BarroMetrics Views: Emotions and Trading
“..With emotions we cannot control ourselves, and without the we cannot make decisions. We appear doomed to chase short-term rewards and run with the herd” (Behavioural Investing, p15).
And I’d add, the market seems to provide traders with the optimal environment to act according to our insticts of fight, freeze and flight.Of course, such decisions more often than not cost us money – loses we often can avoid by reacting more rationally.
Let’s take a moment to clarify the quote.
Studies have shown that humans are incapable of making decisions without emotion (see http://en.wikipedia.org/wiki/Iowa_gambling_task); but, our ability to make optimal decisions in the face of strong emotion is unlikely. (see http://www.hss.caltech.edu/~camerer/web_material/n.html).
How do we overcome the dual handicap so as to make reasonably robust decisions?
At the base of problem is the hard-wiring that moves us towards pleasure and away from pain. We now know we can change the hard-wiring in our brain; and, we know, that our unconscious does not know the difference between reality and ‘virtual reality’.
So, one solution is to identify various possible market scenarios, and then spend time visualizing our response to the market events. Practicing the responses, so that they become relatively automatic, goes a long way to overcoming the problem.
I’ll give an example tomorrow.