I am giving this book to all of my clients

“The Daily Trading Coach” by Brett N. Steenbarger is the best step-by-step guide for traders who want to make steady improvements to their trading game I have read.

The Daily Trading Coach: 101 Lessons for Becoming Your Own Trading Psychologist (Wiley Trading)


I do have one complaint about the book however. Normally, when I read such a book I will mark everything I read that is of value with notes in the margin and then bookmark them with a sticky note. Then, after I finish the book, I will do a quick review of the parts that are relevant to me and create a “to do” list for action items.

This book has over 150 sticky notes and almost every page has a handwritten note in the margins that stimulated or confirmed my thinking. There is so much of value here that I will have to re-read almost the entire book to review the valuable lessons! Because this book is so practical, I am afraid I can’t summarize it and do it justice.

Seriously, Dr. Steenbarger covers every aspect of the transformational process that traders will need to deal with. Reading the book is like walking on a field of diamonds and hearing them crunch under your boots. The issues that my clients are working on are all addressed clearly along with suggested solutions.

Our mutual experience in trading and trading trainers has forged a common psychological foundation that my clients will recognize as they read this book. My process of building new satisfying behaviors (I call Mind Muscles™) sync right up with his self-coaching guide.

If you are a trader who wants to become more consistently profitable by improving your own mental abilities with self-coaching, there is no better resource. If you want to accelerate your process with professional coaching, I will send you a copy of this book for free.

Richard Friesen
RFriesen@MarketPsych.com
415.259.0652

Creating new behaviors means that you are building new neural circuits where none have been before. Imagine driving down an interstate highway with its overpasses, bridges, fuel stops and connecting highways. Now imagine a broad canyon with jungle, boulders and sheer cliffs. Your job is to build a new foot path to a new destination on the other side. To make it even worse, as you hack your way through the jungle, you don't know where you will end up or if there is anything of value on the other side. It is tough to be motivated to keep hacking, when you can hear the cars on the freeway zipping right along the eight lane bridge above you to their familiar destination, even if it isn't where you want to go.

    How do you know you have downshifted to your limbic brain?

Everyone knows that emotional decisions can create havoc with trading profits. We understand this when we are calm and working from our neo-cortex (our rational brain). The problem is, as the emotions increase we go to our flight/fight response, receive a cocktail of hormones (adrenal dump) and we downshift from our neo-cortex to our emotional limbic brain. Our problem is that we don’t have a way to measure this change because our neo-cortex has been hijacked by our limbic brain and we lose calibration.

Until now?

Phillips and ABN AMBRO are testing a concept device. The implications are staggering. The major political disasters have been caused by emotional reaction coupled with unbounded power. What if we couldn’t drive, vote, legislate or trade while under extreme stress?

Until this device arrives, you can still manage your own emotional state by building a new Mind Muscle™. This exercise could change your life.

By managing breathing, you can change your physiology during times of extreme stress. How you breathe paces the rest of your physiological response. Change your breathing and you change your physiological pattern. If truly mastered, you will be able to lower your blood pressure and counter most of the negative arousal effects and stress levels from the adrenal dump during a downshift to fight/flight.

Practice can be done on your own and works more effectively as it becomes automated. Ideally this exercise I call Upshift Breathing is most effective when practiced under actual stress. To begin, practice the mechanics of this breathing exercise through several cycles by yourself. Pace yourself so that each part takes the same amount of time as you slowly count to four during each part.

1. First inhale through your nose slowly to the count of four.
2. Hold your breath to the count of four.
3. Exhale through your mouth slowly to the count of four.
4. Let your lungs relax and stay empty to the count of four.

Start the cycle again.

Additionally, this visualization may help. When you inhale through your nose, do so with steady deliberation and imagine that you are drawing in the room around you. On the next inhale, take in your trading desk. On the next breath breathe in your computer screen, then the markets, then the whole economy. Hold the economy effortlessly in your lungs for the four second count. Then with a complete and relaxed exhale, experience the joy of returning the markets to their former state.

Once you have the mechanics down, take a private moment, become comfortable, and create an imaginary threatening situation. This situation can range anywhere from mildly stressful, such as an argument with a spouse, to a truly terrorizing fear you have carried for years. We recommend that you start with a visualization of an event that is mildly stressful and work your way up to your core fears.

Set an alarm for five minutes (you can adjust the time with experience) and start the fantasy. Imagine the peace you feel before you see signs of danger or stress. See, smell and hear the argument, stressful situation or danger. Visualize it in all its details with all of your senses as if it were a surround sound, 3D movie playing in your mind. Notice the effects on your body as the experience intensifies. Allow yourself to feel the full impact of the stress, anger or danger. Allow your body or voice to respond out loud.

