Using Your Emotions to Trade Better
Mental Game of Trading
Featuring Denise Shull
Published on: August 13th, 2019 • Duration: 25 minutesDenise Shull of the ReThink Group helps hedge fund managers and traders improve their decision-making process by illustrating the power of emotions. In this compilation, Shull explains how to combine emotional inputs with the rest of your process, and provides a few examples of the most common mistakes that traders make. Please note that this video is comprised of shorter clips that previously appeared on Real Vision, compiled here for ease of viewing.
DENISE SHULL: I'm Denise Shull, a performance coach for hedge fund managers, traders, professional athletes, and now some corporate warriors. I founded the ReThink Group, we think of it as a decision consultancy- although I think we're probably known for peak performance- using neuroscience and modern psychoanalysis to help people really deliver their best performances in any realm, actually.
The industry's talks a lot about behavioral finance, and these cognitive biases. And there's a lot of effort directed at trying to make you aware of- I may be invoking recency bias or confirmation bias. And that's, like, fine and well, but the juices in understanding the feeling that's causing you to have recency bias like your cognition is generally not stronger than the feeling. So, what happens is lots of people, when they hear this approach to trading or investing psychology are like, oh, my gosh, this makes so much sense. And I want to implement this. But it becomes really hard because it's so counterintuitive.
I even have clients that I've had for a long time who say I'm doing a great job, but they still have a certain amount of resistance, to actually being aware of all of the feelings that are influencing them. And trying to understand those feelings, those emotions are- those feelings is information- excuse me- is amazing. I have a great client that I was talking to the other day, and we were talking about over his 20-year history, how he- if he looked back, his biggest problems were positions he got stubborn in, where he'd been making money, and then something happened and he is a relatively long-term holder, and they pulled back, and he should just get out, according to his risk rules, he should get out at X amount off of his high watermark. And he's like, but I can't stop right now.
And we were talking about understanding why he got stubborn, which in his case, probably has to do with being the youngest child and wanting to prove he's smart to his older brothers and sisters here. But in any event, I'm like, okay, we got to get in touch with that feeling like there's some sensation of proving yourself smart in your physicality. And he's like, what do you mean? I don't think I know at all that what you mean. And I'm like, like a feeling in your chest or your stomach, like literally, it was just like- a wonderful guy just didn't have any idea. So, I gave him tips to figure out like how to get in touch with that physical information.
And I'm also in a, like, I know there are people who think I'm crazy, that woman who's always talking about emotions in the market and investing- but there's alpha to be had, there's like money to be made if you get a much more accurate sense of how perception and judgment and particularly, perception and judgment in the market, by listening to feelings and emotions. I'm not saying like ignore your analysis or ignore your probabilities. I'm just saying incorporate the whole human being and understand where your confidence and conviction is, which is a physical thing and getting systematic about that. It's like such an advantage.
I tweeted this morning that the single most important thing people can do to perform better is organize their life around getting more high-quality sleep. And it's true. You will perceive better. You will less frequently misperceive risk. So if you're tired, you tend to miss perceived risk, meaning you just don't see it. You think, oh, that's not that big a risk. But there's then the whole health benefit. Gut feel is no longer a metaphor. There's a lot of information now about how we really do think with our bodies. So I will even go so far as into the biohacking world to improve your sleep, which things like lowering cortisol, which is calming. That's where meditation is going.
Cryotherapy, lowering inflammation to lower cortisol. Cortisol is what keeps you awake and what gives you energy. Like, if you wake up at 3 o'clock in the morning to check the markets in London, you're definitely spiking your cortisol and therefore definitely decreasing the quality of your sleep. It's like I have hedge fund guys who do get up in the middle of the night or, worse, call their traders to update orders depending on what's going on in Asia. But they are supposed to have a holding time of two years. Why does it matter? Why did you have to get up in the middle of the night? You are putting yourself in a situation where your perception of risk is going to be skewed.
