, the trading environment is very different from the environments within which early man adapted. This is the fatal flaw that a trader has to grasp to be successful in trading. There has to be a shift from a focus on the certainty of short term success to the probability of long term odds. This is a major shift that does not come naturally.
The next thing that has to occur is for the brain/mind to move from the bias of control over outcome to the recognition that the only thing the trader and/or active investor controls is their performance – not the outcome. This is a major gap that takes significant effort to re-design. And, finally, the trader must also transform his/her notion of winning – or the need to be right.
This is embedded in the very beliefs that drive performance under pressure. That is what is being measured when you look at the health of your P&L. You may have talked yourself into believing that you can control outcome, that you can make things happen, and that you are a winner – but the only measure that defines success in trading and active investing is the health of your trading account. It literally is showing you how effective (not how right) your beliefs are that you project onto the markets for extracting more capital out of the markets than is extracted from you.
To create success in your performances, you have to let go of the illusion of success, that you can make “it” happen, and that you can be right by sheer force of will. Those conditions may produce success in other arenas of your life, but they do not produce success in trading and active investing. A very different attitude has to be developed (and measured by your P&L statement). You will have to become comfortable with being wrong a lot and let go of outcome. You come to understand that the only thing you really control is you – not the markets. You control the mind that you bring into the moment of performance. Not the outcome of that performance. The most difficult belief that has to be altered is about “being a winner”. You have no control over whether or not you win or lose. You control how you play the game. If you win, you simply landed on the right side of probability. If you lose, you simply landed on the wrong side of probability. And when you are wrong, you promptly acknowledge it instead of trying to force the issue.
You control performance – not whether you win or lose. It is a mindset that is developed. It is not intellectual, and it is not developed through the force of will. It is changed by re-building the neural circuits that evolved a long time ago to ensure your survival in a dangerous world. Certainty had to be built in, even if it was an illusion. That belief about your capacity to control outcome no longer applies to the environment of trading. Instead of a certainty-based mind, now a probability-based mind is favored for adaptation.
To their misfortune, this is the gap that few traders or active investors learn to bridge. They keep attempting to force something that no longer works to their advantage. And the markets do not care one way or the other. Adapt or perish. It is critical that you adapt your brain/mind for this new environment. The brain/mind you brought to manage the uncertainty in either trading or active investing is not going to be the one that brings success. That has to be built by your personal design. Beliefs about your capacity to manage uncertainty are now the adaptive forces to be cultivated, not by natural selection, but by design. Your job is to consciously develop those performance beliefs and measure them by the health of your P&L – that is what points out if those beliefs are really effective or not. This is the pathway to the evolution of the probability-based mind needed for managing capital at risk. Fortunately the brain is adaptable. As is the trader who recognizes the need and the opportunity.