Articles on Trading Psychology by Rande Howell, Trader Pscyhologist

Emotional Mastery of the Trading Mind                                                         Part 1 – The Survival Based Biases that Are Robbing Your Potential


After a considerable amount of time searching, traders come to the realization that the real trading edge is the mind you bring into the moment of performance under pressure.  Until your mind is right, no amount of theoretical edge is going to deliver the potential for consistent profitability.  Just look at the health of your trading account for confirmation.  It will tell you the truth if you are willing to listen.  And that preparedness does not come naturally.  The brain that your mind emerges from is built for survival in the short term, wants control over outcome, and is thrown into a state of confusion (which leads to fear and aggression) when forced to experience uncertainty.  Risking capital with an uncertain outcome is literally the worst nightmare imaginable to which you could subject the brain if it is not trained for this experience.  Yet that is what traders keep doing.  And this is what makes it so difficult to become consistently profitable on a sustainable level.

Why does it take so long for traders to “get” this truth that is hidden in plain sight?  The fact is that there are several primitive biases that are rooted in human survival instincts that operate outside of your working awareness.  And because they are instinctual, the trader does not see them in operation as they ambush the Thinking Brain. 

Locus of Control. The Thinking Brain (and the mind that emerges from it) wants to believe that reason and willpower will guide it through decision making while under pressure.  It thinks that it can control outcome (predict what the market is going to do).  Sometimes the trader’s brain is right, which reinforces the instinctual bias handed down from our Caveman ancestors. Those Caveman brains believed that they (and you now) could control outcome.  It produced a powerful survival advantage for our ancestors and got wired into genetically transferred genes to future generations, including today’s trader.  But other times circumstance proved that Caveman’s illusion of control (and yours, sitting in front of your computer managing a trade) was busted by experience.  This is where another bias kicked in to protect the feeling of certainty and power that the Locus of Control Bias provides in our evolutionary development. 

Cognitive Dissonance.  No matter how much evidence is provided to the contrary, the inherent bias of Cognitive Dissonance kicks in on a primitive and instinctual level – below conscious threshold.  Cognitive Dissonance is a bias that has you not listening to the contrary evidence that reveals the magical beliefs that drive faulty reasoning.  In fact, the more evidence that is provided to the contrary, the more the person will dig into a position and stubbornly hold onto beliefs (later to be called limbic beliefs) that are proven false.  They do so simply to maintain the illusion of control and illusion of well-being that the ineffective beliefs provide.  The catch is the trading account.  It keeps throwing up into the trader’s face that the beliefs that he/she is projecting onto the markets are ineffective in extracting more capital out of the markets and the trader gives back to the markets.  Yet the trader denies the truth right in front of his face despite the economic pain being caused by the ineffective limbic belief, because he is biased to assess that he is going to win because of his Optimism Bias.

Optimism Bias.  Traders consistently want to believe that if there is a will there is a way.  They believe (without evidence to support them) that (through sheer effort, will-power, and persistency), they will finally breakthrough to winning.  This is an inborn bias of the limbic system (also known as the emotional brain).  Our Caveman ancestors had to be optimistic about their odds of survival, or you and I would not be here today.  That optimism (winning against all odds) gave our ancestors hope and a sense that they WOULD prevail.  This was a successful adaptation for survival in the short term and was wired into our human genome.  It also operates outside of working awareness of your Thinking Brain.  In fact the Thinking Brain, with its reason, creates a fiction that supports the Optimism Bias.  And that story usually involves finding (something outside of the Self) that will fix the dissonance between the trader’s optimism and the lack of evidence to support the optimism.  It’s called the search for the Holy Grail of trading.  It can be quite obvious to everyone (even the trader) that he has problems managing emotions under the stress of trading, but he/she will still cling to the magical belief that what separates him from success is right around the corner in the form of the right indicator or instructor who has the “secret”.   Yet they still fall from optimism to fear and aggression when the reality of not being able to control outcome seizes them.  Then they want to get their money back and end up falling into the trap of Claw Back Bias.

