Market Mind Games Summary
This is a book about the mindset of trading. Conveniently, the author offers her own summary which I’ll paraphrase with some adaptations
- Create physical energy – Don’t trade when you are tired, hungry, etc.
- Read other people – Think about the emotional state of the market. Is it greedy or fearful?
- Get the risk management edge through knowing yourself and how you feel (your emotional contexts) operating at any given moment – journal before you trade to make sure your feelings are explicit.
- Get the strategy edge by using that knowledge of yourself to understand others (their emotional contexts), which they most likely will act out (since they aren’t doing #3)
- Know when to push it because you have emotional capital and psychological leverage.
- Know when not to push it because you are acting out of an emotional context fueled by the past, be it the immediate past (e.g. a fight you just had with your business partner or spouse) or the distant fractal past (e.g. your relatoinship with your mother)
Notes and Quotes
Logically, if you have a probability that you know will only apply for a limited period of time and by definition that probability tells you that you have some significant chance of being wrong, even while it still applies, how much do you really know?
Notes: 1) a lot of people try to be precisely wrong instead of roughy right
We greatly prefer to know what exactly our odds are. We feel more confident and less anxious when we know or think we know our exact chances. Known as the “ambiguity aversion,” many decision theorists have shown that game players greatly prefer to play a game where they choose between 50 red and 50 black balls versus a game where they have 100 balls but don’t know the exact mix of colors.
Notes: 1) we hurt ourselves by demanding certainty
this day and age of nanosecond global communication, at a very minimum, everything happens faster and more people know about it instantaneously. This means that reactions occur more quickly and just the dimension of speed creates phenomena never seen before.
Notes: 1) the OODA cycle moves faster now
To preserve the distinction … between the measurable uncertainty and an unmeasurable one we may use the term “risk” to designate the former and the term “uncertainty” for the latter.
“We have not considered the first stage: the formation of the relevant beliefs on the basis of observation.”
Notes: 1) stage 1 is the rough outline of a snowmobile pieced together from other places. Stage 2 is refining the snowmobile.
The bottom line is that, in general, we have abdicated our need to use the judgment demanded by a fundamentally uncertain situation under the illusion that the answer is always in the math. Market performance emerges from owning the need to always be improving our judgment.
David Hume, the 19th-century philosopher, generally considered to be in the empirical camp, noticed it when he said that reason is subject to passion, or we think things are a certain way because we want them to be that way
not only are emotions not something to be shunned, dismissed, or overridden, but we need them for meaning, we need them for vision, and we use them for essentially everything.
We can’t actually apply math or logic, let alone do other analyses, make judgments, or decisions, if we lack feeling and emotion.
In 2005, a great article ran in the Journal of Economic Literature. Titled “Neuroeconomics: How Neuroscience Can Inform Economics,” the article’s authors made the point over and over: “It is not enough to ‘know’ what should be done; it is also necessary to ‘feel’ it” and “to influence behavior, the cognitive system must operate via the affective system.”
If HSBC or any other broker could literally remove emotions from their clients’ judgments, they would be very sorry. As no decisions would be made at all, no commission revenue would be gained.
Notes: 1) we need emotions to make decisions. we just need to learn to use them better. get the proper model.
On the day of the Flash Crash in May 2010, certain traders used not their models but their brains, their memories, and their pattern recognition skills to immediately decide to shut down their automatic trading systems. They judged something to be awry. They didn’t know what; but in effect, their lack of confidence or what could also be called that dreaded word “fear” served as their best risk manager.
Notes: 1) they had fingerspitzengefuhl
In fact, the only true thing we have to fear, at least when it comes to decision about uncertainty, is a complete lack of fear. To trade or make any decision under the auspices of uncertainty, one should always explicitly know where they stand on the spectrum of fear to confidence. If they do, they have a shot at knowing their preexisting conditions of beliefs and, in turn, at making their best judgment call.
the numbers only take you so far and then there is a leap,” she said. “It’s a leap that is about reading the other people and about the feelings of fear or confidence you have in that read.”
remembered a study that he had brought up in the interview. He had just stumbled on it on Physorg.com. The gist was that the best market simulation model developed to date relied on “sentiment” of various market participants. Reported by a group of Italian academics, this artificial market demonstrated “sentiment” flowing from one type of market participant to another. In doing so, this market model ended up looking the most like actual market data, where big moves beget more big moves and, in probability terms, the less likely events or “behaviors” were indeed more common. When plotted on probability graphs, the curve has the “fat tails” or more time spent in theoretically unlikely events—exactly as real markets have proven to unfold.
