Risk taking, bringing with it the emotional highs of success and the emotional lows of failure, is an inherent but misunderstood part of the trading environment. Too often, because of their lack of understanding of emotion, traders do not recognize until it is too late that their trading mind-sets have been compromised.
So the question remains: Can a trader better manage the mind that calculates and executes that risk for more consistent reward? On a more operational level, after a string of successes and growing confidence, how does a trader not get sucked into overconfidence, euphoria or exuberance and start minimizing risk to his or her detriment? Or, after some significant losses, how does a trader manage the emotional pressure to perform profitably before things get worse?
At the root of better long-term performance is a better understanding of emotion and its impact on the mind that trades. First, emotions are not optional. The emotional right brain and the rational left brain work cohesively together to interpret market information and make decisions. The emotional brain makes a decision, and your thinking brain produces an explanation that supports that decision in the heat of the moment. This is the glitch that is often overlooked, to a traders detriment. And there is no better place to look to see this partnership in action than risk taking.
Once a trader discovers that all thinking is emotional-state-dependent and that he or she is an emotional being rather than a rational being, the mindful management of emotions while trading becomes an indispensable skill for developing a peak-performance mind. It is the emotionally balanced mind that maximizes the potential of risk taking in the face of uncertainty.
A New Understanding of Emotion
Building a more effective mind for the management of uncertainty begins with better knowledge of emotions. First, emotions are not psychological. They are biological, and they take over thinking. In fact, thinking (the behavior of neurons) is emotional-state-dependent; this means that the quality of perception you are capable of is dependent upon the current emotional state of your brain. Perception and analysis present very different potentials when seen through the lens of distress or euphoria than when viewed through the lens of disciplined impartiality.
Anyone who has made decisions under the pressure of the moment will have experienced this. When under pressure and in a cloud of distress, a trader thinks from the emotional state of fear (distress in the language of stress management), giving rise to the worry-based thinking of second-guessing his decisions and acting for short-term protection. Yet, once the trader calms down, the decisions are reviewed from a state of mind rooted in a rational emotional state. From the vantage point of this emotional state, his thinking is completely different, and he now finds no reason to change the course of his decisions.
The other side of the coin is the overconfidence of euphoria. This occurs when a trader falls under a spell of positivity, after a series of victories, and she comes to believe with certainty that she is in the zone and the good times will continue to roll. And this is when the trader underestimates risk.
Both fear and euphoria take the trader away from a mind rooted in disciplined impartiality. This is how much power emotion has to alter perception and decision making. It is also why stress and the thrill of performing under pressure have to be better managed (not eliminated) for effective decision making under pressure. So, it is not freedom of emotion that is sought, since that is not possible. Rather, the factor that gives the trader an edge is freedom of emotion.
Train Your Mind
Step 1: Emotional regulation or developing a resilient mind.
Because biology, emotion, the brain and the mind are interlinked, interrupting the biological process of emotional arousal can be used to calm the mind. Shallow breathing, muscle tension and accelerated heart rate (as aspects of biological response to stress) are required to build and maintain agitated states that accompany the pressure experienced in stress. If these three components of an emotion are interrupted, then the stress-and corresponding thinking-cannot be maintained.
By developing and applying diaphragmatic breathing and muscle relaxation consistently as volitional skills during the course of a trading day, much of the stress experienced in the body can be reduced and much better managed. The key is to become mindful of your breathing and muscle tension during the day. Learning to attune your attention to the telltale signs of stress in your body allows you to catch it before it becomes unmanageable and leads to regrettable outcomes.
Even being mindful of your bodys reaction to stress and putting brakes on the acceleration of stress do not solve the problem of stress-compromised decision making. Emotional regulation only gets you to the door of the mind, where perception is housed. But without emotional regulation, the mind simply cannot be approached. Once the body is calmed, a tool must be developed that allows you to open the door of the mind so it can be observed.
Step 2: Mindfulness or developing awareness of the beliefs that drive your thought life.
Observing the effects of stress on the body is very different from observing your thought life and performance impacted by stress and pressure in the moment. The body does indeed mirror mental state, but it also exposes the beliefs (about your capacity to manage uncertainty) that drive your thought life that accompany performance in the moment. This important step requires developing awareness of your thought life while under pressure.
The core of a mindfulness practice is the awareness that you and your thoughts are not the same. It is the defusing of thought from the observer of the thought that gives mindfulness its unique power-the power of awareness outside of thoughts. Being able to examine your thoughts and beliefs from the vantage point of a higher degree of self-awareness allows you to recognize that you are not your beliefs. But as long as you are not aware of the lens of the beliefs that your mind sees through, those beliefs (outside of awareness) are shaping what you see, how you interpret, and how you perform-for short-term benefit, such as survival in the moment and the thrill of the chase, versus long-term benefit such as success over longer time frames.
This is the feedback loop back into stress and emotional-state management that applies to trading performance and decision making. What you see as possible is shaped by the beliefs that color and shape your world. In prolonged distress or eustress (so-called good stress), there is an operational belief about being overwhelmed or incapable of error. And the available solution that shapes typical responses to this problem is to work harder by doing more, which leads to eventual exhaustion and costly mistakes. But instead, what if work were about your capacity to produce effective action instead of working harder?
With a new set of eyes and understanding, a new possibility opens up to manage the stress of being part of the professional trading community. Beyond simply working harder and harder and finally hitting the finite wall of exhaustion or overexertion contained within this solution, effective work can also encompass your attitudes and beliefs about the work and payoff of trading. Through consciously examining historical beliefs, a shift becomes possible from the illusion of a mind that believes outcome is predictable (in a world proven to be uncertain) to a resilient mind competent to manage probability in a world acknowledged to be uncertain and impossible to predict.
By applying these principles, the work of the resilient trader is to no longer attempt to accomplish the impossible-to predict outcome. Now the work is to develop the mind that manages the probabilities of uncertainty. Stress becomes more manageable. And the mind is freed from the distress of managing the impossible to the eustress of managing the possible. The challenges of trading decision making are still part of the environment, but the mind that you bring to the challenges of managing uncertainty is better suited to the task.
The trader lets go of the illusion of control over outcome and focuses on the one thing he or she can control: the mind the trader brings to the performance of trade execution.
Rande Howell is the author of two books on trading psychology, Mindful Trading and Maverick Trader. He has lectured before BlackRock, J.P. Morgan, Lazard Asset Management, Morgan Stanley and other investment firms.
