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Have you heard about the battle between the rational actor crowd and the behavioral finance people? The leaders of the two camps BOTH won Nobel Prizes and their followers are somewhat like religious or political zealots in that they are sure - despite whatever evidence they may get - that their camp is right.
What are the two basic arguments? (the ultra-Cliff's notes version)
- Rational actor - people will choose the path that is in their own best interest (maximize utility)
- Behavioral finance - people use mental shortcuts and have many ingrained biases that will cause them to evaluate data and for all practical purposes, see what they want to see
There is enormous empirical evidence for the behavioral finance account but in general the whole world of finance and trading keeps working with the first model. Let me suggest that the resistance to the reality of the second is that no one knows quite what to do about these biases so in essence, they keep trying and hoping that their rational minds will somehow ultimately override them.
We at Trader Psyches (and yes there is a we in that we now have two consulting modern psychoanalysts on staff and a fabulous assistant named Sandy to keep us straight) offer both an explanation between the two camps - and have some specific ideas about how to leverage the latest neuroscience to the benefit of your trading account.
In short, it boils down to emotional awareness or what we might call holistic intelligence. Instead of trying to control your feelings, you realize that they are sources of information and treat them as such. We are kind of lucky in that we figured this out in our own trading and then the neuroscientists came on board once they could see the live brain in action.
Colin Camerer of California Institute of Technology calls it RADICAL NEUROECONMICS. Here is a quote from his excellent survey article in the Journal of Economic Literature, 2005. "It is not enough to KNOW what to do, one must also FEEL it!" The short version of a long and comprehensive paper is that way more that half of our analysis occurs either unconsciously (automatically) or emotionally (conscious and unconscious).
Now this is exactly what the rational actor crowd hates and the behavioral finance guys observe but have no real explanation for.
As another researcher, Myeong-Gu Seo of University of Maryland and Lisa Barrett of Boston College discuss in their article..."Contrary to the popular belief that feelings are generally bad for decision making, we found that individuals who experienced more intense feelings achieved higher decision-making performance. Moreover, individuals who were better able to identify and distinguish among their current feelings achieved higher decision-making performance via their enhanced ability to control the possible biases induced by those feelings."
Net net - just give up any vestiges of the belief or effort that you have to control your feelings.
- First of all it doesn't matter one iota what you feel as long as you act in the way that you want. Some of the best traders I know are also the most emotional! They just know how to use that emotional information in a way that others don't
- Two, every ounce of effort that goes into controlling feelings goes against what people who know a lot more about the brain know! Worse, that effort goes directly into the energy fueling impulsive, out of the trade plans - which of course, your "behavioral finance" biases will justify - right up until the action starts draining money from the trading account!
Typically at that point you go back to the refrain of "I must follow the plan, why can't I follow my plan, what kind of idiot am I?" All that useless self-flagellation will go away if you can buy into what the neuro guys know and start down the path of leveraging a new, different, radical view of how we make decisions. That will turn inevitably into a less volatile, more profitable, more upward sloping equity curve.
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