Intuition and Impulse in a Great Trader

What makes some traders stand out can also bring them down

A great trader is one who has the uncanny ability to predict price action based on the behavior of other market participants, particularly other professional traders.

Is that skill analytical or intuitive?

Two broccoli florets on whiteFor the past several years, neuroscientists interested in this question have been developing brain-imaging experiments designed to answer it.  One study in particular1 – Exploring the Nature of ‘Trader Intuition’ – traces that skill to what the researchers call Theory of Mind (ToM).  In brief, ToM is the uniquely human ability to read intentions (or goal-directedness) from patterns observed in one’s surroundings.  Simple examples are behavioral inferences from eye expression, moves of an opponent in strategic play or a faux-pas.

Reading the Market

Top traders tracking price movements (and other price-sensitive developments) intuitively recognize market patterns that dictate the timing and size of their trades.  Surprisingly, the experiments show that ToM is not correlated with mathematical or logical reasoning and that superior trading intuition is consequently not attributable to excellence in abstract thinking.

The laboratory research on ToM also indicates that the region of the brain involved in pattern recognition (paracingulate cortex) applies not only to interpersonal interactions but also to patterns in large-scale, anonymous social structures like the stock market.  This finding itself is logically inferable from the fact that reading the mind of another person and forecasting price changes in the markets both involve detecting intentionality in one’s environment (from multiple sources in the case of the latter).

Since the markets are double-sided, competitive environments, every trade is ipso facto a zero-sum game and every trader is bent on winning it.  However, even great traders have very bad days, and what ToM also reveals is that the need to prevail on every trade brings out other innate patterns in the behavior of the trader that stand in the way of success.  In other words, the same skills that distinguish top traders also expose their greatest weaknesses by evoking their deepest feelings when faced with risky decisions in the midst of uncertainty.

A Self-Development Game

According to Denise Shull2, a New York City neuroeconomist who coaches traders in achieving and maintaining peak performance, trading is actually a “self-development game.”  What she means is that the competition inherent in the trading process brings out the psychological issues a trader has been wrestling with since childhood.  For example, traders whose instincts are to “fight the trend” in prices commonly reveal a need to prove how smart they are to someone influential in their past.

After a bad day in the market or a miserable night at home, a trader may try to overcome his or her frustration by resorting to “revenge trading” —  building up an uncharacteristically huge position or executing a rapid succession of trades that give him or her the euphoric feeling of being in control again.

A common pathology even among great traders is the “make it, give it back” syndrome.  A trader’s reaction to a sizable trading loss or error is rooted in how the trader dealt with problems when he or she was a kid.  After a bad day in the market or a miserable night at home, a trader may try to overcome his or her frustration by resorting to “revenge trading” —  building up an uncharacteristically huge position or executing a rapid succession of trades that give him or her the euphoric feeling of being in control again.  Shull refers to these emotional outbursts as “trading temper tantrums” which, in her view, are bound to fail.  She also says that virtually all traders fall prey to them at one time or another.

‘Fear of Future Regret’

While Wall Street has traditionally admonished traders to keep their feelings in check, neuroscientists have shown that no decision is ever made without emotion.  In trading, the spectrum of feelings ranges from panic to fear to confidence to overconfidence.  One pervasive trading fear, the “fear of future regret,” presages missing out on a profitable opportunity that competitors exploit (or falling for a losing trade that others avoid).  This apprehension can be exacerbated by unconscious memories of past life disappointments such as getting bad grades at school or being cut from the football team.  One of Shull’s clients, for example, came to realize that he approached trading the same way he played rugby, trying to barrel through the market and ending up with positions that later turned out to be too big.   The fix for him was to imagine the light touch he applied when play-wrestling with his two young daughters on weekends.

Broccoli Florets

Shull says trading behavior is actually ‘fractal,’ just like many elements in nature.  She bases her coaching on the notion that a trader’s decision-making process resembles the mental and emotional patterns he or she developed at an early age (think of broccoli florets or nested Russian dolls).  In her counseling sessions, Shull focuses on traders’ reactions to earlier syndromes in their lives that inform and condition their trading behavior.  Once she gets a trader to realize the self-similarity of what he or she is acting out, she can then help the trader formulate a strategy for separating impulse from intuition and neutralizing self-destructive behavior.

In Shull’s view, “nothing is more important to a trader’s long-term success than confidence.  It’s undermined when the same mistakes are made over and over again, even if the trader’s overall performance is positive.  To have the discipline necessary to make optimal risk decisions in the heat of trading, traders can benefit greatly from appreciating the deep connections between their current emotions and their past behavior.”

1Swiss Finance Institute Research Paper, Series No. 10-02, authored by Antoine J. Bruguier, Steven R. Quartz and Peter Bossaerts, all of the California Institute of Technology (2010).

2 Denise Shull is founder and president of The ReThink Group of New York City and author of Market Mind Games: A Radical Psychology of Investing, Trading and Risk (McGraw-Hill 2012).

  • Margot

    What I’d like to know is: How does one discern whether one’s decisions more like broccoli florets – or more like nesting dolls?

    • Anupama Pande

      product analysis annd understanding of past trends. :) good q Margot.

  • Anupama Pande

    My question was Mr Bornstein – ina system world this has / should be resolved and levels of authenitcation (may or may not be communicated to trader/broker/agent/franchise/branch.. and the consolidated report makes “mincemeat” so i appreciate “individual error spotting” but for an organisation that is unaccceptable maangement managerment. just opinion today.. 2/10/13 11.15IST. thanks ..

  • Mark Clyde Brant

    Rather simplistic, but useful and insightful. Each trader must make personal adjustments to these baseline ideas, but starting points are essential.