Shrink Rap: The Value of Tempered Emotion, Part 1

It's time for a Wednesday dose of reality about emotions and the market. For all those who think that cool, calculated thought reigns, I submit the following examples as evidence that raw emotion is more often the norm during trading:

Look at the guys in the commodities pits and the Chicago bond traders, bursting with emotions. Their typical state of trading is one of gesturing wildly with their enigmatic sign language combined with split-second decision-making. Sometimes these guys are so frenzied, they look like women battling for Herm¿s scarves at a Neiman-Marcus half-off sale.

How about those seasoned traders handling the block orders on the floor of the New York Stock Exchange? You see them on CNBC scurrying around, placing orders in such a hurry that they leave the phones dangling off the hooks. When the action in a name is hot, they're at the post for that stock crowding in on each other, pushing and elbowing, forgetting any sense of personal space. They don't exactly look calm and collected, do they?

You think the traders sitting at the terminals on the institutional trading floors and hedge funds, watching the futures jagging up and down on their monitors, aren't filled with emotion? Walk in some time and witness all the nervous habits that belie their being calm and cool. You can take odds that more than half of them have bitten their fingernails down to the quick.

How about all the day, swing and position traders out there, both those at trading firms and trading at home? You think they don't feel a jolt in the gut when the market reacts violently to news? Or when they've just lost a quick two points watching a long position in Brocade take a dive? Sure they do. I've witnessed this often enough firsthand to know the truth. Lapses of concentration, becoming frozen with fear while staring at the monitor, entry errors, poor money management, yelling at their multiple monitors -- all of which are related to coping with emotion and the adrenaline released with it.

The whole industry built around being disciplined while trading -- all the books, workshops, software, entry and exit techniques, trading schemes, money and risk management tools -- is based upon a simple realization. And that is this: Following your rational intentions is tough to do in the face of the emotion that arises when money is being risked and quick decisions need to be made. Simply put, discipline didn't become such a popular notion in the world of trading for nothing.

Beyond All or Nothing Thinking About Emotion

I disagree, however, with the popular thinking that emotion is the enemy when trading, although it's true that emotions in their most raw and unmoderated form are usually not useful for good trading.

The problem arises when the edict against emotion is taken to mean that all emotion is harmful to trading, and that it should therefore be filtered out as a source of information in guiding decision-making. This results in traders attempting to block or numb themselves from feeling anything. No matter what the books and experts tell you, I view this as shortsighted, misguided and a mistake.

It is shortsighted and misguided because it does not acknowledge or respect the full spectrum of emotion. It is a mistake because it deprives us of necessary and useful information. We need to appreciate that the experience of emotion does not have to be an all or nothing event.

I'll take a trader who's in touch with his or her emotions and knows how to utilize them any day over a trader who is afraid to let emotion be part of the equation. The psychology of the market (in contrast to the psychology of the trader) is what the other guy is thinking and feeling. We refer to it as market sentiment, right?

How are you going to get a sense of market sentiment without valuing emotion? You've got to be able to feel market complacency, greed, panic, fear, disgust leading to capitulation, and euphoria. And not through someone else telling you about them but through your own experience of these states -- even if in only a brief and diluted form.

I want to respect my emotions, especially their power to shape my behavior when quick decisions are called for. I don't want to wipe them away. I want to use them during trading (and in the rest of my life) to my advantage. Perhaps this bias might be expected from a psychologist who has spent a career helping people understand, label, experience, express and contain emotion.

So, how can we best use emotion to our advantage during trading? I suggest that tempered emotion is the answer. I hinted at this in my column on the benefits of meditation on trading. I wrote that creating a "mental space" between impulse and action can help us learn to trust our feelings to help us make the best decisions, rather than believe that feelings can be only a hindrance.

I also pointed at it more directly in last week's Fear is Just Another Word for Somethin' Left to Lose when I advised a trader that he learn to value the fear he felt after a series of losses and that he use it as his "warning radar." But now I want to do more than just point at it. I want to spell it out in no uncertain terms.

The serious game of trading is not about eliminating emotion. If you think it is, best to find a good mathematical program and let it make your buy and sell decisions for you. The real trick is how to manage and temper your emotional reactions so that they may inform your decision-making, not dictate it.

Next week in Part 2, I'll give examples of tempered emotions and their relation to trading.