Notes: 1) modeling sentiment or emotion was more predictive than any other market data
The study seemed to say that tracing the trail of market players’ thoughts and feelings from one trader or investor to another held the key to creating a research tool that looked like real markets.
numbers actually serve a whole different master—a master – less precise, more artful, and much more subject to interpretation—the function of a language.
Notes: 1) this is basically the Epsilon theory hypothesis? numbers are just part of the narrative.
Know that you are trading or investing against people who at the end of the day read the same books you do. You want for people to see what you do—just after you do. You don’t need to know what everyone is doing, you only need to imagine that the people you are buying from or selling to are indeed more like you than you tend to think.
The lesson? Intentionally resolve to evaluate the social/human context through which you analyze your data, projections, or probabilities. Do this first for yourself as a risk management tool, i.e., what are the emotional and social pressures playing on you, and second as a strategy tool for understanding market action.
2005, Ming Hsu, who now heads the neuroeconomics lab at University of California, Berkeley, published (with his colleagues) a piece of pivotal research that looked into what the brain does when it comes face to face with a traditionally defined risky situation (where the probabilities are known) versus the ambiguous scenarios (where historical probabilities provide only a clue). Classic decision theory assumes the brain handles both in the same way; but Hsu wasn’t so sure and, indeed, they found differences in the route the blood takes through the brain, depending on the type of problem at hand. Hsu proffered the idea of an “uncertainty circuit” or the idea that a sort of red flag went up saying “more information needed.”
The Duke team showed, at least in their experiments, that a critical node in the brain’s scenario, the posterior inferior frontal sulcus (or pIFS for short) apparently thrives on uncertainty. It lights up with oxygen flowing through it like a Christmas tree when you flip the switch. It lies beneath the temples, and it strikes me as possibly a non-coincidence that many of us, when “thinking hard,” feel compelled to massage our temples. Checking Google for “rub your temples” in fact yields pages and pages of how it helps headaches, serves as an acupressure point, and is used in yoga. Theoretically, you could extrapolate that the massage increases blood flow, as massage does, and in turn sends even more oxygen to the part of the brain which needs it most! More ironically, this pIFS evidently works faster than other nodes more associated with known probabilities. Counterintuitively, we deal with uncertainty faster than we deal with arithmetic! Could this be because the vast majority of what we deal with is actually uncertain even though we typically forget that in reality, we don’t ever know what will happen tomorrow. Whether we talk markets or life, instead of uncertainty being the exception, it is the rule.
Beyond the neuroscience however the point remains: you gain psychological leverage when you make a set of contexts explicit with an intentional focus on the “meaning gap” between where numbers leave off and good judgment begins.
Notes: 1) in practical terms what does this mean? make a decision journal?
You automatically go in one of two numerical directions.
1. Project expected cash flows for a fundamentalist.
2. Model the relative prices of tech stocks to say banks or big cap tech stocks to a certain type of economy.
Notes: 1) there is a destruction and creation element here where these work at first then break. you have to optimize for a metric no one else is optimizing for. usually one they cant measure.
Let’s say we have a new problem to understand, analyze, or make a decision about. It could be anything but let’s suppose, since it is our topic, that you want to develop, a forecast for the price of a coffee futures contract. Or better yet, how can we make sense of the market moves this past week when they are unprecedented? Even 2008 didn’t see the same number of sequential swings we have seen this past week. What would be the first step? Wouldn’t it be deciding which information is relevant? And wouldn’t deciding which information is relevant be greatly influenced by the beliefs you currently have about the best way to analyze market movements? If you are a CFA (or Chartered Financial Analyst), chances are you will turn to crop forecasts and demand curves. On the other hand, if you are a Certified Market Technician, wouldn’t you first turn to pure charts of historical price action? And in fact, wouldn’t you think that the other guy was going about it the wrong way?