So there's a whole series of things that you can do at this point. And in some senses, I'm not the biohacking expert. But whether it's cryotherapy, red light therapy, something called PEMF, which is an electro-pulse that deals with inflammation. And actually, I did it last week. And I slept like a baby for three days. But I do a lot of things. Now, eating early, circadian rhythms, we all think it's sunlight. Getting sunlight first thing in the morning is great for your circadian rhythm, because it turns out- and this is really important for those of us who travel all the time- jet lag is related to your eating times more than sunlight.
Sunlight's a big deal, but as it turns out, to have less jet lag, if you keep your eating schedule on the time you want to be- and there's even apps for this that will tell you. Look, I'm going to Hong Kong in a couple of weeks. And I have the app that will keep me eating on east coast time, because I'm only going to be there for four days. You'll have less jet lag. Intermittent fasting, eating way less. How it's related is basically you're reducing the inflammation in your body. You're reducing the cortisol. And you can sleep better, therefore your risk judgments will be better.
Just yesterday, someone said- they heard me gave a talk about all those feelings and emotions and perception, judgments- came to me and said, yeah, but I develop models and algorithms and how does it affect me? It was really great. How does it impact me? And I said, so what about that X factor you used? Like how did you choose your implied volatility?
Like there are discretionary decisions that model and algorithm builders make. They forget that they've made a discretionary decision. And like they choose an implied volatility factor or just some timeframe that makes their model work. So, they have the same problem while they're doing that, that anyone else has in making the actual market decision. For the person doing it, it's the same process of getting to know yourself, like your reaction of wanting your model to be like the most brilliant model ever built. And needing to show you're smart.
So, you might get stubborn like maybe the algorithm, it's based on the model isn't producing the results, but you're a little like someone who's just making discretionary decisions, may be likely to stick with their trade. As an algorithm builder, you may be likely to let it run too long before you adjust for the same exact reasons. So, you can use all this same self-awareness to actually improve your models.
Now, there's another problem. If you're on the other side of that, the character of the market has changed. Like you just don't get the kind of momentum moves because the algorithms jump in.
So, I was having this conversation with a longtime portfolio manager this morning. It's almost like your two choices at this point are to trade really short-term or longer-term than you used to, so that you can survive the noise of the machines fighting and the machines jumping in to take the other side, just when in the past, it would have been the moment to jump in on a momentum move. Those algorithm guys figured that out and have their machines trading against the old-fashioned momentum moves.
Algorithms certainly have a built-in danger because they can plow through prices and obviously, no time flat. And maybe human being does need to step in to stop that. It's a real challenge to manage that combination of man and machine. And so, for the clock world, you can get better at that. Like you can just get better at that.
I think I heard Stanley Druckenmiller talk about Garry Kasparov saying in chess, like ultimately, it's going to be the man with the machine. And that's the same for the markets. So, if you've got a machine, you can make that machine more productive by working out that relationship and being more cognizant of like the tendency to want to be right, to not change. Or the tendency ops tends to be changing too much, just like it's the same sorts of stuff where a human being is acting out a feeling they don't know they have. They're just acting it out via an algorithm.
I had one guy who managed a clock shop in Europe. He said he basically had 1000- between 1,000 and 2,000 algorithms to choose between. Like these days, it's no different than choosing stocks. Like I have to figure out which ones are going to run on any given day. So, that's just as bad or just as hard. It's really important that people- whether you're investing or trading- really do know what your strategy is, why it's your strategy. It's like knowing what position you're playing on a football team or what position you're playing on a basketball team. You're playing well, even amateur sports, you can't just go changing positions. Your friends are going to get mad at you. But obviously, professional sports, you've got your tasks.