Claw Back Bias.  One of the hardest biases to overcome is the urgency to make up for prior losses.  The problem is that you cannot do so.  If you accept that winning and losing as certainties is beyond human control, you can see the flaw in this bias.  No matter how hard you try, you do not control outcome – much less a series of outcomes.  Yet when random occurrence clusters several trades in your favor (once you have been swept away by your Claw Back Bias) you become convinced that you can make up for your prior losses and at least get back to breakeven for the day.  It’s not rational, but it is a hotwired instinctual bias that pushes you to get back from the markets what it has taken from you.  Then you lose several trades in a row and both the aggression of anger and the fear of death surge through your blood and in your neuro-synapses.  And, as you know by countless experiences, disaster makes a house call. 

Chase Bias.  Every trader knows the plot – after the fact.  A trader starts making some money.  It feels good.  Dopamine pulses through his veins.  It feels so good (remember dopamine as a neuro-transmitter is very similar to the drug cocaine) that you feel invincible.  You suddenly have confidence that trading is going to go your way.  You are in control.  You believe it is YOU making all those results happen and not probability.  That dopamine fix makes you feel certain that you can make things happen.  You are confident (through not in a good trading state of mind) that you know where the market is going and you start chasing trading (commonly called over-trading).  You see the action and are eager to achieve victory.  You can feel it in your grasp.  This is the dopamine and testosterone of the Chase Bias.

Confirmation Bias. This is particularly common in trading mistakes.  You have a belief in where the market is going and you seek out evidence to support that belief and ignore evidence that is contrary to your pre-determined belief.  You want to be right as a bias to the point that you become fixated.  And, therein, lies the problem.  While you are focused on being right, the market is simply doing what it does – with or without you. 

The Instinctual Biases of the Emotional Brain

The above are common, built-in assumptions that trigger the emotional brain to instinctual action.  That instinctual action bypasses your Thinking Brain and sweeps it away into creating narrative that supports the emotional brain’s survival instincts.  Listen to that.  The Thinking Brain (governed by emotion) creates alibies (or stories) that support whatever the Emotional Brain has already decided.  And much of what the Emotional Brain decides is based on historical biases transmitted to your current brain based on survival conditions for a world that no longer exists.  This is particularly true in trading.  There are no saber-toothed tigers, no ferocious 10 foot tall bears, or other dangerous predators looking for an easy meal.  But what you bring to trading in the form of your mind is the legacy of that Caveman adapted for a dangerous world. 

You don’t have to be wondering about what just happened to you when you experience emotional hijacking that later causes you to wonder – what was I thinking?  These common biases of the human kind are always present with you.  They are part of your heritage as a human being.  The biases are not bad.  They are there because (at one time) they were highly effective for the short-term survival needs of our ancestors living in a dangerous environment.  They were adaptive and so were built into limbic learning and an effective solution to our human survival needs THEN. 

But this is NOW.  Trading demands a probability-based mind.  This is not what you brought to trading.  You brought the old brain with you.  The one that falls apart when it experiences the uncertainty (with real risk) of trading.  Old hard- and hot-wired biases kick in from the perception of threat from combined uncertainty and risk.  You do not see the biases, but you do see their handiwork both in your performances under the pressure of uncertainty and in the health of your trading account. 

My invitation to you is to start looking for these biases in your trading performances.  Right now, most likely, you do not even see them.  I’m asking you to observe them.  They are not going away.  However, in emotional self-mastery of the trading mind, they have to be dealt with.  There is no choice in this matter.  Either you learn to deal with these instinctual biases directly or your performances (which belie their presence) will result in trading losses.  It is all about retraining the Thinking and Emotional Brain into a new partnership.  But you will have to learn how the Emotional Brain actually operates and helps create the performance mind capable of hijacking the Thinking Brain.  Or you can learn to support the Thinking Brain in creating a new way of engaging Uncertainty - one where the brain (and you) learn to control truly what you can control – the mind you bring into the moment of performance.  The magic is in shifting the mind that engages uncertainty away from an emotional reactive set of neuro-patterns that limits performance to fight/flight responses, and towards a mind that engages uncertainty with curiosity, discipline, patience, and impartiality.  This is the probability mind I call Traders State of Mind.  It has to be built.  Otherwise the instinctual survival biases of the Emotional Brain invisibly direct thinking into short term survival – which does not work in a probability-based endeavor like trading where uncertainty has to be embraced.    

Mastering Trader Psychology