How Neuroeconomics can Improve your Trading

Bright MindsBright Minds is a new podcast hosted by Money Manager and Trading Expert Patrick Munnelly. Through insightful conversations with notable guests, ranging from economic forecasters, to psychologists and experienced traders, we seek to answer the most commonly asked questions around trading and investing. Bright Minds is not just another podcast about trading: it goes deep into the psychological aspects of trading, such as tips on how to handle trading losses and on the trading mistakes to avoid. Listen or watch to the full episodes: www.tickmill.com/tools/bright-minds-podcastCan traders use feelings to their advantage?For traders, motivations and incentives are driven by emotions, from fear and greed to excitement and joy. Acting impulsively can be disruptive to long-term investment strategies.Avoiding short-term anxiety while investing or trading comes at a very real long-term cost. So, how can traders harness control and use their emotional reactions to the market as a positive contributor to increase returns, rather than allowing feelings to impact performance?To talk about that, Patrick Munnelly invited Dr. Andrew Menaker, a licensed clinical psychologist and performance coach working with high achievers. He’s also an experienced trader and has previously worked as a crisis management and threat assessment consultant for the U.S. military and law enforcement.A conversation with Andrew Menaker, clinical psychologist, trader, and performance coachPatrick: Andrew, could you get things started by telling us a little bit more about your career? Andrew: The way it all started is an interesting story… I was working at the Alameda Naval Air Base, which is no longer in existence. It's an island here in the Bay Area, Alameda, and one day there was an employee that showed up making threats and it was a civilian employee, making threats. He had called the local media, television crews were there, and the commander of the base actually asked me to come and see if I could resolve the situation, and it was very stressful. I had no training in this particular situation at all. So, long story short, the situation resolved itself. I was able to get this person's trust, and everything ended peacefully. The event got into the newspaper and the media, Wells Fargo had heard about it. They were interested in my working with their traders and asked me to come in. And that's basically how it started. I told them I had no experience in markets, but I quickly did. This was about ‘95, ‘96. And I got bit by the bug. As soon as I got involved in working with traders and began trading myself (this is sort of in the dot com boom in the nineties), I was very interested in trading after that. Patrick: That's certainly an interesting path into the business, not what I've come across before. Andrew, could you briefly describe the field of neuroeconomics and what its aims are?Andrew: Neuroscience and neuroeconomics is really the latest iteration around how we look at, how we can understand decision-making under conditions of uncertainty and ambiguity. But it involves a lot of the body, not just the brain. Patrick: I've certainly had experience of working on biofeedback to understand better my emotional response to the markets. So, from your perspective, what's going on in our brains when we are in the position of having to make high pressure decisions?Andrew: There's a lot of things going on, I'll just choose one. The field of Neuroeconomics says that the brain is a prediction machine, basically. Although in my coaching practice and in my blogs and other public talks, I might use the word triggered. The more accurate description of what's happening in the brain is that it's trying to predict what's happening. We're not really reacting or predicting. So, in that moment of, I call it the heat of the moment: “Should I get into the trade? Should I stay in, should I get out?” — At those moments, the brain is trying to predict what's about to happen. And as a result, there's a whole host of biological functions occurring in the body and in the brain. And I'll just finally say that emotion is both a body state and a brain state together at the same time. Patrick: What do you think is the main difference between uncertainty and risk?Andrew: Under conditions of uncertainty and risk, what they have in common is the brain is generating anxiety. That's the brain's job. Under conditions of uncertainty, there's also a lot of ambiguity, right? There's mixed signals. We see some things that suggest that it's going to go on our favour and other things that suggest it may not. Plus, there's our history, our background, our personal experience. And all of that essentially serves to influence or actually it constructs, it generates the emotional experience that we're going to have. And so, uncertainty is ever-present. Anyone who suggests or thinks that there's a way to eliminate uncertainty in trading or investment decisions is unfortunately misguided. It's one of those realities that we have to learn to deal with. Same thing with risk. I'll just say this, when I work with a trader, a client, one of the things I'm doing initially is trying to get a sense of what is this person's default mode around risk? Do they tend to be more risk-averse or more risk-seeking in moments of high pressure?It's usually not always one or the other, but there usually is a tendency. And that's a good place to start with someone. Patrick: I've found that some of your stories around how our lives outside of the world of trading can ultimately impact our operations or our market operations in the market. And could you talk to us about that, please?Andrew: There's so many things outside of trading. I'll say this, in that heat of the moment, it's not simply about what we're seeing on the screen. It's our P&L or account, how we feel about ourselves, how we feel that other people see us in terms of our degree of success in life. Those are some examples of things outside of the trade that affect the trade. Another big one, Patrick, I think you're probably aware of this, is it goes back to that biology piece. The amount of sleep we've had the previous night, that has a huge influence over how we perceive and tolerate risk. So, these are all examples and there's many others, things that are beyond the