There’s a long-standing truism in medical science: Every 50 years we find out that half of what we knew was untrue.
I suspect we are now in a period of diminishing returns on that front in terms of western medicine and the understanding of the human body, though hopefully we’re close to many breakthroughs.
Where I suspect we will re-write all the textbooks in the coming 50 years is the understanding of the human brain and a pioneer in that field is Lisa Feldman Barrett.
Her book on How Emotions Are Made is what I’m reading right now. For traders, it’s a critical subject. Trading educators often repeat that emotion needs to be removed from trading but anyone who has done it will tell you that’s impossible (or is lying).
What Feldman Barrett and others pushing the theory of controlled emotion write about his how the mind is always predicting: And not just the traders’ mind.
As someone speaks, your mind is unconsciously predicting what they will say. If isolated, around 50% of the words you hear are unintelligible but our brain uses context to fit what it expects to hear next and fits it to the sounds, always staying one step ahead. If you turn around and look away from your screen as you read this, your brain already has an idea of what’s there and as your eyes deliver that message, it’s fit to what you remember.
It’s the same with emotions as your body anticipates what you will feel in a certain situation.
That’s brings us back to trading.
I’ll be writing more about this book and trading psychology in the weeks ahead but the first lesson I’ve taken from it — and I’ve been dabbling in this field for awhile — is that you can set yourself up for success or failure in a trade by accurately anticipating your emotions and preparing yourself.
For instance, most people only think about the upside and (briefly) the downside when putting on trade. You might daydream about the emotion of nailing the trade or the pain of getting stopped out. What most traders fail to do is anticipate the twists and turns of the journey.
It’s my belief that there’s a power in anticipating the full range of emotions when you put on trade. Two traders might believe that oil is going to $100 but both know it won’t get there in a straight line.
One will make the trade based on his faith in the fundamentals and manage risk around it.
The other might have a thought process that looks like this:
- I believe there’s a high probability that oil will hit $100 in the year ahead
- I believe it will be a hard journey
- I expect to feel doubt
- At times I will be bombarded by price action and headlines that go against my thesis
- I will undoubtedly feel pain
- I will manage risk around this trade and will take losses at the times it goes against me
- That will diminish my total return but it will keep me in the trade
That way, when the emotional pain comes, it won’t be a surprise. Of course it will still feel awful when it happens but having anticipated some of that pain and emotions, it’s more manageable.
Of course, in theory the first person will outperform because he won’t thin the position on the drawdowns. But it’s my belief that the second person is far more likely to stay in the trade to completion.
What this new psychological filed teaches us is that feelings inspire thought, not the other way around. So when you feel that doubt or pain, it will change your whole thought process. You need the conviction to overcome that but anticipating and visualizing the full range of emotions you’ll feel on the journey is a tool that will make you a more resilient trader.