When the five minute alarm goes off, notice what is going on in your body. Notice everything you can. Inventory your entire body: breathing rate, vision, hearing, muscle tension, stomach etc.

Now, start Upshift Breathing. Breathe slowly. Focus on your body. Notice the changes as you slow you breathing. Practice this breathing several times until you feel you have the cycle of fear and relaxation automated.

Then the next time you are staring at disbelief at your trading screen as you are stopped out of you sixth trade in a row, your boss yells at you or your spouse makes an accusation, start your Upshift Breathing cycle. Pay attention to your body at the start of the Upshift Breathing cycle. Then notice your state as you cycle through the breathing exercise. This real-time awareness is an important part of the experience. As this breathing becomes part of your life, it will happen automatically in the very real high stress trading situations where you really need it. Law enforcement officers who use this technique report that it has become automated when they feel threatened, helping them asses danger and save lives.

If you can automate this breathing response during trading, it will eliminate the majority of emotional trading mistakes. The challenge is that most of us have a resistance to deep breathing because we have contracted our bodies to protect ourselves over the course of a day, week, year and lifetime. Slow breathing not only takes you out of the fight/flight downshift to your limbic brain, but has the potential to open other life pains. So, be gentle with yourself. Notice if you intend to do this exercise but don’t. Your resistance is there to protect yourself, even if that protection is no longer necessary.

To learn more about building Mind Muscles™ and a free consultation please call.

Richard Friesen (415) 259-0652 RFriesen@MarketPsych.com

    
We are all wired differently. We all bring different skills to trading. We all have distinct dispositions. We also have our own unique mental baggage that we deal with day in and day out.

This is good news.

Because you are unique, you can build a trading process that works for you. The ultimate goal is to accept who you are, know your skills and limitations and find a way to turn you internal trading machine into a statistical trading “edge.” Once you know your own “edge,” you can then create a trading strategy that emphasizes your edge and ameliorates your mental baggage.

Some traders need control. Others love excitement. Some traders want a clear system to execute. Others feel imprisoned by mechanical systems. We all have trading weakness that can be triggered in certain market conditions with certain positions.

A system that is built on who you are, your trading needs and ameliorates your emotional triggers can turn a volatile P&L into more consistent profits.

The first step is to determine what you really need. Not just what you say you need, but what is the underlying need. And don’t be shy here. It is ok to know that you need an adrenaline rush. There is no shame in this. It is fine to recognize a need to avoid being terrified.

Try this exercise to see if it reveals any deeper needs. Make a list of what you need out of trading. This will probably include money, but be sure to look for other needs as well…perhaps recognition, proof of your intelligence or escape.

Once you have written down all the benefits of trading, take the one that seems the most important. Then ask yourself, what you get out of this benefit. Write that down. Then ask again, what do you get out of that benefit? Write it down. Keep drilling down until there are no more underlying benefits. Then, go to the next most important trading benefit and drill down again.

For example, if you start with money as an important benefit, ask yourself, what benefit to I get out of money? The answer may be security. Then ask, what benefit do I get out of security? And keep drilling. The answers may surprise you.

You can also learn more about yourself by taking the MarketPsych Trader Personality Test gratis. It returns scoring on personality factors and biases.

The next step is to find out what your “edge” is. Edge is anything that gives you a statistical advantage for a trade. It might be pattern recognition, fearlessness in the face of market panic, discipline to follow a system, or an algorithm. What is your edge? How does it work? Why does the market not discount this edge? Why is the market going to give you profits? Make sure this edge is in sync with your skills, temperament and emotional baggage.

Once you have defined your “edge,” you can then create a system. The more clearly defined it is, the more it can be followed, tested and improved.

Understand who you are, use the best of yourself to create a statistical edge and build a system based on this foundation. The MarketPsych trader training coaching programs are built on this process. Please call if we can be of help.

Richard Friesen
RFriesen@MarketPsych.com
(415) 259-0652

    All trading systems work. All trading systems fail. It is difficult to find a trading system that DOESN’T work in some market at some time. It is also difficult to find a system that DOES make consistent returns in all market conditions.

Here is the really good news.

Independent traders have the luxury of picking and choosing their trades. They don’t have to trade all of the time. This is their edge. They can wait until the market patterns are working for them.

It is in the evolution and transition of trading patterns that a lot of money can be made and lost. Because trading patterns are driven by humans who trade repeatedly with the same behavioral responses the destruction and emergence of new patterns create profit opportunities.

The problem we have as traders is that if we have a system that is making money in one market pattern, we get attached to that system. We build our ego on the fact that 15 of our last 18 trades were winners. This rewards our dream that we have found the secret to trading.

It’s like one of those Zen puzzles…any belief you are attached to, the market will destroy. As a trader, it is your ability to see new trading patterns emerge that create the most profit potential. To do this, the mind needs to see the markets as they are without the prejudicial filters we all carry around. If our ego is attached to a trading system and its success, the ability to see new patterns emerging is difficult.

