Amy wants to have a nice house and a car and wants to travel the world. She also wants to be a philanthropist. She wants to be a trader. She believes that she can make a lot of money in the markets which will fulfil her dreams and why not? After all, she is intelligent and smart and her intention of having the money and spending it on needy and poor is for a good cause.
She reads a few books on markets and starts following an analyst. After some initial understanding of electronic trading on a demo account for a day or two, she opens a real money trading account. Amy is excited. Using the advice from this newsletter provider, she takes her first trade. Very soon the trade goes against her. She is hopeful that the market will turn around in her favor. Let’s average out the losing trade. She hears her inner voice. After all, it is logical. Click. She takes another position. The market moves further away from her positions and she has now compounded her loses.
After a sleepless night, the next morning she finds that her account is down over 20%. What’s going on? She talks to herself in a state of panic and with a click of a mouse, she takes another position to average out her already losing trades. She asks herself why she took a third position? As if this was an involuntary action. She gets no answer. She closes the trading platform and opens the television to watch what’s in the news. May be she can make an association of market movement with the news. There is news that aliens will soon be landing on earth and they will take over all our natural resources. She checks her email and finds that the market analyst has also reversed the market direction in his short term analysis but maintains the long term forecast.
She quickly opens the trade station. It seems like it’s taking forever to open the application. Finally, the application opens. The market is going down further and she is losing more money. Her heart starts beating faster, her muscles become tense, her breathing is quick and shallow, her pupils are dilated, her mouth is dry, she has what we call the Adrenaline rush. With cold and tense hands she clicks the mouse button to close her positions. The orders are not filled. She clicks again and again and accepts whatever price the broker is offering. Her mind is racing with thoughts like money doesn’t grow on trees, this is hard-earned money, it will take forever to make this money back. Click, click, click. All trades are closed. Suddenly the tension in her arms is released and she starts to feel better. The thought process returns. She survived this time but what’s next is even worse because she has just created neural pathways in her brain and a learned trading behavior. This is the only way she knows how to trade the markets! She is now a Fear Oriented Trader.
Amy is not alone. Every day hundreds and thousands of amateur traders lose an incredible amount of money in the markets. In wall street, this money is called dumb money. Please don’t ask me why. All I can tell you is that the dumb money trader and investor will always get crushed in the markets.
UNDERSTANDING RISK AND THE NEUROSCIENCE OF TRADING
It is possibly the most important concept you need to understand before you decide to trade the markets. Please read the following several times and believe in it.
THERE IS NO SUCH THING AS ‘ZERO RISK IN TRADING‘. THE ONLY WAY YOU ARE GOING TO BE SUCCESSFUL IN THE MARKETS IS WHEN YOU FULLY LEARN HOW TO MANAGE RISK IN YOUR TRADING BY BECOMING A RISK ORIENTED TRADER.
To do that, you need to understand the underlying processes of your brain that function during different modes of trading. Our concepts of Neuroscience Trading Technology (NST) will help you understand and teach you how to tackle your behavior during testing situations in the markets. I will try my best to keep the concepts simple without using complex medical terminology.
AMY AND HER AMYGDALA
The brain is central to our existence. Trading is a biologically driven process. It has physiological components.
What Amy went through is a neurological process of a physical response to a perceived threat. Amy and all of us have two Amygdala (plural Amygdalae) one on each side of our brain. If you draw a line through your eyes and your ears, the Amygdala sits where these lines cross on each side of your brain. it is part of what we call the Mid-brain. It gets its information from your senses. You do not want to upset your Amygdala. In fact, you need to keep it calm when you are trading. It’s a little child who gets upset when you are risking your hard-earned money because it wants you to be safe.
What happened with Amy is that her Amygdala eventually perceived it dangerous and unsafe to trade and through a series of neurological pathways in the brain, it sent her body into a fight or flight response as a result of which the blood supply to the Prefrontal Cortex or the thinking and intelligent part of the brain was cut off. The response is because of an association of the sensory stimuli to an event that happened in the past- Pavlovian associations and conditioning. Every decision in this state is an emotional response. Trading at this level feels like being under attack.
Remember? She checks her email and finds that the market analyst has also reversed the market direction in his short term analysis but maintains the long term forecast.
The Amygdala is not the thinking part of the brain. It is responsible for memory, fear, and emotions. Its function is survival. It is not bad in any sense. It is useful. You just have to know-how to keep it calm.
The Prefrontal Cortex is the thinking part of the brain. In this state of perception of losing too much, the thinking process or the logical reasoning was gone and long term forecast was totally ignored. In fact, no forecast or analysis with this state of mind will ever matter. In Amy’s case, by the time she took the third third, the blood supply to the Prefrontal Cortex was already cutoff and trade was taken at an unconscious level in a state of fight or flight.
Let’s discuss the role of the prefrontal cortex. We have more brain matter in the prefrontal cortex than any other species. It is the executive behavior regulator. It is nearest to the superego. It is that part of the brain which says I wouldn’t do it if I were you. It keeps us constrained. Some prefrontal cortex tasks we have mastered since childhood are getting potty trained, riding a bicycle, driving a car. It is not fully developed until the age of 25. Learning to read the market is a prefrontal cortex function.
The brain learns to trade the markets by developing neural pathways. When you learn and trade economic news or a technical indicator, the brain will eventually form connections. The more pathways you will create, the more you will be destined to trade in a certain way. The question will be is your way to trading creating profits or losses?
If you have been a consistent loser for the past year or more, you are trading from fear. If you are not relaxed while trading, you will be in a state of fight or flight. You can relate to Amy at a physiological and neurological trading level.
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