Mastering Trader Psychology

Articles on Trader Psychology by Rande Howell, Trader Psychologist

The Emotionally Intelligent Trader

Integrating Reason with Emotional Instinct to Create the Peak Performance Mind

                “The intuitive mind is a sacred gift and the rational mind is a faithful servant.

                  We have created a society that honors the servant and has forgotten the gift.” 

                                                                                                                 Albert Einstein

   “I can’t explain it.  Somehow I knew it was time to get in.  Things weren’t perfect, more grey area than I would have wanted, but something told me this was the right time and place.”  Have you experienced the instinct of intuition – a knowing that was not dependent upon logical reasoning?  Most traders have – they just don’t know how to use it.

   Traders are taught to exclusively rely on reason and logic in their decision making.  Yet, many things happen so fast they there simply is not time for the deliberation that reason demands.  If they stopped to deliberate, the trading opportunity would have come and gone by the time the trader came to a decision based on logic alone.  It is this grey area, where reason begins to fail decision-making under pressure, where instinct by-passes the thinking circuits associated with reason.  It is here that knowledge by reason and knowing by instinct will co-mingle.

   Yet, this seems to contradict the trading axiom – plan your trade and trade your plan.  Or does it?  What if reason and emotional instinct were really on a continuum where there was a zone where both could influence the other?  In fact, what if instinct simply has been given a bad rap? 

Intuition – Unconscious Pattern Recognition Providing Knowledge 

that By-Passes Reason   

    In our evolutionary heritage, humans adapted to a world where our capacity to reason and think through things gave our ancestors an enormous survival advantage.  Over time humans began to rely on reason more and more to the exclusion of instinctual knowledge.  By Plato’s time, this instinctual knowledge and action potential was considered to be a detriment.  Plato saw reason as the driver of a chariot and instinct as an unruly horse that had to be tamed. Human passion and emotion had to be controlled by reason. It seemed reasonable at the time.  Even Plato’s Republicwas rooted in Reason to the exclusion of emotion. More and more emphasis was placed on reason.

  By the time of Rene´ Descartes and Isaac Newton, reason had been put up on a pedestal as the shining beacon to becoming truly civilized.  No one listened to the wisdom of David Hume, who noted that reason was slave to human passion.  The Age of Reason progressed and access to our instinctual nature was pushed further and further away from being a conscious contributing part of human perception.  Sigmund Freud did not help.  He labeled human emotional instinct as the Id.  The impulses and passions of the Id had to be controlled to be civilized.  

   In man’s folly, did man’s instinctual nature simply fade out of existence?  No, it simply went underground in the shadowy world of our mindlessness.  Emotional instinct and reason still interact with one another.  But not acknowledging human instinct and learning to work with it, will allow it to hijack reason at the very moment a trader needs it most.  However, before turning to trading, let’s take a look at how reason and instinct work together in the brain of an NFL quarterback. 

   The Offensive Coordinator calls in a play.  In the huddle, the quarterback calls out the play to his teammates.  Everything seems driven by logic at this point.  A group of analysts have been observing the other team’s defensive tendencies and have called a play that they think will take advantage of the situation.  The Age of Reason is firmly in control at this moment.

    Then the offensive team goes to the line.  The defense, meanwhile, is out to disrupt the patterns they see in the offense’s strategy.  The quarterback surveys the defensive alignment.  Something’s not right.  He can’t put his finger on it and only has a short time before he snaps the ball.  There is no time to reason through his decision-making.  The clock is ticking.

    Instinctively, knowing without knowing how he knows, the quarterback calls a different play.  Why?  The quarterback can’t explain it.  He hasn’t reasoned though his decision-making process.  They had a game plan – worked on it all week.  The quarterback’s job was to act on that plan (sounds like trading now, doesn’t it?).  Yet, his gut instinct is acting on pattern recognition that his conscious, rational, mind does not recognize. 