trade, beyond the screen, beyond the chart that influences what we see and ultimately, what we do. Patrick: And in your experience, do retail and professional investors or traders encounter the same barriers to success, or are there different concerns for different levels of traders?I think back to my early days in the markets, I would go through periods of hitting a certain level in terms of P&L, and it would almost be like a glass ceiling that I would hit that same level, and then I would go through a drawdown that would take me back and I'd have to recalibrate, refocus, start again.But then as soon as once again, I drew close to that level of P&L again, something in my psyche kicked in, and it was almost like self-sabotaged to a degree, and that seemed to go on for a period of I guess three to six months until I became consciously aware of it and almost journaled my way through it.Andrew: Very common pattern, Patrick. I've seen this over many, many years, over thousands of traders, is the ability to make money over days, usually, a few weeks — a week to three weeks. And then like you said, that that ceiling, we hit that glass ceiling, we have the drawdown, we give the money back. There's a lot of different things happening in that cycle. One of them, of course is perhaps, we're not adapting to changes in the market. That's an easy one to suggest. Another possibility is that do we feel was as though we deserve the success, how do we feel about having that increased level of success, having that increased amount of money? Most people think consciously that they want it, but there's also other factors going on subconsciously around worthiness, self-worth and many other psychological concepts that kind of come to bear right at that point, at the end of that cycle. Patrick: One of the things I struggled with in the early days was the idea that you had to have a trading plan rigidly adhere to that almost in a robotic fashion.And what I started to realise  was that there was a degree to which the more time I spent in front of the charts, the more I started building up a subconscious pattern recognition.I'm not talking about trading on gut feel, although I know people who do that pretty successfully. But for me, it was understanding how to incorporate that intuition aspect into my trading plan.Andrew: What you just said, Patrick, is so important for people to hear. When someone is just starting off as a trader, maybe a year or two under their belt, the idea of having a plan is actually more important when we don't have that experience. The more experience a trader has, the more ability we have to recognize that there's a change in the market, that we may have to adapt or alter our plan in the moment. For newer traders, I believe personally, it's much more effective and less damaging for them financially if they really have a concrete plan in the beginning. As they gain some experience, they will start to recognize that there are times when they need to alter that. But in the beginning, in other words, being more of a discretionary trader is dangerous with a lack of experience. Patrick: Could you give us some idea about some of the cutting-edge research in the field of neuroeconomics that's happening right now?Andrew: People can look this up and Google it, the somatic marker hypothesis, which  says that emotion is not just a brain state, but it's a body state. And very often, our body experiences the emotion before our mind, before cognitively, we recognize that we are in an emotional state. The latest research is showing that to improve performance and trading and investment decisions, it's not simply a cognitive matter in terms of the brain and thinking, and it's not simply just feelings and emotions in the brain, but it's also what's going on with their body. The idea of biofeedback, heart rate variability, is increasingly becoming an important area for performance and trading and investing.And a lot of that goes up the vagus nerve to the brainstem, and it influences how our brain creates an emotional experience. In other words, a rapid heart rate could be anxiety, could also be excitement, depends on how the brain's going to interpret it. Patrick: In addition to that, what are some of the other practical ways in which our listeners can use the findings of neuroeconomic research to improve their trading or investment performance.Andrew: Another very important area is to understand that our emotional experience is information. And instead of trying to eliminate or suppress our emotions or view our emotions as a weakness, to accept that we are emotional creatures. And one of the practical ways of doing that is something that I teach, is called live drill down writing, which is when you're in the heat of the moment you're interacting with the market, is to be writing about on paper, what am I feeling? What's going on with my body? What are my thoughts? Why am I having these feelings? When is the last time I had these feelings and what did I do? How does that work out? Should I be following this feeling or not? Engaging with your emotions and self-awareness is very impactful around performance and environments of uncertainty and risk. Patrick: I guess one of the key aspects for me in terms of development was developing a meditation practice, and incorporating that into my daily routine as a trader, and that was invaluable to me.Is that something that you encourage clients to do or have had experience of yourself?Andrew: Yes. I had direct experience myself and something I do encourage my clients to engage in regularly, primarily because the idea of mindfulness, which is what meditation creates for us, a sense of being able to observe ourselves, hopefully in a non-judgmental fashion. When you're able to do that and you practise that on a regular basis, it's essentially what you're doing is you're building what I call your self-awareness muscle. And the stronger your self-awareness is, the faster you're going to catch yourself and notice a certain emotional state. And you'll also be able to understand in terms of what the potential behaviour is that you may engage in, and also, get a sense in the moment, is this something I want to do or not? You can read more about Andrew’s research and ideas on his website: www.andrewmenaker.comQuestions, feedback, suggestions? Reach us at [email protected]