Notes: 1) this is why autodidacts win. everyone else learns industrially which by definition destroys the margin. In Boyd’s terms they get very precise on the model. autodidacts have a different set of inputs so they see things that others can not.
But here’s the rub about beliefs that Camelia Kuhnen of Northwestern and Brian Knutson of Stanford showed in their paper, “The Influence of Affect on Beliefs, Preferences and Financial Decisions.” Pictures of rotten food, erotic scenes, or plain old books sitting on chairs can change our feelings—or at least the context of feelings—we bring in either a positive or negative direction, and subsequently modify our beliefs and our confidence in a simulated stock/bond choice game. Rotten food makes you feel disgusted. Erotic scenes arouse you (or at least the graduate student volunteers in their study), and then the feelings induced through those pictures color how you perceive a subsequent decision.
Notes: 1) recency bias or why you should meditate before making investment decisions.
The article, “See It with Feeling,” recounts the story of Michael Moy who lost most of his vision at age 3 and then at 40 had a successful corneal transplant, but at first could only see colors and shapes. As time passed, and presumably as he developed connections between the physics of his vision and the emotional processing tissues, he became “fluent in vision.” In fact, at least five studies on basic vision and affect or feeling show that in order for our eyes to actually see, they seemingly require emotional inputs. Evidently, the visual cortex needs the context of emotional meaning to turn shapes, colors, etc. into anything identifiable.
Is the human being inferior because of emotion or superior because of nuances in meaning that we recognize on a feeling level?
Understand the data source of the feeling—the real impetus—and you will not only understand the behavior but have a new and powerful lever into how to choose behavior that best serves your purposes. No amount of thinking harder, twice, or more rationally is going to change the imperative role of “emotions as data.” One way or another, your cognitive unconscious will signal to your cognitive conscious through the conduit of feelings.
Knowing, Not Controlling, Your Emotions (fC or eC) Can Be Your Secret Weapon
Notes: 1) if everyone is trying to be Spock then this is a source off competitive advantage
one gentleman at CME Group in March 2009, the day of the first big rally off the bottom of the 2008 swoon, came up after a talk called “The Brain on Risk” and said something very much like: “I have heard you before but I have one question. I get anxious and I don’t hold onto my trades as long as I intend to. I try to talk myself out of being nervous but that generally never works. Almost every time, I get afraid of giving my profits back and so I stop myself out only to watch the stock go on a tear. What do you advise?” I told him to “put the feelings into words and write out exactly how the doubt and fear felt.” The conversation lasted a few more moments but nothing else of substance really transpired. Six months later, I got an email from the gentleman, saying that his profits had improved and he’d been handling his trade much better.
Notes: 1) you have to make an entry into the decision journal before executing a trade.
As you become more and more adept and facile with your own decision dimensions, it becomes easier to understand to “read” the collective fC operating in the market via all or even a relevant subset of competing market participants.
think conceptually though I see what you are saying—if you can see that many traders traded at a price, then you can extrapolate what they might do when it market comes back to that price.” “Exactly. And it is a pure way of seeing people through the chart—not a derivative like all of the indicators that people get so caught up with,” said Chris.
Notes: 1) if you see a lot of action at one price going up then you will likely see it at that price going down or vice versa.
The mistake too many people make, it seems, is either not having the plan in the first place or once they do, treating it as immutable law.
Markets can have what these days is called multiple or dissociative personality disorder, and a trader has to be ready to recognize a new personality within a very short period of time.
The numbers of markets are a language—symbols for meaning—they aren’t absolute; and the real game is learning to read this language.
Notes: 1) market literacy is apt metaphor
All decisions require emotion; therefore, emotion needs to be re-imagined as data in order for any decision maker to be fully leveraging their brain power.
• I categorize conscious or easily noticed feelings and emotions as follows:
• The fC—or general physical feelings, which include tired, hungry, energized, nauseated, etc.
• The eC—or emotional contexts, which connect ideas and experiences to judgments and decisions.
Notes: 1) interesting metaphor. you must manage your emotional state just like you must master your energy state.
Psychological Capital We tend to think our market asset is limited to our cash capital. We also tend to think only of our intellectual capacities as the avenue to an edge. In both cases, we omit a key factor in our success—our total mental or psychological capital. Think of “psych cap” as the sum total of your physical, mental, and emotional energy available to you at any one time. Like prices, it constantly varies.