It's so easy in a crazy uncertainty of the market where you don't really know to get swayed to change positions, meaning start using another strategy than is the one that you believe in and you're committed to. Even if it's a brilliant idea, you can't execute because you don't have the belief in it, you don't have the confidence in it. So like I have a hedge fund manager, who's got a terrible tendency to take ideas from his friends. They may be good ideas, but it's not going to work. Because when the price action is not doing quite what you think it's going to do, it's not the position you used to playing and you don't really know what to do. Because in a market environment, you just don't have the conviction.
So, there are a gazillion ways to make money in the market. And unlimited number of timeframes and unlimited number of lenses to see which I'm likening to positions on a football team. Figure out what yours is, like what resonates with you? What makes the market makes some sense, and stick with it. Resist the temptation to do the thing the person next to you is doing or the people at the conference you talk to are doing because you just you don't know how to execute in their position.
How you stick with it, by the way, is admit to yourself that you want to play their position. Admit to yourself that you want to do it the other way, as a way of like externalizing that and then your intelligence kicking in and saying okay, I would really like to take that trade or I'd really like to get long gold when I've never had a gold position in my life like once you externalize it, you can look at it a little bit more and see that the risk is probably not worth the reward.
Poker and portfolio managers generally go hand in hand. Not all portfolio managers play poker, but a lot of them and a lot of traders play poker too. There's a certain appeal to it, I think, because it's like the markets. And it is, in many ways, a good analogy. The markets are a global poker game, really. You have all these participants who are looking at these numbers, making bets on their relative value, just like the poker table- making bets on the relative value. And in poker, you win not with the cards, but by betting against other people's bets. It's really about figuring out who's bluffing and who's not.
So, that's also true in markets, not that anyone's bluffing. But that you win in markets, like the neuroscience shows that those who are best at predicting price action are predicting the people. Our brains are very social, the market is effectively social, the value of any given thing at any given moment is just a collective social perception. There's not some, like, be all end all truth over here that says this is worth that, because tomorrow, it's worth something different. So, you're always betting against what other people are thinking, which is really the way you win in poker. So, that's why there's a good parallel.
The thing about that markets, though, is like the cards change. At least in poker, the cards do mean what they mean. They don't in the markets, like the relationship between bonds and the dollar, or the gold and oil, or whatever is going to change. Now, the relationship between aces and the kings isn't changing. So, the markets are actually harder than poker, but the process of practicing thinking about, like, what cards do these people have? And how are they betting? Like that process is good practice for market decision making.
The main difference, also, like the poker game ends, the market doesn't end, which also makes the market harder. But at least you know when the hand is over, and who's got what money, which makes it a little more satisfying than the market. The whole never ending thing and you can't make anything happen is part of what makes markets so hard.
You got to know what game you're playing. And the game of markets is unlike any other game. It's not exactly like poker. Poker is the closest, but it's not a sport. The game never ends. If the ball goes backwards, you don't know if it's a good or bad thing. There's a clock, there is no clock in the markets. So, realizing that you are in this never-ending game that's going to give you constant information that's in conflict with the previous information, that the current information only means something in context of the previous information. Like it's way too easy to use sports analogies.
The worst is in sports, you can make something happen like the point is to make something happen. There are very few people or institutions in the world who can make anything happen. But yet we tend to invoke these make-it-happen sports power analogies, which tend to just lose you money. So, by recognizing how fluid and uncertain the game is and how the fact that it never ends keeps you playing, keeps you hoping, get a good grip on the parameters of the market as a game and how it's different than anything else.
It's a great question to think about how traders or for that matter, portfolio managers deal with what really amounts to overconfidence from trades investments going well. And you get this feeling like, oh, gosh, I really do have it. And what it generally causes you to do is take more risk. Of course, then what happens is you take more risk and the result of taking more risk comes home to roost, meaning you give some money back, and then you're aggravated over giving some money back. So, the irony is just like with any other emotion, to put it into words, and own it.