When I was an option floor trader, I would get a “sense” that a market pattern was about to change. This “sense” was built on years of experience. Even though I might not be able to articulate what was happening, I could feel it.

At these times I would go to the market to reduce my risk. It was expensive because I would have to trade with other market makers to change my positions quickly. More often than not, nothing had changed. I would have paid $10,000 or more for the insurance. However, a few times a new pattern would emerge and I could see it because I didn’t have positions based on the previous pattern. Other market makers, with large complex positions based on the previous pattern would need to believe that the current change was an aberration and that the markets would come back to their previous patterns. As the market continued the shift, it would get more and more expensive to realize the losses, and the more stubborn these market makers would get.

Here is the cool thing. Since I no longer had a risk position, a few times I was able to visualize the new patterns very early in the shift, reset my option volatility tables and start building a new position. I would often be trading with other market makers whose values were based on the previous patterns. Slowly, one by one, the other market makers would see what was happening and the options would come in line with the new pattern. With the new option values, I made a lot of money.

As a market maker, I had to be trading and make markets for incoming orders at all times and it was expensive to shift positions. But as an independent trader, you can pick and choose the times to trade. This is a powerful advantage. You can get out of a position with a click of the mouse when you sense a market pattern is changing.

Here are some potential indicators of changing market patterns:

Psychological:


-Unusual Emotions in yourself such as exuberance, fear or cockiness
-Emotions in other traders you talk to such as exuberance, fear or cockiness
-Overwhelming consensus of where the market is going
-Physiological changes in yourself such as stomach pain, tenseness, funny taste in your mouth, back ache etc.
-Emotions in the news and headlines

Market Indicators:


-Volume
-Daily Range
-Volatility and implied volatility in options
-Momentum
-Size of trades or unusual large orders
-New chart patterns
-Unexpected price moves
-Time of day pattern shfits
-Opening market patterns changes
-Closing market pattern changes
-Changes in your ability to execute trades
-Changes in your P&L patterns
-Unusual price gaps
-Sudden quiet
-Shifts in how the market reacts to news
-Changing margin requirements

Remember, all trading systems work during certain market periods. All trading systems eventually fail. It’s the law. If you can free yourself from the belief in your system as the holy grail, you can see new patterns as they emerge and profit.

Easy to say, but how do you see new patterns? In my coaching practice we create a series of Mind Muscles™. These are neurological circuits that help us create new responses to market conditions. Creating concrete visualizations is one way of building new Mind Muscles™ and behavioral responses. If you want to create a Mind Muscle™ for new pattern recognition try this exercise.

First, get comfortable in a place that you won’t be interrupted. Take a moment do some deep breathing exercises. One exercise that works well is to slow count to three on your inhale through your nose. Hold the inhale for another count of three. Exhale through your mouth to a slow count of three and rest at full exhalation for another count of three. Repeat 10 times or until you feel your body settling in.

Then close your eyes and imagine a dog, a well trained bloodhound. He is sniffing the air, the ground and various objects. Imagine this hound dog in detail, his colors, movements and sounds. He is looking for some scent that is out of the ordinary. Spend some time with him as he sniffs his world. Now give him a name. Sniffer works great if nothing else comes to mind. Call the dog to your side. Pet him and give him some love. Then tell him to go and sniff out new patterns and to bay at the top of his voice when he finds one. Call him back, reward him with love, and send him out again.

Now, when you are trading and have a moment, visualize your new bloodhound. He represents a new behavior you have created in your brain. Call him by name. Give him some love. Tell him to go sniff out pattern changes. Watch him as he sniffs both psychological indicators and market metrics. And wait for the baying to begin.

For more on the how and why of creating Mind Muscles™ please call.

Richard Friesen
RFriesen@MarketPsych.com
415.259.0652

    When I am talking to a prospective coaching client, one of the questions that frequently comes up is about my success rate, or clients that don’t progress. A professional trader and potential client asked me this question today.

This is a great question because it has stimulated my own thinking.

As a trader, I am all about pattern recognition (by the way, neuroscience is finding out more about how pattern recognition works in the brain…my next blog?). What is the pattern of traders that never make it?

We all have deep core needs, some of which have never been met. Most of us compensate (I know I have) and live great lives. However, sometimes that deep unmet need is connected to a belief about ourselves, our world or the markets. This belief becomes a story and this story becomes our lifeline and hope for the future. We will protect our belief in this story like life itself.

As a result, we are unable to see the market for what it is when it doesn’t fit our story.

If we felt ignored in our early years, we might create a story that successful trading will bring us acclaim. If we were told we were stupid, successful trading might prove that we are smart. If we felt powerless, sucessful trading will give us the power we deserve. If we were abused as children, successful trading will release the anger we feel. If we feel unworthy, we may sabotage our results.

