Gut Instinct

The wise are instructed by reason, average minds by experience, the stupid by necessity and the brute by instinct.
Marcus Tullius Cicero

Nobel laureate Herbert A. Simon, a professor of psychology and computer science at Carnegie Mellon University who has studied human decision making for decades, thinks that we are able to develop a "gut instinct" because experience enables us to "chunk" information so that we can store and retrieve it easily. Our brains then "cross-index" this stored information, automatically finding patterns in one area that correspond to patterns in another. 

When you look at a chart, in 10 seconds or less your brain will tell you - Yes this is worth a further look, or just hit the button and NEXT. In other words, your gut instinct tells you more than you can logically know, because it represents much, much more information than you could ever logically process.

That being said, most traders will admit that sometimes their gut instincts have been wrong. That is nothing more than the nature of the beast we love. You are going to be wrong, don't let it bother you it's a part of this business. What your instinct is telling you is simply that you have come upon a "high probability trade", not a guaranteed one. A good gut instinct in trading is developed through experience as it is in any other profession. The more experience you have the more information your mind retains, the better your gut instinct becomes.

Be careful though, not to misinterpret your experiences. We all have that capacity. If you misinterpret your experience and allow that misinterpretation to become part of your subconscious programming you will defeat yourself. Also be careful on your perspective about what has happened. If you ask four traders to interpret what just happened you are very likely to get four different interpretations.

So how do you educate your gut instinct? How do you develop a powerful intuition that is much, much better than that of the average trader? Trust more in your experience than the experience of others. Remember, the experience of others may be distorted by misperception or miscommunication. Your experience, if you are lucid, is genuine. 

Trusting in your experience doesn't mean trusting the conclusions you draw. Challenge your conclusions and interpretations by talking to others. After an important incident, one that might have suggested a lesson to you, have a conversation with other traders you know. How did they see what happened? What lessons did they draw?

Ask yourself:

• What went right?
• What went wrong?
• How could it have been better?
• How could it have been worse?

Again, ask your colleagues for their opinions. Do they agree with your views on what went right and wrong? If not why not? The conclusions you draw from your actual experiences are the most valuable resources you have. They are collectively the foundation of your future decisions, the bedrock on which your future success will be built. Make sure those conclusions are valid and your instinct for making the right decisions, in any situation, will inevitably get better. If you do this in earnest, I promise you an improvement in your trading, more and more as time goes on.

PrudentTrader Archives 2004

The Emotional Trader

You have to be okay with wins and losses. You can't just be looking for the wins and, when the losses happen, you can't buy more and more because you're sure it's going to bounce. We call that revenge trading.
Josh Brolin

The nature of trading demands that you have an objective and logical approach. If you are experiencing extreme elation after a winning trade and likewise extreme disappointment after a losing trade, then you are riding an emotional roller coaster: Up and Down, Up and Down. Your account balance is probably doing the same thing jumping Up and then Down. Many go to the extreme of picturing and trying to become an emotionless being, such as the ultra-logical Mr. Spock from "Star Trek." That's fine just realize it is not easy. After all how can you not get at least a little excited after a win and become just a little disappointed after a loss, its human nature, it's natural to feel that way; and that's the point, it is not easy to control your emotions, it takes lots of practice, but it is possible to control your emotions in order to achieve your objective, a logical mindset that is conducive to profitable trading.

Probably the most significant way to control your emotions is to use proper risk management. If you're risking money you cannot afford to lose, or you're risking too much of it, you will feel pressure. However if you minimize the

amount of money you risk on a trade (think position size for instance), you'll be able to tell yourself that the actual downside is bearable; you'll know you can easily survive the worst case scenario. It will also help a great deal if you have a detailed trading plan and keep a log of each trade with clearly spelled out strategies for how you entered and how you will exit.

Emotion control and discipline require energy, both physical and psychological. If you are under stress because of external life events such as a death in the family, a new home, problems at work, or with your spouse, that will eat up a great deal of your energy and make controlling discipline and emotions a much more difficult, if not impossible task. Don't underestimate the powerful influence stressful events can have on your life. If you are feeling extreme stress, take a break from trading until those issues are resolved. You will save yourself untold additional hours of stress from the markets and in all probability saved a good deal of money from making careless errors. 

If you feel you must perform flawlessly on every trade, you will also feel pressure. You will become easily fearful and disappointed by minor errors or routing trading losses. Accept your limitations, you are human after all, you will feel more at ease. You cannot do more than is humanly possible no matter how much you would like to. Patience and practice build the skills you will need to be a consistently profitable trader.