   Who knows?  A linebacker could be inching up disrupting a pattern of pass coverage.  It could be the extra tight coverage the cornerback is giving his wide receiver.  Lots of ambiguity is what his logical mind sees.  But he is not trying to analyze the feeling as something wrong to be having.  He is listening to it.  Reason cannot fill in all the gaps in his perception.  And the quarterback has come to rely on his instincts to fill in the gaps that are beyond reason’s capacity to calculate.

  The ball snaps.  Chaos ensues.  He’s micro seconds away from the pocket collapsing.  He’s reading his options.  This is way too fast for the debate of reason to handle – he’d be buried under a pile of 300 pound men if he waited for reason to find the logical receiver to throw to.  Time is running out, defensive linemen pushing offensive linemen backward – the pocket is collapsing. 

  The logic of the offensive scheme fell apart.  The ball is thrown based on instinct.  It’s a completion.  In the chaos and uncertainty of the moment, reason took a back seat and instinct made and executed decisions based on knowledge beyond reason’s grasp.

 Rehitching Plato’s Chariot

    How many times have you experienced both reason and instinctual emotional knowledge attempting to work together in your trading?  Struggling traders attempt to separate reason from instinct because that is what they are taught.  They are told to “trade without emotion.”  The problem with this “trading truth” is that it is impossible to do.  All thinking is emotional state dependent.  Reason is slave to emotion. 

   The emotionally intelligent trader is not trying to distance him or herself from emotion and instinct.  They are using emotion to create the mind that can manage uncertainty optimally rather than avoid it.  The nature of trading is uncertainty.  Control over outcome is an illusion held by the rational mind.  However, by learning how to work with emotional instinct, the trader can control the mind that they bring into the moment of execution. 

   Something has to make sense out of all the ambiguity and confusion that is thrown at a trader as he engages probability.  There is simply too much to know too quickly for reason alone to master all the information coming into the brain while a trader acts.  He’d better have a game plan that has been reasoned out.  He’d better also have highly trained instincts that allow him to know without knowing how he knows.  Reason and instinct need to work together to produce highly effective trading.  Reason may drive the chariot, but reason must learn to use emotional instinct as another way of evaluating and acting on information coming into the brain.  The decisions are just too fast for reason alone to master.

   What does this look like in trading?  Two professional traders I know also run trading rooms where they both teach and trade live along with their students.  Both have very detailed training programs that teach a methodology that is proven.  There are rules for everything.  Their students love this rule bound methodology because it gives them a sense of control and confidence as they engage live trading.

   Invariably, the master trader takes a trade and the greener trader shouts out in unison --  “Why did you take that trade?  It does not fit your rules.”  The master trader will say, “Yes, it does.”  Upon review and some explanation, the trade is found to follow the rules.  The students were looking for a black and white checklist that would define the trade set up.  But there was ambiguity even in the midst of solid entry rules.  For the master trader, emotional instinct (unconscious pattern recognition that allowed the trader to know without knowing how he knows) kicked in (just like the NFL quarterback) and filled in the grey areas of the entry conditions. 

   The master traders have learned how to listen to their instincts as part of trade evaluation.  They did not necessarily act on instinct alone.  But they were able to forge reason and instinct into a more complete mind for the management of uncertainty.  This is what an emotionally intelligent trader does.

   To accomplish building this Traders State of Mindrequires the development of skills that traders generally do not bring to the table.  These skills have to be learned.  To get at the quiet voice of instinctive intuition, the trader has to really be able to regulate emotion, to be mindful of emotion and reason, and to build a mind that incorporates both reason and instinct. 

   This is the primary challenge when traders discover that the problem with their trading is not “out there” – it is inside their head.  It is the mind that trades that has to be developed once you learn the fundamentals of knowledge-based trading.  Your instinctive nature is going to be there whether you like it or not.  Ignoring it simply allows it to blow up your trading account.  Turning toward it and learning how to work with it is where emotional intelligence and knowledge-based IQ become partners in your success.  Reason and Instinct, together, are in Plato’s chariot.