Emotional Trading Alarms

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

Turning Your Uniqueness into Market Edge and a Trading Strategy

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

Investors Are in the 4th Stage of Grief - Depression

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

The Destructive Power of Revenge: Bailout Plan Fails

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

IT'S HERE: Inside the Investor's Brain

After a year-long writing odyssey, it's with great excitement that I announce the release of my new book, Inside the Investor's Brain. You can purchase the book here: Inside the Investor's Brain: The Power of Mind Over Money (Wiley Trading).

The ability to manage your mind in the markets is necessary for long-term trading and investment success. This book teaches the science of achieving high investment returns through an understanding of the power of mind. Endorsements are here. I won't repeat the publishers's long blurb (here: Inside the Investor's Brain: The Power of Mind Over Money (Wiley Trading)), but below is the table of contents:

Introduction.

PART ONE. FOUNDATIONS: THE INTERSECTION OF MIND AND MONEY.
Chapter 1. Markets on the Mind: The challenge of finding an edge.
Chapter 2. Brain Basics: The building blocks.
Chapter 3. Origins of Mind: Expectations, beliefs, and meaning.
Chapter 4. Neurochemistry: This is your brain on drugs.

PART TWO. FEELINGS AND FINANCES.
Chapter 5. Intuition: The power of listening to your gut.
Chapter 6. Money Emotions: Clouding judgment.
Chapter 7. Joy, Hope, and Greed: Hooked on a feeling.
Chapter 8. Overconfidence and Hubris: Too much of a good thing.
Chapter 9. Anxiety, Fear, and Nervousness: How not to panic.
Chapter 10. Stress and burn-out: Short term pleasure, long term pain.
Chapter 11. Love of Risk: Are you trading or gambling?
Chapter 12. Personality Factors: What are great investors like?

PART THREE. THINKING ABOUT MONEY.
Chapter 13. Making Decisions: The effects of probability, ambiguity, and trust.
Chapter 14. Framing Your Options: Seeing the world in black and white.
Chapter 15. Loss Aversion: Cutting losers short and letting winners run.
Chapter 16. Time Discounting: Why we eat dessert first.
Chapter 17. Herding: Keeping up with the Jones’.
Chapter 18. Charting and data mining: Reading tea leaves.
Chapter 19. Attention and Memory: What’s in a name?
Chapter 20. Age, Sex, and Culture: Risk-taking around the world.

PART FOUR. IN PRACTICE.
Chapter 21. Emotion Management: A balancing act.
Chapter 22. Change Techniques: Going deep.
Chapter 23. Behavioral Finance Investing: Playing the players.

Notes.
Glossary.
Index.

It is my sincere hope that Inside the Investor's Brain will help you achieve investment (and life) success beyond your wildest expectations.

Richard