Physical energy, for example, makes a difference. It seems very mundane, but human fuel—in the form that emerges from food, sleep, and exercise—matters. With athletes and performers, we tend to naturally appreciate the whole body-mind continuum. We expect them to tend to their bodies, their energy base, as job number 1; but we rarely, if ever, think of this angle as it relates to making decisions under uncertainty.
Notes: 1) Bill Clinton always fed diplomats and made sure they got a good nights sleep before negotiating so they were in a good mood. you need to be in a good physical state to make investment decisions.
For example, do not make any decision you don’t have to when you lack physical energy. In other words, don’t trade when you are tired—you will lose money.
you have or can get control over your trading schedule, map it to your physical and emotional energy. Arrange your days so that you can be working from peak or near-peak energy the majority of the time.
Notes: 1) make trading decisions first thing in AM after meditating
“non-volatility begets volatility”
The most predictive element of context is the feeling-emotional one, the fC or eC. To quote Jennifer Lerner of Harvard: “The empirical literature suggests that emotions influence numerous cognitive processes—selective attention, evaluative judgments, perceptions of risk and estimates of value, causality.” Therefore, take any decision you want to understand. Don’t look first at the logic or seemingly lack thereof; look at the eC or emotional context. With a trade you can’t understand, ask what was the emotional context? Stop thinking about your thinking and behavior; instead, understand the psychological environment. The emotions are your data—the data that, when properly analyzed, holds the best explanatory power!
Notes: 1) true of blog posts. Most emotional ones perform the best.
Think of it as mark-to-market emotions. You spend almost all of your time monitoring price action, right? You pay attention to almost every tick. Why can’t you do the same with internal data?
Notes: 1) mark your emotions to market and trade momentum. double down on big oned and get out of little ones.
Begin to capture a record of what you are feeling. The simple act of acknowledging it, which by definition occurs when you are writing it down, will actually provide some protection from the destructive and unconscious acting out of feelings that you thought you were supposed to control.
Notes: 1) Doing this in the morning journal would be a good experiment.
The Spectrum of Fears To help you with step three, I want to give you the spectrum on which most of your conscious feelings are going to fall. Call it the FAD (or fear, anxiety, and doubt) spectrum. It has two primary ends punctuated with two extremes. On the far left, we have panic—of the kind seen in October 2008, March 2009, or August 2011. On the other end, we have FOMO (fear of missing out), or I guess what we should really call the panic of missing out as we saw way back in March 2000 with the high of the Nasdaq. You see it in short squeezes on a much more regular basis, a slow grind upward that some like to call “the melt-up,” which ends with a very fast, high-volume long jump in prices. Between these two extremes of panic you have the more common spectrum of fear of losing or being wrong to fear of missing out.
Notes: 1) where on this spectrum are you before making a trade?
Vow to always ask: How will I be feeling in the future if I take this trade?
Jennifer Lerner also found that happiness decreases our recognition of risk. We all know this feeling. Things have gone well and it gives us a lot of confidence. It feels good and in the midst of that feeling, new choices or challenges look easier than they turn out to be. In my mind, I kind of imagine our spectrum as having a diving board on the right-hand side, leading from the pool of fear into the pool of overconfidence.
Notes: 1) you want to trade in the middle of thee spectrum. I think I am too risk averse so maybe I want to move down the spectrum a bit.
Don’t be afraid to put it into words. In fact, reams of research out of the psychoanalytic traditions and now even decision science indicate that putting feelings into words, does indeed provide a great benefit. Putting feelings into words not only reduces anxiety but verbalization can actually allow us to work more effectively on a thinking level. Here’s another example from a client e-mail: The first surprising thing I learned was about ambiguity: all it took to “embrace” it was to physically write down or say out loud “Yea, ambiguity!” I would laugh and then not worry about it; because the benefit of embracing ambiguity was not some great insight into what the market was going to do, rather it was an increase in energy.
FOMO lie behind the largest percentage of trades or even whole asset classes gone bad.
Notes: 1) never make a trade out of FOMO
(Don’t underestimate the power of unconscious pattern recognition.)