For example, a former exchange floor trader who worked for my trading firm was adopted and had always felt unworthy. He had overcome a number of problems in his life (like stuttering) but his lack of self-acceptance was a deep unacknowledged wound. Before I hired him, he had made a lot of money trading then blew out (He lost all his trading capital). After training, he followed our option trading system but had mediocre results.

I brought in a hypno-therapist to work with him. She gave him the tools to visualize and build a new relationship to himself, as someone who was worthy. After a few sessions, he became a tiger in the pit. In fact, he became so aggressive that he got into a fight on the floor. My firm was fined, and I was very happy to pay. He went on to become both profitable and consistent.

But what if he had kept the story that he was unworthy? Would new trading systems, new gurus, new algorithms make a difference? Probably not.

We all have unacknowledged stories. Most of them are benign. But occasionally, one story can be so attached to a core wound that at this time, we can’t let go, even with all the help in the world.

The first step to discovering our own story, is awareness. Here is an exercise that may be helpful in expanding your own self-awareness. When trading isn’t going well, set an alarm to ring in ten minutes or more. When it goes off, freeze! Now take an inventory of your thoughts. Are you telling yourself a story? If you are feeling badly, what drives that feeling? What story creates that feeling? If you find a story, write it down in a journal.

The story is your way of protecting yourself, so give it respect like a wise elder. If you want to take this experience further, see what the story is protecting. You might find a door to a new insight.

Richard Friesen
www.MarketPsych.com
(415) 259-0652
RFriesen@MarketPsych.com

    One of my overseas coaching clients had become frustrated with the complex trading system he was using. He had recently received a stinging set of losses.

We had just completing our third phone coaching session and I suggested that he stop trading. There was a long pause on the line.

“You want me to stop trading?”

I responded positively suggesting that since he wasn’t making money anyway it wouldn’t hurt to just stop as a way to find out what was going on.

He agreed.

Three days later he gave me an unscheduled call. He was very frustrated with not trading. So I had him do some relaxation breathing exercises with me on the phone. Then I asked him if he was willing to experience a guided imagery. He agreed.

We did some exploration of his frustration until it was located and had a voice of its own. The voice was anger. Anger at not being perfect. Anger at losing money. Anger that if he couldn’t trade, his dreams of the future were threatened.

This session was very productive. While he was trading, this anger was still there, but unrecognized. By stopping trading, we were able to see the emotional state that he brought to the market. This same emotional state was sabotaging his efforts.

This trader was smart, and had made a lot of money in past and had a workable trading system. We are now working with the anger with a new awareness. It has some important message for the client.

We all have voices and emotions that we have walled off. If not recognized, they can undermine even the best traders and systems. One of the processes we use in coaching is to create an environmental shift that gives the client new powerful awareness. Even a simple awareness can produce significant breakthroughs and return trading to profitability.

Richard Friesen
Director of Trader Training
MarketPsych LLC
415.259.0652
RFriesen@MarketPsych.com

    It's been a loooooong time (and a 20% S&P500 rally!) since we last blogged.

We've been investing and training financial advisors - among whom, as you might imagine, there is a huge (and long overlooked) need for psychological tools to use for the benefit of emotional clients in volatile markets.

We thought you'd find the below graph interesting. Optimistic discussions of real estate are rising to decade-long highs in the mainstream financial media (in this case: WSJ, NYTimes, Financial Times, and Barrons). IYR is the iShares Dow Jones Real Estate Index. The chart demonstrates the time period from January 1, 2001 until today.



Such charts are important to consider in context. Many investors are still "shell-shocked" - trapped in negative views of real estate and the markets and waiting for the next "correction." It's important, after a distressing year such as we've had, not to be stuck in the mental habit of pessimism. We're seeing and hearing much more pessimism than optimism among money managers, yet the key is to try to remain flexible and adaptable to new information - which is always the most difficult thing.

Happy Investing!
Richard

    Been a little remiss in my blogging the past month, but I wanted to update folks.

I will be on CNBC Monday morning (supposedly between 10:30 and 11:00 AM) with Erin Burnett and Mark Haines talking about Fear and Market Bottoms.

So tune if you wish.

And congrats to Richard and the MarketPsy Asset Management crew who have been riding high through these turbulent markets. When it comes to secret formulas for deliciousness, there's Coca Cola, Kentucky Fried Chicken... and MarketPsy.

    
It is again rumored that there IS a monster in the closet, and this one is bigger and badder than any previously imagined. The monster is in the form of bad debts on bank balance sheets -- creating an insolvent US banking system with "$2.5 trillion" worth of bad debt. I'd say that's a scary situation to be in.

