From the Heart (Part 2)

When traders and markets are emotional about emotion.

As we go into Easter, Indices remain seasonally strong ...


... and the Dollar resurgent on the back of US yields and poor EU data.


But they are both ready to turn back down—on the back of yields.


One of our projected themes for 2019 was a disconnect between resurgent stocks and a USD that starts strong and turns back down. Such a divergence is likely to confuse and aggravate traders in an increasingly emotional market. Indeed, confusion often heightens emotion further as the trader quest for resolution needs black and white answers not uncertainties. As traders we cannot afford either to be confused or indeed emotional as trading requires both clarity and discipline. Last week we looked at how to control emotion through a particular trade. This week we focus on how to maintain control and trading success in the longer term.


We and many have written much about how emotion adversely affects trading in the form of fear, greed and complacency. We and many others have offered ways to control those specific emotions in the many possibly emotional instances in trading.  But you do not often see advice that helps you maintain emotional balance and therefore trading success over the longer term. And I never seen anything that attempts to break down the necessary balance into its component parts to provide a trader with the essential solid emotional foundation to make money in the long run. In the last year I have done just that – not as an academic exercise but as a necessity. It has worked and I want to pass that on.


1. Control of Specific and Variable Emotion.
There are many clichés (good and bad) about the existence, recognition and control of specific emotions that come with a trade. There are far fewer about the many series of emotions that confront a trader over the hundreds or thousands of trades in a trading career. And how they change over time. Before you even consider a trade, emotion enters the equation. Many beginners have learnt the difference between trading a demo account and a proper trading account as real money is involved.


Many have noticed a change to the level of emotions when they have either increased the size of their account or position size or even become full time traders. Even experienced professionals have been significantly affected when they have started to trade other people’s money and particularly when you meet and get to know the investor as a person. In some cases, your success or failure can affect their lives. The stuff that emotional rides are made of.


Each step therefore requires greater control as the possible specific and variable emotions are increased. How? By recognising and acting on the two further components of emotional trading: emotional balance and intelligence.


2. Control of emotion about emotion (emotional balance). 
Articles, clichés, theses about controlling specific trading emotions always seem to presume a neutral starting point. That the trader is completely devoid of emotion and therefore able to apply the words of wisdom without any difficulty or hesitation. If only!


Humans and in particular traders taking risk with money are necessarily a complex and variable mix of emotions at any one time. Our ability to control specific emotions relies partly on our emotional state. The more objective and less subjective or emotional we are the better we will be able to recognise and neutralise any adverse emotions. Our ability to do so depends on why we are trading, our goals our perspective but also therefore what else is happening in our lives.


For example, the get rich quick trader isn’t aware that successful trading is a long-term process.


The get rich quick trader hasn’t yet learnt that it is the series of net successful trades that pays long term dividends than the probably elusive one-off amazing trade that they can retire on.


One of the reasons why I switch off the P&L section on my platforms is that I am trading a market, not my P&L. Clearly if you trade for a specific financial goal that takes you away from the market and the ability to make right trading decisions back into the P&L world. After all the construction of the trade should have already addressed the P&L considerations (Risk/return, probability, position size etc.) and don’t presumably need to be continually revisited. However, in the longer run it is different.


Trading is a business and necessarily (revenues/costs/capitalisation etc) needs to be treated as such.


It therefore reduces the reliance on what the market may be doing day to day—even if the cyclical and sectoral nature of market volatility requires adjustment. Sharpe Ratios for foreign exchange funds and how they go about trading and maintaining/increasing funds should have changed in the last year due to the collapse in volatility.


Clearly a sustainable business should be structured on realistic goals and the environment in which it operates. A trader therefore needs in some respects to be a temporal schizophrenic. Someone who is so immersed in the market in the short term that they do not need to track the P&L of specific trades because they are conscious but not thinking what it will be. But also, someone who can step back and asses what they are doing and how it affects their P&L over the long term. Emotion can clearly affect or derail both.


The less emotional or more objective (less subjective) one is about both the more likely we are to maintain an appropriate perspective and consequently a greater likelihood of success.


A while ago I was approached by a well-known name in the market as they launched a new significant venture. They had got off to a terrible start and were distressed and apparently in need of advice. As someone who was neutral it was a relatively easy proposition and twofold answer.