Back when I was trading, I actually texted someone on a Fed day, because I was pretty good at the post Fed reaction. Like I'm a genius. But I knew what I was doing, I was trying to expend that energy so that I wouldn't trade feeling like a genius. The guy didn't know what I was doing. It was like ragely egotistical. But the truth is, it's the same. The only way you can ever prevent acting out the emotion is to put the emotion into words. So, it doesn't matter whether it's a negative emotion, or whether it's a positive emotion, you got to be at least talking to yourself about how you're a genius so you don't just go acting like you can control the market.
The trick to performing better, the trick to making more money is to become more self-aware and to start to understand this data set of senses, feelings and emotions that's delivered through your body, physical knowledge. But that's not a data set that anyone's learned to work with in any organized way. A good place to start is make yourself spectrums, like a spectrum of confidence, which you might start with one being panicked or terrified or something like no confidence whatsoever. But if you go all the way to seven, seven should be something like overconfident or genius or- people find it really hard to believe.
And it's so counterintuitive in our popular culture today, that putting emotions into words, all of them, makes them less likely to be acted out. The better you get it being able to get the right word for your physical experience and your reaction to results, that more likely, you'll be able to get information out of that physical knowledge. And the less likely, you'll just act it out. And by the way, what will you have at the end of learning to do that, you will have more real skill.
A specific tactic that people could use when they're grappling with a decision particularly like getting out of a loser decision, but really any decision, is ask themselves how this will make them feel in the future. What you're trying to do is make it explicit that you're worried about getting out and giving up potential profits, or you're worried about getting out and locking in a loss. And if you make that explicit, then you're much more able to not act it out. It's the same thing, though, you got to get better at understanding how you feel in the moment to get better at predicting how you would feel. It's actually called an affective prediction.
And it's a great way to do less of the things you don't want to do in any realm of life like myself, back in the Chicago days, I used to drink a lot. And now, this age is like, no, no, we are not having that third glass of wine because I'm going to feel lousy tomorrow. I didn't used to have that. It's the same thing in a market decision. If I add to this position here, like how am I going to feel tomorrow or next week? What you're doing is you're fighting the current impulses with a future vision, and that has the ability- much more than your intellect, to fight the unhelpful, emotionally driven behavior.
How will this make me feel in the future? How will it make me feel in the future if I get out of the position and it continues going? Like if you realize that you're going to be upset, that you've prevented yourself from making more money, then you're less likely to take that aggravation over being upset that you got out of the position too soon. What happens is people do that, they get out and that position keeps going, they're mad at themselves, they jump into some other trade because they just want to make that money. And that second trade is impulsive and unlikely to make money.
If we think about the worst mistake that a trader could make, it's usually overtrading. It's usually like, I made x amount of money. I gave some back. I just want to get to my high watermark. I'm just going to do these one or two more trades, whether it's for the day or the month or the year for that matter. And then, of course, those don't work that well, and then you lose a little bit more money.
I have seen so many people go into what amounts to a fistfight, like a bar brawl, and like, just don't. I realize- I say just don't. But recognize that you have all this reaction to being off your high watermark, or having given money back, or having think the market cheated you, or a piece of news came out to screw you, or whatever, and do something else with that energy that makes you want the money back, other than trade. I don't care what it is.
I just can't tell you over the years how many clients- I've seen spectacular days, months, years, turn into disasters because something set someone off and they did a gazillion trades. I've even seen portfolio managers do that. Like, all of sudden they're long term, and they normally have 40 positions and all of a sudden they're in 50. It's the portfolio manager version of the trader who just did 60 trades when they would normally do 5 in a week, or something.
That phenomenon of getting aggravated over whatever, and then acting out that aggravation is probably the single worst thing that happens to people. There is this tendency amongst traders and portfolio managers to do these goals. Like, I want to make x amount of money or x%. It's not the best way to do it, actually.
A really good way to do goals and objectives is to make the goal conceptual. Like, what are you trying to accomplish? And then within that goal, have some objectives. And those can be numerical. But having said that, any form of, I want to make x amount of