There are a number of potential remedies to dealing with the monster -- the UK may choose to go the route of nationalization, which is apparently favored by Shelia Bair (currently head of the FDIC). The danger of nationalization is the destruction of shareholder value that would ensue and the further loss of investor confidence.

In anticipation of this worst-case scenario, today we saw the stock market acting as if nationalization were likely to occur - creating a self-fulfilling prophecy of plunging share and asset prices, which itself increases the risk of banking collapse. Such psychological positive feedback loops don't stop unless some signal is given by the government (or a credibly strong authority) that nationalization is not likely to occur. Because we're in the midst of a momentous political transition, such information probably won't come this week. Which sets us up for a very volatile week.

Psychologically speaking, there are a few things we can do when we think there's a $2.5 trillion monster in the closet, which roughly parallel the "freeze, fight, or flight" response:

1. FREEZE: We can hide under the covers and hope it goes away (hasn't worked so far).
2. FIGHT: We can grab a baseball bat and run into the closet swinging. (This seems to be the TARP method, but too many blows have missed the monster and hit us on the other arm -- ouch - which makes parents (i.e. taxpayers) angry and reduces our monster-fighting motivation).
3. FLIGHT: We can jump out of the bed, sprint to the light switch with a pounding heart, fumble to find the switch in a panic, turn on the light, and slowly turn to face the monster. (Just shedding light on the monster reduces the uncertainty and fear we feel.) If instead of turning on the light we fled from the house, then we'd be homeless and the monster would get our Serta, which isn't tolerable for most of us.

Right now we're hiding under the covers, and the monster has been growing bigger and more bold.

I'm concerned that in the next rescue - Part 4 - the government may destroy shareholder value via nationalization. To do so would further undermine confidence in the stock market, at a delicate time, and in my opinion it could delay the economic recovery. The lower asset prices go due to nationalization, the more forced liquidations and underfunded pensions we'll see. That may be inevitable in the course of this unwinding, but it's not economically desirable.

If we turned the light on the monster, had a long honest talk with it, gave it it's own bedroom (the "good bank, bad bank" method), and let it find a job on its own time, then we might make it through without being eaten. Seems like the best option so far.

We may have to live with a stinky expensive monster for a while, but that's better than ignoring it and having crippling anxiety attacks and insomnia which ultimately undermine our ability to get on with life.

And don't forget that the banking system was insolvent in the early 1980s as well, and it made it through that storm intact.

Richard

     A few thoughts about the auto industry bailout failure:

As Congress is considering this decision, there is so much baggage from past consdierations (prior bailouts, anger about SUVs and "sabotaged" electric cars, union pay and benefits, etc...). The emotional baggage is getting in the way of rationality.

Psychological research shows that facts and numbers are needed to make the best decision in such a situation. Grandstanding over ideology is what happens when no one has come up with clear numerical projections. Numbers such as: 1) how many people will become unemployed and their families will draw federal and state benefits? 2) what are the consequences of bankrupcy reorganization to employees, suppliers, and others? 3) What are the realistic future strategies of the companies? 4) Who are the creditors who will be hurt by bankruptcy?

These are useful questions, but under stress and uncertainty the human mind will latch onto emotional images without such numbers, often making worse overall decisions as a result.

Richard

    Faith.

What is it? What does it mean to investors?

If something is provable, certain... there is no need for it.

You don't need faith when you already know.

Faith is for the times when you really don't know.

It's the belief in something despite a lack of evidence.

The essence of faith is doubt.

We investors are getting our faith tested these days.

Faith in policies that we were assured will fix the problems. Faith in the people who make them. Faith in companies who say their balance sheets really are okay. Faith that investing in stocks is a good and safe choice for the long term.

Algonquin Round Table raconteur, Alexander Woollcott once said, "Everything I love is either illegal, immoral or fattening."

Exactly.

Cheating vs. Owning Up?

Looking the Other Way vs. Taking a Stand?

Broccoli vs. Red Velvet Cupcakes?

You want a short and reliable guide to making the "right" choice?

It's the one that's most difficult to choose.

So here we have a market that is tantalizingly cheap (historically speaking) and absolutely terrifying.

What choice do you make if you have a long term horizon?

I say unto thee, brothers and sisters: Those who have faith in this market will be rewarded somewhere down the road.

I believe that. In fact, I'm acting on it.

But to tell you the truth, I'm just going on faith.

    
It's been a depressing time to be an investor these past few weeks. In my opinion we're at the worst point in this crisis so far, yet surprisingly to me, the MarketPsych Fear Index has only begun to rise in the past 3 days.

I think investors have been in a state of despair, not fear. They have essentially become resigned to further losses. That's obviously not healthy for the markets. And on a technical level, it doesn't bode well for a price recovery. On a psychological level, I think the entire financial community is in the 4th stage of the Five Stages of Grief called "Depression." See midway through this blog post for a prior discussion of the five stages.