Firstly, they had proven over many years that they were an able analyst/trader. But they had been ‘too’ keen to start well and had changed what they had done so successfully before. So, go back to it conceptually if not in detail. Secondly, because they were so keen and because they had done badly they had magnified the levels of emotion through greater hope and subsequently greater disappointment and become emotionally unbalanced. They needed to regain balance and recognise, just like markets, a trading business is cyclical.


That was a particularly difficult time in the market that would change.  You are not only as good as your last trade or week or quarter or even year. You are what you are in the long term and what you do next. If you do what you do best and identify and neutralise the weakness that are stopping you do that, then you should be successful again. Or at least believe that and become balanced again to enable success. Advice he could have given himself if he weren’t too unbalanced to be dispassionate to recognise the problems. Anyway, he then returned to winning form and hasn’t looked back since—and possibly nothing due to my advice.


In my 30 years of trading I have been confronted by two periods of emotional imbalance, both in heart-breaking and life-changing family matters, that affected how I trade. Neither was due to trading in itself, but it still affected my ability to make trading decisions. During those periods, I significantly underperformed in the market.


After the first event in 2000, even though I recognised I was emotionally challenged and sought to do what I normally did, the performance wasn’t there until my life returned to relatively normal when I started making good money again. I had no idea about the detail of how or why my performance suddenly improved. Except the obvious observation, in retrospect, that I was too unbalanced to do what I normally did properly.


The second event was in the late 2018. Again, I sought to do what I normally did. And in fact, detailed later investigation showed that my analysis, particularly in the short term, was if anything was even more accurate. And yet I was missing trades and even occasionally making the wrong trade based on the probability implied by my analysis.


The most striking example was the ramp and fade in indices prior to the December crash. I was heavily long looking to close and sell the euphoric Trump trade war spike. I would have made a ton of money but didn’t. Why? Its only after we analysed this that we identified the two changes not just through the current performance, but also my trading records from 18 years earlier.


The first reason is that I had become risk averse. Because of the inevitable distress associated with each event, I was operating at a permanently higher level of emotion than normal. As a result of the inevitable increase in emotion created by trading, I was unprepared and unwilling to accept more than a certain amount of additional emotion or pain and shied away from the harder (contrarian based) trades that tend to be more successful.


Instead I was more inclined towards the easier more obvious trades that tend to be less successful. Secondly, partly because of this I also got out of a rhythm with the market. Rhythm is not a concept easy to explain in one sentence only. But it is an ability to read a market and continue reading a market based on a number of less quantifiable factors. Some would call it gut feel.


But gut feel can be quantified by more than two words. After all the Matrix trade equation (Risk/Return x Probability) is an attempt to quantify what the most successful traders do intuitively. An important part of reading what the market is doing is understanding what other traders or the herd is doing. For much of my successful career I have used a device to gauge an aggregation of emotion or, simpler, market sentiment that has enabled me on many occasions to top or bottom tick a market: average Joe Trader. Joe is a nice guy seeking to make money trading but who is subject to normal emotions and gets swept along the price movements and stereotypical commentaries.


Thinking through to a point where you know what Joe would be doing at any one moment is enormously instructive. It is a contrarian device that I found helpful sometimes to perfection. Although I thought I was still reading Joe correctly what I didn’t recognise is that I was unable to decipher Joe’s emotions.  Because I was suppressing my own emotions I was unable to sense what Joe would be feeling or thinking. This is a good example of how emotion can in fact help as if empathise with someone making mistakes you can avoid them.


In recent weeks many have noticed I have become far less risk averse and that I am quite often top and bottom timing a market, thanks to Joe who will be featuring in the article Bloomberg are writing about me and Brexit Cable. And the results are showing. In fact, the journalist told me on WhatsApp:

To which I replied:

The key difference is between thinking you know what’s going on not just with the market but also yourself and actually what is happening. In short, when you should be in or out. And that comes down to


3. Emotional intelligence. 
Next week we will explain the role of emotional intelligence in trading. Unlike normal intelligence, which is the ability to acquire knowledge (and, argued by many, cannot be taught) emotional intelligence can be part of a natural disposition and hence why some people make better traders than others.  But it can also be learnt particularly in the market place—and why we can all be better traders.


Life has taught me the game as well.


Sometimes there is no gain without pain. Part 3 on Emotional Intelligence will be the subject of next week's newsletter.


Here’s to making the very best. Don't forget I will be appearing live next Thursday 25th at the XTB Global Online Masterclass. My slot is at 1045GMT (1145UK, 1245CET). You can register here. Below is a short video about the webinar.

Good Luck




Ed Matts
Matrix Trade


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