Notes: 1) Fingerspitzengefuhl
regret theory seems to have been overlooked in a number of ivory towers. Developed by two separate groups, the theory stated that if you add the desire to avoid future regret to a theory of subjective utility, or any one person’s own view of what will serve them best, you could build a more accurate model of the way we make decisions.
“The conscious mind is not at the center of the action in the brain; instead it is far out on a distant edge, hearing but whispers of the activity.” He noted early on in the book that “Freud’s intuition about the unconscious brain was spot-on.”
When it comes to our psyches, eventually, if we peel back all the layers, sooner or later, the core fractal usually turns out to be our feelings about ourselves in relationship to our mothers.
because children are narcissistic by nature (i.e., they think the world revolves around them), anything that happens that is bad (an argument, a divorce, an accident), they attribute to or blame themselves.
[T]he compulsion to repeat is an ungovernable process originating in the unconscious. As a result of its action, the subject deliberately places himself in distressing situations, thereby repeating an old experience, but he does not recall this prototype; on the contrary, he has the strong impression that the situation is fully determined by the circumstances of the moment. These patterns acquired in childhood are forgotten and are instead acted out and repeated in life. It is reproduced not as a memory but as an action.
“Almost immediately upon entering a trade (unless it moves in my direction right away), I feel it was a mistake and I have a strong impulse to exit before it blows up in my face.”
Once I heard a man worth hundreds of millions of dollars talk about a bad month in his business. I teased him about being worried, to which he responded, “It might all go down the drain.” He laughed with that nervous kind of “maybe it is true” laugh. I realized I was hearing his fractal-emotional context of perception. He really did still feel like maybe he didn’t deserve it or some other nuance related to being not good enough that clearly sprang from an earlier time in his life. When we seem to sit passively watching the market’s ticker tape, it can easily taunt you like some smattering of the people who populated your early life. Just about everyone has a father, mother, brother, teacher, or schoolyard friend who made them feel “not good enough.”
Notes: 1) we all feel not good enough which causes fear at the time of the trade
the market and trades become anthropomorphized (or turn into people), and we “relate” to the collective of human behavior as if it were a real person standing before us.
(“I can’t leave the screen because something that I must attend to might happen”) is a repetition of how his mother deals with the world.
Everyone spends all their time searching for what everyone else doesn’t know, when a lot more money can be made searching for what others are about to know.
“The amateurs trade the open and the pros trade the close.”
For example, where are you on the spectrum between fear of losing money and fear of missing out? If you want psychological leverage, you need to elevate this introspective analysis to a priority even higher than knowing what the market is doing at any given moment. If you don’t know the feeling or emotional context you bring to any decision, market, trading, or otherwise, then you become the computer with GIGO (garbage in and garbage out).
Notes: 1) write down your emotional context before each trade.
A Very Basic, Very Powerful Psychological Leverage Plan
Let me boil the basic plan down to a cheat sheet:
1. Create physical energy.
2. Read other people.
3. Get the risk management edge through knowing yourself and how you feel (your emotional contexts) operating at any given moment.
Get the strategy edge by using that knowledge of yourself to understand others (their emotional contexts), which they most likely will act out (since they aren’t doing #3).
Know when to push it because you have emotional capital and psychological leverage.
Know when not to push it because you are acting out of an emotional context fueled by the past, be it the immediate past or the distant fractal past.
Notes: 1) good summary
one of the ironies of trading is that winners almost always make you feel bad—either you didn’t stay in long enough or you got out soon.
“Denise, are you saying that instead of using his intellect or cognitive capacity to remind himself that the two sides of the trading argument were not literally his mother and father, you asked him to do the opposite? Most people would try to remind themselves about reality, right? But if I follow you, you are saying that a kind of play acting that demonstrates the underlying feelings can be more effective. Is that correct?”
Notes: 1) don’t fight the feeling. go with it and work with it.
Using your head to talk yourself out of the feelings you have just doesn’t work very well, if at all. It might look on the surface as if it does, but the feeling will linger and reappear, oftentimes acted out instead of just felt. Leaning into the feelings or fully experiencing them without any judgment about whether they are the right way to feel or whether you want to feel that way has this ironic effect of disrupting the feeling.