The image above was borrowed from Irvine Housing Blog, and even though it incorrectly orders the progression of the Five Stages, it gets the point across.

I've been to New York to train portfolio managers and financial advisors every month since the crisis began, and I'm finding a tragic progression in the psychology of the people I've spoken to, just like the stages of grief (above).

In late September, I still heard hope - "this is a bad year, but it might still recover." A few people were frazzled and had abandoned their long term strategies for cash, but the vast majority had stayed invested and were taking big losses. (In general, the hope for a recovery, and the attempts to time the bottom, are characteristic of a continuing price slide, not a bottom.)

By late October I encountered paralysis and shock. There was furious scribbling when I described stress management techniques, but otherwise the portfolio managers I spoke with were somewhat listless and exhausted.

Last week, I encountered profound sadness, hopelessness, and despair. Some people approached me with deep concerns about their abilities to keep their jobs and their clients.

Nothing will ever be the same on Wall Street, and I'm afraid the shakeout of the financial industry is just beginning.

By being real about where you are, and staying positive and proactive, you'll make it through this crisis OK. Remember to work on the things you can control, and let go of those you can't. And dust off your Plans B and C - hopefully you won't need it, but knowing it is there is psychologically settling.

Once you've come to terms with the sad realities we're in, then it's time to start positioning for the future. There are great opportunities that come out of every crisis, and there is usually plenty of time to spot them and take advantage, since so many others are paralyzed. For example, boat trailer sales are up, since many people can't afford marina slip fees for their boats anymore. And of course, Safe sales are up... There is always opportunity, but sometimes it requires a little more creativity to see it.

Best wishes,
Richard

    
Are you glued to the financial news?
Ruminating and checking prices frequently?
Having difficulty sleeping? On edge, tense, or nervous?


These are all symptoms of stress, and they are common for anyone working in the finance these days. Unfortunately, stress can erode the ability to think clearly and perform consistently during the times we need those skills most. Fortunately there are several steps we can take to manage stress that will get us back on track to excellent performance.

Stress is the brain’s way of trying to protect us. It prepares us to handle unexpected surprises and potential threats. When we’re under stress, our adrenal glands release stress hormones such as adrenaline and cortisol. These hormones actually affect our brains, causing a short-term focus, increased pessimism, impaired concentration, reduced attention span, increased mental rigidity, decreased patience, and enhanced detail-focus. These traits can be problematic for investors since they predispose them to make impulsive trades and information processing mistakes. That’s why stress management techniques can help you “keep your head” in volatile and unpredictable markets. In order to reduce stress now and make a long term plan to prevent future stress, try the three stage process in the attached document.

Best wishes,
Richard

    This crisis is now fundamentally about psychology.

Trust is the oil in the engine of capitalism, without it, the engine seizes up.

Confidence is like the gasoline, without it the machine won't move.

Trust is gone: there is no longer trust between counterparties in the financial system. Furthemore, confidence is at a low. Investors have lost their confidence in the ability of shares to provide decent returns (since they haven't).

This is now a PSYCHOLOGICAL problem. That's what Frank and I do - manage psychology, so here is my prescription:

1. A show of financial force is needed. Confidence has been lost in the ability of any one institution or government to solve this crisis. Now, to restore order, EVERY major central bank in the world needs to stand shoulder-to-shoulder and say: "We won't let this system fail." What? I didn't hear you... "WE WON'T LET THIS SYSTEM FAIL!!!" That's what the business community in the world needs to hear. That's how confidence is restored. It has to be a HUGE intervention and very credible.
2. I've said for a while that if the bailout plan had passed the first time, it may not have needed to be spent. Sometimes just the idea of a price floor is enough. That requires action to demonstrate that there is a buyer of last resort who will establish that floor. Sadly, we've seen the weakness and pettiness of U.S. political leadership, which has terrified investors. And so the credit crunch continues.... Only coordinated action by governments with their hands on the money spigot can pour enough financial oil into the engine now.
3. We need to believe that a BIG entity or institution or consortium is in control, or plans to take control of sorting out the crisis. Otherwise the fear and credit contraction will continue.

That means that when the coordinated action happens, it can't be watered down, and it needs to include the sentiment EVERYTHING will be done to fix this. Less than urgent STRONG action is not enough. Everyday huge amounts of wealth and growth potential are being eroded. It doesn't have to be this bad, but it will if no one steps up to the plate.

Unfortunately, I'm concerned (as is the market), that no one with the power has the leadership drive or political will to get this done. There are huge political risks to this, and sometimes explaining the psychology of what you're doing is enough to undermine it. For that reason, the final solution will need to sound very mechanistic, but the fundamental effect will be psychological.

