... to be a Trader

The week was again dominated by the Trade War. Markets initially reacted badly to the previous week’s tariffs and trade talk failure but were then comforted by Trump tweets walking back some of his bluster, particularly on European auto tariffs, and given a brief lift by the best Michigan Consumer Sentiment print in 15 years. The result was an erratic flat week—as the Sell in May stock correction and a soft yield slow Dollar turn continue.

 

There is little to suggest this will not continue as markets remain subject to a vacillating battle of strategy and wits between two leaders—an emotional saga and market. As Michael Kalikow & Katherine Monson said “The ability to manage our own emotions and deal with those of our counterparts is one of the distinguishing factors of effective negotiators.” It is also one of the distinguishing factors of trading success: control of one’s own emotions and understanding how other’s emotions (in aggregate sentiment) will move the market.

 

It is perhaps ironic that during the 2016 US election campaign, Donald Trump was accused of lacking the emotional intelligence to be President. 50 former national security officials, Republicans, published a letter saying a President must be "disciplined, control emotions, and act only after reflection and careful deliberation.”Simply put, “Trump lacks the temperament to be President". And yet his continued trade war against the Chinese is likely to secure a quasi-permanent shift in the trade balance between the US and China. Indeed earlier in 2013 President Xi said “It’s not your educational background, integrity, experience, or people you know that matters. What it takes is emotional intelligence”. So too for the trader particularly in increasingly erratic and volatile markets.

 

But also having done the ground work in the form of accurate sound analysis.

 

This week, as DAX broke back below 11900, we built the largest long position we probably have had in over a year. Why? Our analysis suggested it was a high probability bottom. The risk return was excellent. But we are also to use the confidence that created to cast aside any doubts or emotions emanating from others and catch a bit of luck when Donald Trump announced the delay to auto tariffs.

 

This week’s newsletter explains such emotional intelligence in the trading context and how we can to make emotions work for us, instead of against us. Controlling emotions so we act on sound analysis is the key to the successful trading and the great thing, unlike normal intelligence, it can be learnt.

 

Emotional intelligence is the capability of individuals to recognize their own emotions and those of others, discern between different feelings and label them appropriately, use emotional information to guide thinking and behavior, and manage and/or adjust emotions to adapt to environments or achieve one's goal(s). (Wikipedia)

 

The term first appeared in a 1964 paper by Michael Beldoch and gained popularity in a 1995 book of that title by author and science journalist Daniel Goleman. Since then it has been debated developed not just with respect to relationships but also how a worker interacts with their peers and its effect on leadership and negotiation. But the role of emotional intelligence can and should be developed further in the trading world.

 

There are four branches of emotional intelligence as outlined by Mayer, Caruso and Salovey.

 

  1. The ability to perceive emotions
    This is the self-awareness that we, as traders, may be subject to fear or nervousness, greed or complacency and the many other trading emotions—the subject of our first article.
  2. The ability to understand emotion
    It is one thing to recognise emotion but it is important to appreciate how may affect our decision making. We may, at times, be tempted to enter a trade based more on our emotions of the moment rather than evidenced based analysis that should underlie every trade we take.Because risk has the potential to increase our emotions it often has a greater potential impact on existing positions. As a market approaches our stops or limits quickly we may be tempted to take a loss prematurely or not take profit when we should even though our analysis remains unaltered. It is our emotions that have changed not the evidence that helped formulate our analysis.
  3. Managing emotions.
    It is a cliché that we should eradicate all emotions from our trading decisions. Analysis not temperament should be the foundation of all trades. But as it is impossible to remove emotion we need to be able to manage those emotions. Many traders seek not just to suppress emotion but deny their existence.The problem is that there is a risk they will come out when we possibly become unbalanced either due to market volatility (when we need to manage them most) or changes in our personal circumstances such as having a drink, becoming tired or stressed. This may lead to decisions or behaviour that makes us further unbalanced and more prone to emotional based decisions either in our trading or personal lives.Also in order to suppress emotion, some people filter out important market information that may require a change in our analysis, eg confirmation bias. In short, it is arguably better to have some form of the emotion but not let it affect decisions unless that emotion itself is evidence that our analysis should change.
  4. The ability to use emotion.
    Emotion can be used to facilitate thought. Firstly to understand that our emotions may indicate where the market is or going (or similar emotions in a similar previous instance). I have found many fractals (similar setups) by recalling a similar set of emotions.When I have become unbalanced (that is less emotionally intelligent) it has become much harder to make such comparisons because my emotions have become more variable and different. Secondly as sentiment is the key to any market and difficult to assess, using other traders’ emotion as expressed in social media or similar outlooks helps identify the aggregation of emotion or market sentiment.For example when a bullish trader exits a trade too early and then ends up selling out of frustration, ego or boredom. Indeed when we see others venting their emotions and in extreme forms this may be an indication the market itself is reaching an extreme. A characteristic of much of the early 2019 stock rally was that many people were bullish but waiting for a dip to buy that never came. And ended up chasing the move until SPX new highs (falsely) confirmed they needed to pile in—and into the sell in may correction.
One of the reasons why sentiment is complex, dynamic and fickle is that it is built on emotion or, in a contrived way, the market’s emotional intelligence. Many of the clichés surrounding market lore, eg herd instinct, is that the market is itself emotional unintelligent. The difference between successful and unsuccessful traders is often not their underlying analysis but their emotional intelligence.

A more emotional intelligent trader is better able to perceive understand manage and use their emotions.

 

The question therefore some inevitably will ask is whether are emotionally intelligent enough to be a successful trader in the long term. It is true, like cognitive intelligence, some people are naturally more emotionally intelligent than others; that is they are naturally more emotionally balanced to live with the ups and downs of a trading life.

 

When I started trading I recall a psychometric test that everyone took in the trading room that showed I was one of the least likely to become emotional when the market temperature heated up. I have also found people from certain backgrounds tend to make better traders. Curiously engineers tend, in my experience, to make better traders. Why? Maybe it’s because the temperament that makes a better engineer also makes a better trader. But I suspect its more because engineers necessarily use a rigorous form of process to manage variables that are sometimes affected by human decisions. And this, I believe, is the key to becoming more emotionally intelligent. Understanding and using processes that manage emotions to good effect. Its because we can learn processes that we, however emotional or otherwise,  are all able to learn processes that help us become more emotionally intelligent and rely on our analysis rather be derailed by emotions.

 

The next article in this series will investigate how we can, in turn, perceive understand manage and use emotional intelligence rather than just emotions themselves to become better traders. That necessarily involves building and maintaining processes, emotional, mental and physical that will increase our emotional quotient, the level of our emotional intelligence, and therefore our chances of a successful trading career.

 

Here’s to making the very best.

Good Luck

 

 

Ed Matts
Founder
Matrix Trade
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