Intuition, as it’s usually called, is that knowledge communicated via a feeling that stems from having seen something before and recognizing the details at a level below awareness. I like to call it unconscious pattern recognition or tacit knowledge
Another 2008 study showed how experienced people make decisions faster. The author said that our unconscious builds a picture book that it sorts through to reference.
four different cases, people reviewing the outcomes of more complex decisions were happier with the results when they made their choice without “attentive deliberation.”
Look for these differentiators. If a feeling feels urgent, if it feels compelling, suspect it as impulse. If on the other hand, it feels calm, if it is a sense coming out of nowhere, consider it as recognition of something you know but aren’t conscious of yet.
This meltdown occurred and got worse through psychological levers on more than one level. The first one is easy—too many decisions made while you clearly were sleep deprived. I know how easy it is to forget. When you need to remember the importance of trading as a physical endeavor, it is also simultaneously the most difficult to do. The second is the fear of missing out—the markets seemed oversold and you were acting out the fear that you would miss a chance to substantially outperform. The third and most influential is the general feeling of having no power; I am sure when you got word about Tom, you felt helpless to do anything. Adding to the position gave you a feeling of some modicum of control.
In a new world where feelings and emotions count, step one turns out to be quite different than you would think. Ironically, the most helpful thing to do when you have blown it is to feel bad! It won’t kill you, it won’t even cause you to throw up (most of the time), but it will put your body in synch with your mind and your mind in sync with reality. If you have made one or a series of spectacularly stupid decisions, what else are you supposed to feel? Isn’t feeling like a chump rational? You blew it so of course you should feel like crapola! In other words, step one of recovery amounts to mourning.
Typically, men more than women want to “do” something and intentionally feeling whatever feelings exist doesn’t seem like doing anything. (Even though it is.) Men tend to immediately ask, “What should I do?,” where “do” involves some sort of deliberate physical movement. Many of my clients move first toward taking action and the action of consciously feeling something, maybe because it is internal and can be done sitting still, clearly doesn’t seem like doing anything. In terms of understanding one’s over-arching emotional context, taking action can prevent one from ever knowing what that context really is. It just doesn’t make sense to literally do anything (take physical action) until you really understand what went wrong and you don’t have a snowball’s chance of understanding where your perception got so off track until you let yourself feel crummy—most of the time, for however long it takes. I know you have visions of half-empty pizza boxes and beer bottles strewn all over your office, but, even if that did happen, would it be so bad?
Most of the time, if you have the courage to feel badly, get to the root of the feeling, and realize that x-y-z feeling or fractal-emotional context crept up on you without you knowing it, the feeling “pops” like a balloon. Even if it doesn’t pop, it begins losing air like a tire going flat. The overwhelming sense of urgency begins to dissipate.
Notes: 1) We give the feeling fuel. Ido this too try and punish myself.
Feeling bad has informational value. It leads you to be introspective, and while you are doing so, here are some questions to ask:
• What was the feeling context and emotional context, the fC and eC? Where were you on the spectrum between the fear of losing and the fear of missing out? You were definitely somewhere, and more often than not, the mistake you make will be on the right-hand side, at the fear of future regret.
• What was the fractal-emotional context, the F-eC? Of course this third one will take a little help to figure out, and even more diligence to manage. But it is manageable—set phone alerts, put up sticky notes, talk about it.
When the thing you need to do, get out or walk away, seems to be literally the hardest thing to do, you can be assured that what you are feeling has a fractal component. It mostly is not about the here and now.
Notes: 1) The Resistance
you recognize it sooner, you get to the point where you can have one awful trade, just one (sort of like one potato chip or one chocolate chip cookie). Instead of turning into a gorge-fest, you have a psychological strategy to fall back on. Then you will have made it. It is rarely, if ever, that first loser that kills you, it is almost always what comes after it. In Chicago, they used to say, “Your first loss is your best loss,” and it is true. Furthermore, if you manage to a strategy of psychological capital and leverage, oftentimes you will have your signal to take a break before you even get a chance for the second loss.
Notes: 1) when it starts going against you then break it off
The markets have many personalities and what works with one doesn’t work with the other. It can take a lifetime to get good at them all or give up on the ones that just don’t suit your internal rhythm.
Notes: 1) pick the markets and strategies that fit you.
Last Updated on April 18, 2019 by RipplePop