The implications of a huge coordinated bailout/buyout will be hard to swallow for many people, on philosophical grounds. They might say, "but how can you advocate what is essentially a worldwide regulator or central banking system?" To which I say, "would you prefer a worldwide depression?" This credit crunch and the current market panic is THAT serious. And it needs the appearance of such an entity, for restoration of global confidence.

We need a coordinated, BIG, credible, active, and absolutely forceful response that demonstrates who is in control (and it has to be a unity of governments and central banks with a strong leader). Maybe the IMF and Worldbank will come up with something at their annual meetings this weekend? Maybe...

Richard

DISCLOSURE: I'm net short equities.

    The market appears to be crashing (in an orderly way) as I write this.

On the NYSE, New Highs = 1, New Lows = 1000. The VIX is over 55. Our MarketPsych Fear index is the highest ever.

If you're an active investor, what should you do?

Here's an NPR Marketplace interview with me about this.

1. First take a deep breath.
2. If you can't think clearly: go exercise, change your pace, play with your dog.
2. Now orient to where prices currently are. Forget about where you bought a position, or how much it is down. Right now, prices are what they are. And the first source of mistakes is being unable to come to terms with where things are right now.
3. Now, if your holdings are still hurting you, then take some action. You can't think clealy until you stop the bleeding. That doesn't mean sell everything. That means consider selling a small portion of a very painful position to relieve the pressure.
4. But now come back and consider that this is a historic time to find bargains in the market.

For example, if you believe that financial catastrophe is coming (and you have logical reasons for believing this), then gold is usually a good bet. Recently gold mining stocks have fallen in tandem with other stocks (yet their profits will be greater in an inflationary environment).

If you believe deflation is coming, consider this statement: "During deflationary environments, equities have performed poorly; however, high-quality fixed income has performed well." This powerpoint is a primer on managing investments during deflationary and inflationary environments.

Keep in mind that the best investments going forward will often be in stocks that you probably haven't heard of. And corporate bonds may perform better than stocks.

A stock screen looking for companies with high cash levels (and little debt) is sure to find some great opportunities in both stocks and bonds.

Distressed debt and preferred stocks currently have high yields, and you are likely to be very happy about owning these going forward. Also consider convertible bonds. A bond screener (such as at Yahoo Finance), can help you locate these.

If you've ever considered buying Google shares, it's cheaper now than in the past 2 years: $371/share. And they have $12 billion in cash to use to buy cheap and washed out companies.

Remember:

Tune in to your internal sense of balance first. Stabilize your mind first, and only then begin the process of sorting through the rubble.

In general, you don't NEED to do anything. However, sometimes inertia can cost you if you're not well-positioned.

And keep in mind that it's always good to keep cash available for bargain shopping.

Richard

Disclosure: I own several gold mining stocks as a short-term trade (but I don't believe financial catastrophe is coming).

    Studies show that people will pay to punish others who have violated "social norms." That makes some sense, since it ensures that we all have an incentive stick to the rules. But what is more unusual is that many people will pay their own hard-earned money to punish others even if they are unaffected by the rule-breaking. They simply want revenge.

This revenge urge is even stronger in men, than women.

In fact, studies show that the neurochemical dopamine is released in the brain (reward system) of people who take revenge on others. They actually get satisfaction from punishing rule-breakers. This can be addictive, and it certainly feels pleasurable to them.

So to me it makes some sense (biologically, not economically speaking) that a majority of House memebers voted down the bailout plan. They seem willing to endure some economic pain for themselves and their constituents in order to have the pleasure of punishing "greedy Wall Street bankers" (in the parlance I've heard used by some, such as Senator Richard Shelby, on CNBC).

The problem is, the pain our economy and reputation is going to endure is likely to cost much more than $1 trillion (how many trillions in stock and bond market equity have already been lost?).

Trust and confidence in financial institutions is the grease that keeps the capitalist engine moving. Unfortunately many in Congress are saying, "we don't see anything wrong." Well, sadly, they will. The engines of credit have largely dried up, and the longer they remain dry, the longer it will take our economy to right itself again.

Banks have lost trust in each other, investors are losing trust in the markets to provide a comfortable long term return, and now we are all losing faith in the ability of government to solve major problems (some people never had that trust in government, and unfortunately they'll see that government is necessary to the smooth functioning of the economy if we don't get a bailout package soon).

I moonlighted in prisons as a psychiatrist several years ago, and I'll never forget the inmates I met who seemed "hard-wired" to be enforcers of rules. These guys would punish someone for a perceived infraction, such as disrespect (even non-verbal disrespect such as standing in the wrong place), with violence -- violence that usually landed them in "the hole" and added about 90 days to their sentence. Some of them couldn't seem to stop punishing other inmates for breaking prison "norms," and so I would see them for a psychiatric evaluation. Some told me, with self-confident righteousness, about the "high" they got from punishing rule-breakers.

