Embrace Emotion

I've always been of the philosophy that in order to beat the market--if it's possible at all--I have to remain calm at all times. People panic at local minima, believing the market will keep going down forever and feel euphoric at local maxima, believing the good times will always last. Instead, better to remain calm, buy when everyone panics, sell when everyone is an optimist. In the words of a trader I greatly respect, "In the midst of chaos is an opportunity to profit."

There's an interesting article at The Big Picture about a study recently conducted on this topic. The author Steenbarger writes,

In a study that I conducted with Andrew Lo and Dmitry Repin of MIT, we found that emotional reactivity to financial markets was correlated with trading performance. Specifically, “…subjects whose emotional reactions to gains and losses were more intense on the positive and negative side exhibited significantly worse trading performance, implying a negative correlation between successful trading behavior and emotional reactivity” (p. 352).

In that study, we found, no single set of personality traits was significantly correlated with favorable trading outcomes. Rather, it was emotional reactivity overall that seemed to best predict profitability.

These results would seem to support the common perception that success in financial markets requires an elimination of emotion from trading decisions. A corollary of this view is that all good trading must be rationally conceived, planned, and executed: that good traders are those, as the saying goes, that “plan their trades and trade their plans.”

But, he says, that doesn't match up with what he's observed in trading firms.

These results would seem to support the common perception that success in financial markets requires an elimination of emotion from trading decisions. A corollary of this view is that all good trading must be rationally conceived, planned, and executed: that good traders are those, as the saying goes, that “plan their trades and trade their plans.”

The problem with this perspective is that it does not fit the realities of trading floors at the firms where I work as a psychologist and coach. Traders, even the most successful, are often highly emotional and competitive. Many sustain significant profitability year after year trading actively each day, holding positions for mere minutes. Invariably these very active traders have no time to research their trades, not to mention develop formal trading plans.

This describes what I've read about George Soros. He would take large bets in one direction after telling everyone why he's absolutely certain the market will move in that direction, only to change quickly his tune completely and make large bets in the other direction.

The answer seems to be that some people just have a "gut feel" that's more often than not, correct.

Research into implicit learning suggests that people routinely apprehend complex patterns in the world without necessarily being able to verbalize those patterns. For instance, young children can form grammatically correct sentences and yet cannot explain the rules of grammar. Very active traders develop a “feel” for markets that enables them to act on short-term shifts in momentum without being able to formally lay out the rationale underlying their trades.

Antonio Damasio’s research suggests that such implicit learning is cued by “somatic markers“: a felt sense of fit or non-fit when we perceive patterns in the world. Such markers, for instance, may cue us to shift topics in a conversation when we sense that the other party is uncomfortable. We may not be able to verbalize the reasons for the shift at the time–it occurs spontaneously in the flow of interaction–but we know it feels right in the context of discourse.

Very active traders describe a similar feel for what they do. A market will be weak and suddenly the trader will perceive that “we’re having trouble going lower.” Quickly he enters bids into the order book, gets filled, and rides a reversal move higher. Asked what made him think we were putting in a bottom, the trader simply replies, “They just couldn’t break ‘em.”

Damasio’s contention is that the feel that accompanies implicit learning is indeed a kind of feeling: emotion is an integral part of decision making. What makes emotional arousal detrimental to trading is not that emotion necessarily biases decision making, but that it can cover over the more subtle, felt somatic markers that alert us to subtle market patterns. When we are frustrated with our profits and losses, we can no longer fully attend to what feels right when we process complex market relationships. That leaves us out of sync with the market’s conversations.

In Lo and Repin’s study, ten experienced traders were connected to biofeedback equipment while they viewed financial markets. Interestingly, all recorded significant physiological changes during such trading events as breakouts from price ranges. “Contrary to the common belief that emotions have no place in rational financial decision-making processes,” the authors explain, “physiological variables associated with the ANS [autonomic nervous system] exhibit significant changes during market events even for highly experienced professional traders” (p. 332).

The intriguing implication of this work is that those who have immersed themselves in financial markets probably know far more than they know they know. Their performance crucially hinges, not on brushing emotion aside, but in sustaining access to those implicit cues that literally embody expertise.

I think anyone who's a "natural" at anything probably has a talent for seeing patterns at a subconscious level. They can't explain their success because they can't rationally tap into that nether-brain.

On a related note, my gut tells me that though VT is a one touchdown underdog against Alabama tomorrow, and even though VT has traditionally performed poorly against big programs, VT will win. My mind, of course, believes my gut is crazy.

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Further reading

They can't explain their success because they can't rationally tap into that nether-brain.

Read this. It's interesting. Don't let the title turn you off.

I think I've linked to

I think I've linked to Sirlin's essays before on the blog. He's good stuff.


But his understanding has its limits. For instance: his understanding of Starcraft is almost embarrassingly bad.

Still... the concept of "design" in video games needs more emphasis. In that regard, he's a godsend. You have the coders. You have the engineers. All of these technical wizards... but they collectively aren't dealing with or paying attention to the gameplay considerations which include but is not limited to, game balance, to give one example.

Props to Sirlin. We need about eight million more of him.

He also didn't give a fair

He also didn't give a fair shake to GuildWars, which he admitted he was biased against because of his familiarity with the WoW interface. His specialty seems to be fighting games, not RTS's or MMO's. Here was my post on Sirlin back in '06

His specialty seems to be

His specialty seems to be fighting games

Exactly. And he tries to piggy back his "fighting game philosophy" into a genre such as RTS. In so doing he treats every genre as a fighting game and is apt to judge it accordingly.

Guild Wars is a very good game for PvP.

MMO as a test bed for social philosphy

I'm not an MMO player (GO is my game of choice lately) but just as a small comment: I'm surprised that MMOs - as a potential artificial seasteading experiment - haven't been discussed AT ALL as far as I can see.

The artificiality of a "fake" world, may alleviate real consequences, but there is still room for some form of experimentation which is - as far as I know - untapped.

Snow Crash was pretty much a

Snow Crash was pretty much a prelude to Second Life, and predicted the potential an MMO might have as a test bed for social philosophy.

Edward Castronova is an economist who studies the virtual economies of MMOs.

I wrote an article a few years ago for a Diablo II fan site about the political economy of the game, in response to this article by Nathan Danylczuk. In my search for the links to those two articles, I just discovered that, in turn, my article was critiqued by both by Samuel Kite and David Ko Leong, and all four of these articles are referenced in a footnote in a book published by MIT Press, Cheating: gaining advantage in videogames, by Mia Consalvo, a Professor of Telecommunications at Ohio University.

David Friedman plays WoW and occassionally writes about the economic/social/political aspects of the game.

I've written some blog posts related to the WoW economy.

There is something you learn about economics from playing MMOs with virtual economies that you cannot learn as easily from a textbook or a classroom: namely, you actually get to experience the reality that prices are constantly in flux, and that there is no such thing as a fixed, "fair" price, other than what the market will bear at any given point in time. In order to do well in these markets, you have to keep yourself constantly updated of changing conditions, shifts in supply and demand, especially when rule sets are changed or new items are introduced.

That's a post right there too

Just cut and paste.

I had no idea you were referenced in a book.

Neither did I until 15

Neither did I until 15 minutes ago!

I should probably also

I should probably also mention the academically-oriented group blog Terra Nova.


Well, I stand corrected. :)

Good info.

since the "users posting in the last 30 days" is rapidly...

...dwindling, why don't you post that article as a separate post? Best if you include a brief synopsis.

At one point I did. But I

At one point I did. But I took it off. I didn't think it really "fit" here.

If I have some time in the future I don't see why I couldn't add that as a post.