In the course of learning to trade, you will have losses and they will cause you pain. You may not remember the details of those painful experiences, but your brain stores details about everything that ever hurt you and tries to avoid those things in the future………
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The following information on Trading Psychology is the life work and passion of Dr. Kenneth Reid. Kenneth is a practicing psychotherapist, trading coach and trader. He also works as a Senior Analyst and Editor for three national stock market newsletters with thousands of subscribers. He has appeared on CNBC and written for Forbes.com and SmartMoney.com.
This page describes Random Rewards, one of the primary causes of trader failure. Follow the links to read about the other causes.
RANDOM REWARDS
In the course of learning to trade, you will have losses and they will cause you pain. You may not remember the details of those painful experiences, but your brain stores details about everything that ever hurt you and tries to avoid those things in the future.
A trader’s relationship to the market worsens for the same reason marriages tend to get off track: too much pain and not enough reward. If the balance of pain and reward is poor, the amygdala begins to associate key market patterns with pain. In marriages, the ratio of positive to negative experiences needs to be around 4:1 for the marriage to last. The same ratio holds true in trading.
THE TIPPING POINT
If the balance of reward vs pain is around 50-50, things do not stay emotionally balanced; instead the brain gets very confused. At the 50-50 balance point, the trading environment becomes “randomly rewarding.” What this means is that Action A sometimes produces Reward A and sometimes produces Nothing or Pain. The brain of the average trader (and of mammals in general) is not at all happy with that 50-50 ratio.
At first, the randomness of the rewards causes humans and animals to try harder to figure out a satisfying solution. Dr. B.F. Skinner, a behavioral psychologist, observed this phenomenon in his rat laboratory in the 1950s. Rats pressed the level faster and faster. Ultimately, however, a randomly rewarding environment becomes a terribly demoralizing situation, even for a rat.
Neither humans nor animals can tolerate being powerless to act consistently in our own best interest, especially when the consequences of failure are painful, physically or monetarily. Prolonged random reinforcement is so toxic to the mind that it has been applied as a brainwashing technique to breakdown psychic cohesion and resistance in prisoners of war.
If one is not mentally and emotionally immunized to the unavoidable frustration of this randomness, i.e. losing more than expected, being wrong more than expected and missing out more often than expected, one gets mentally disoriented and emotionally disturbed. It is not unusual for randomly rewarded traders to feel as though they are literally being tortured by the market. No wonder so many traders quit. But before they do, they are in a debilitated state in which they trade poorly as they try various desperate adaptive tactics to rescue themselves.
RANDOM ACTS OF TRADING
In this highly ambiguous situation, a trader’s own behavior
becomes more random in an attempt to sync up with the market. As uncertainty becomes more and more uncomfortable (because it becomes increasingly associated with painful consequences) traders come to over-rely on analysis, intuition and gut feel. Randomly reinforced traders shift focus on their trading plan and focus on trying to predict what the market will do next in order to avoid the painful consequences of being wrong. This leads to the trader-as-mind-reader syndrome discussed in the Mind Traps section.
If rewards from trading remain at a random level, the emotional damage increases to the point that a trader’s behavior becomes increasingly chaotic and results in an account blow up. On average, traders re-fund futures accounts 3.8 times before the torturous “wash and rinse cycle” is complete and they are hung out to dry.
BOTTOMLINE
It is crucially important for traders to increase their “immunity” to random rewards, while also increasing the absolute ratio of wins vs losses well above 50-50. Some traders have a higher tolerance for random rewards than others. My Risk Profile is one way to evaluate your susceptibility.
My coaching program is focused on reducing the psychologically debilitating effects of randomness in the market and increasing your win/loss ratio to a sustainable level. Email me to schedule a FREE 15-Min. CONSULTATION (or click here to sign up now).
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