This is the dark side of "righteousness"-type thinking, which often fuels revenge. And I fear some of it may have leaked out from behind bars and into Congress. I hope not, but I'm beginning to wonder.

That's my 2 cents.
Richard

    How do we manage our fear in these chaotic markets?

Below I'm reposting some questions from Asa Fitch, a reporter at www.thenational.ae in Abu Dhabi, followed by my responses.

The first assumption that is good to challenge is: "Is it good to buy on fear, or should we actually be selling on fear?"

>>> What's the prevailing thinking on this?

The truth is that most of the time it is a good decision to buy on fear. But sometimes, such as in the past year, it was bad to buy on fear (especially in financials, since they have dropped 90% since the overall fear level began to increase last year). Buying on fear in Japan for the past 18 years has also been bad.

This is why Warren Buffett has said: "We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful" And as Buffett knows, there is more to it than just the emotion.

In the short-term, it is almost always good to buy on fear. And if you are thinking of selling because you are afraid, wait several days before acting (the price will usually be better then).

As a trader, it is best to buy on decreasing fear. And if you know in advance what events are likely to decrease fear (such as the passage of the U.S. bailout), then it is good to buy on fear there.

So before learning to "stop" fear, we have to be sure that our fear is not justified. Sometimes we should be afraid! (E.g., the financial crisis last August was only the beginning).

>>> Are there psychological strategies investors can use to get past the overwhelming urge to move to cash?

Yes, there are several techniques they can use to manage fear:
1. Externalization -- see the fear around you so that you can distance yourself from your own fear. For example, look at how much fear others are experiencing by looking at the VIX (volatility index) or the MarketPsych Fear Index (www.marketpsych.com). Then recall the Warren Buffett quote above (in 2007 he was the world's richest person, so he clearly knows what he is talking about). This quote "reframes" fear.
2. Reframing -- remember that fear is a buying opportunity. Turn from a "fear frame" to a "opportunity frame." The traditional Chinese character for crisis is comprised of two traditional Chinese characters. The second (bottom) one is "opportunity," and the first (upper) is "danger." [Corrected by Kay McCharles - Thanks!]
3. Fear is an anticipatory emotion -- it is about the future, while panic is in the moment (right now). Someone might be afraid of jumping off a pier into the ocean, but they are still safe. When they are in the water, if they are sinking, then they aren't afraid anymore - they are panicking. So changing perspective to a long-term view can be very helpful. For example, deliberately think of how happy you are in your life/family/overall finances before panicking about one small position in the markets.
4. Fear biologically induces a short-term, minute-by-minute focus of attention. We need to break that and remember the big picture. Think of long term goals, remember the justification for your current trading strategy.
5. If you haven't backtested your investment or trading system over many historical periods and examples, then you should be afraid and should not continue to use it unless you test it during a period similar to the current one -- past crises.
6. Of course, most people are long-term investors, and for them the best antidote to fear is diversification across countries, currencies, and industries. You won't get rich quickly being diversified, but you will better manage risk and volatility.
7. Comparisons -- if you are a long term investor having trouble holding tight, look at how you are performing relative to the worst sectors and funds in the market. It could always be worse.
8. Relaxation techniques -- You can use deep breathing and meditation techniques to learn to let go of the stress inducing emotions.
9. Exercise -- this is perhaps the most important technique for reducing stress and clearing your mind. Be sure to elevate your heart rate and sweat for at least 20 minutes continuously. You are demonstrating to your body (and your mind) that you can control and work through physiological "stress" -- in this case "good stress" induced by exercise.
10. Diet -- eat more whole grains, fresh and steamed vegetables, and cut out refined sugars, fried foods, and creamy desserts. Also consider an Omega-3 supplement (best is filtered fish oil) to take every day.
11. Do one thing you enjoy every day.
12. Dramatically decrease your information consumption. Most people find that they are reading several newspapers and watching many newsfeeds and technical indicators during the market day. Cut down your information consumption to the most essential 3 sources or indicators. This will help clear your mind and reduce confusion.

>>>>> Should you put your foot back in the water slowly to avoid the inherent reluctance to get back in after a big loss?

Yes, but be careful not to invest in the same areas. Many people repeatedly get in and out of the same stocks as they go down. If you sold out of your positions, and want to get back into stocks, then be sure to buy something completely different. let go of the money you lost. If you "play revenge" with the market by trying to prove that you were initially correct, you will continue to lose money.

>>>>>> Should you keep some small portion of your portfolio in cash to satisfy this urge to get out?

Yes, everyone should have some cash in different currencies for investing during crises such as the current one. The cash takes some pressure off and allows us to realize that there are many opportunities in this market. Having cash and not borrowing on margin for investments keeps us from losing everything during times like
this.

I hope that helps!

Richard