Warren Buffett once wrote that to invest successfully over a lifetime does not require a stratospheric IQ, unusual business insights, or inside information. What is needed is a sound intellectual framework for making decisions and the ability to keep emotions from corroding that framework. I doubt if Mr. Buffett ever traded options. He seems more like the value investor who buys and holds for a long period of time. But if he had, he would likely proclaim that controlling one’s emotions required a greater effort when trading options, particularly when it comes time to sell or exit a position.
Buying and selling stocks may often involve long time frames, but in the world of options, time frames shrink, actions must be concentrated and assertive, and the influences of the psychology of investing are suddenly exacerbated. The previous week is a good case in point. As the economic crisis in Greece played itself out on the European stage, markets the world over went into hyper-drive. Volatility soared. While currency traders focused on their
EUR/USD charts, savvy traders were tuning into the futures market to glean valuable information highlighting arbitrage opportunities. Time was of the essence. Profits were to be made, but stress has a way of waking the idle recesses of our emotional psyches, and we can easily become our own worst enemies.
The nascent field of investment psychology has actually uncovered valuable insights from a variety of behavioral experiments conducted over the past decade. Clearly, the difficulties a trader faces when it comes time to exit a position are comprised of both external influences and internal drives and motives. We tend to be victims of social imprinting and our negative emotions. In order to survive and thrive in a stressful trading environment, we must develop coping behaviors to avoid the minefields our minds have created for us.
For example, tests have shown that people with obsessive qualities, which most of us have due to the perfectionism that is demanded in today’s electronic workplace, tend to sell too early or hold on to losses too long. Obsessive people have a great deal of unconscious guilt from early childhood programming. Success actually stimulates anxiety, and losing money conversely appeases their inner feelings of guilt. The result is a trigger-happy trader who must learn to hold a bit longer on gains, yet cut losses more quickly.
It is not a requirement that you be obsessive to experience feelings of greed or fear when in the midst of trading. Research has shown that people value a Dollar lost twice as much as a Dollar gained. This emotional over-weighting of money lost probably accounts for the panic we feel when the market suddenly moves against us. Basic psychoanalytic theory already postulates that loss is the most disorganizing event to the sense of self. The threat of loss suggests pain, impending failure, and loss of self- esteem. Our minds will shift into overdrive to avoid these types of situations, having learned very early on in life that pain avoidance is a good thing.
Selling invites failure, second-guessing, and doubts as to our capacity to perform. It inspires us to flee from the possibility of self-humiliation. An aversion to admitting failure is not healthy for our mental psyches. Denial, though dysfunctional, creeps in to protect our fragile ego. Unfortunately, denial leads to rationalization, which then results in procrastination, another deeply rooted psychological behavior. Refraining from selling has now become a defiant act of a powerless and emasculated ego.
For the battle weary trader who is beginning to feel a bit gun shy or is beginning to doubt his intuition, there is hope. The tried and true approach to silence the distraction of doubting voices in the back of your mind is process, process, process. You must step back and document your
trading routines, step-by-step, practice those routines until they become second nature, and trust your mind when it follows this oft repeated and disciplined approach. Professional athletes follow this guidance to eliminate the distractions around them in the heat of competitive play. You can, too.
Whether we like it or not, long before we ever conducted our first trade, our minds have been absorbing and adapting to whatever world and associated behaviors surround us. Our intuition, which passes as free will, is a valuable asset, but it helps to know what might be masquerading as free will may only be unhealthy hardwired programming emanating from our unconscious minds.
If any of these words have hit a nerve, then, perhaps, a self-examination is in order. Awareness is a key first step. Our trading will always consist of gains and losses, but it is the net result over time that is important. Focus on consistency and your routine in times of stress to overcome the foibles of the mind, and success will surely become your trademark.
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