In this chapter, we will look at language—human and market-generated—and see how the tools and tactics utilized by therapists can help us better understand the markets. So far, we have focused attention on the subjective experience of traders. Now, however, we will turn the tables and put the markets on the couch. In so doing, we will learn how to become more adept as observers and how to gain greater control over our trading.
THE INTERVIEW FROM HELL
A most uncanny experience occurred during the first year of my training as a psychologist. My cadre of beginning-level graduate students was scheduled for an observed interview. These were largely enjoyable experiences, in which we took turns interviewing clients from our clinic, finding out about their problems, and formulating ideas for helping them.
The nervous tension within my group betrayed the realization that the interview would be unlike any others. This patient had been recently discharged from the state psychiatric hospital. Indeed, he had spent a significant portion of his life in such hospitals. He displayed the classic signs and symptoms of schizophrenia: disordered thought and language, hallucinations, delusions, and odd emotional expressions. We were warned in advance that much of what he said made no sense whatsoever. We were also told that he rarely stood still and that sometimes, in his agitation, he made physical contact with others. According to the clinic director, he had come to us for help after abruptly discontinuing his medications.
We listened intently to the briefing, our discomfort mounting. Most of my group had never actually talked with a psychotic person. An uneasy silence permeated the observation room as we settled in behind the one-way mirror. Each of us, it seemed, was confronting the inner questions and doubts of the neophyte professional: What will he be like? What will I say? How will I fare as I take my turn interviewing a truly mentally ill person?
We fared poorly.
The man was unshaven and disheveled. He grimaced as he paced back and forth in the interview room, ranting, "I am Woolworth! I am TG&Y Store! I am Woolworth!" His agitated gestures and facial contortions, combined with his fanatical insistence that he was a discount department store, cowed us all. We had no clue as to what to say, what to ask.
Several of us tried in vain to conduct a standard interview. We asked about his problems, tried to elicit details of his personal life, posed our well-honed open-ended questions. He ignored us. It was as if no one was talking to him. He continued pacing, all the while pressing his claims that he was a retail outlet. More than a few of us found ourselves hoping that the class session would run out of time before it became our turn as interviewer.
Finally, a more experienced graduate student tried his hand at the interview. He was unlike the other students, not merely because he had experience but also because there was something different about him. It was nothing tangible, just a look in the eyes and a peculiar intensity. He didn't seem altogether normal, which, for me, made him especially interesting. Indeed, I had heard rumors that he was quite practiced in dealing with psychotic patients. These rumors were not necessarily spoken in a tone of respect.
He calmly sat beside the raving man. His demeanor conveyed the expectation that he was going to have a normal conversation with a normal person. Meanwhile, his head thrown back and his arms shaking, the client continued the chant, "I am Woolworth! I am TG&Y!"
The student was unfazed. He looked straight at the agitated man before him and quietly asked, "What's for sale?"
From my perch behind the observation mirror, I could feel my heart stop. Instinctively, I knew he had asked the right question.
The man paused. His tone became flat and emotionless. "Nothing," he replied.
"Why not?" the student asked. "Why isn't there anything for sale?"
The man stopped his pacing and gesticulating. For the first time, he looked at his interviewer. "The shelves are bare," he said.
"How about the customers?" he continued. "Where are they?"
His face a contorted, anguished mask, his eyes burning far too brightly, the man whispered, "They're all gone." For hours he had been trying to get people to pay attention. He was not a patient. He was a store—a dark, empty store with barren shelves. He needed to be restocked. I was stunned. The other graduate students seemed indifferent. Some even snickered. I looked from one to another, desperate to see if anyone shared my epiphany, the eye-opening realization that was to forever change my professional perspective: This patient wasn't irrational at all. He was simply speaking a different language.
Twenty-three years later, I'm an old hand at the therapy business. I have worked with just about every type of person and problem that exists. In that time, I have witnessed markets that run away to the upside and those that plunge downward. I am still waiting to meet a wholly irrational person.
Or a truly irrational market.
OBSERVING PATTERNS
When people—or markets—seem irrational to you, there's a good chance you are failing to read their language. Dreams, the conversation of young children, artwork—many a profound truth comes packaged in ways that make more psycho-logical than logical sense. Irrational markets suddenly make sense when you recognize that their volatility is a direct reflection of the emotionality of their participants. Such markets, like the Woolworth man, are screaming their messages to you—if only you can make the proper translations.
Many traders attempt to predict the market and look for prices to follow. Great traders understand the market's language and follow along. Just as it took a therapist who was a bit off center to appreciate the communications of the Woolworth man, you can best apprehend the market's messages by attending to your own volatility.
There is a myth among beginning therapists and traders that consummate professionals check their emotions at the door and operate under strict logic and reason. Is it possible to shut off your feelings in such a manner? Would this even be desirable?
It is interesting that cognitive neuroscience research has addressed just this issue. A number of studies have investigated individuals with brain lesions who display what would seem to be a trader's dream: Their reasoning mind remains intact, even as their capacity for feeling is blunted. The result is not a superrational, intelligent being, such as Mr. Spock from the old Star Trek series. Indeed, the person without the capacity to feel is much like the Woolworth man, issuing tossed salads of words that connote much but denote little. As neuroscientist John Cutting noted, the person who is devoid of feeling is a mere gesturer, issuing words that are divorced from meaning.
Why is this? It appears that feelings are one's guide to the value and the meaning of events. In the language of cognitive psychology, emotions reflect a person's appraisals of the world. Suppose I see a man walking toward me on a dark, empty street. If I interpret the man as the friend whom I am planning to meet, I may feel eager anticipation. But if I interpret the approaching figure as a potential mugger, my emotional response is apt to be quite different. Good/bad; safe/threatening; for me/against me—feelings cast the world in terms of its relevance to the perceiver. It is difficult to imagine a therapist helping people or a trader attending to the significance of market action in the absence of such a guide.
Like the therapist for the Woolworth man, the successful trader feels the market but does not become lost in those feelings. Emotions are information, no less than a wide-range bar on a chart. Indeed, a strong emotion can be thought of as a personal volatility breakout. Just as an experienced trader becomes exquisitely sensitive to the patterns emerging from the tape, traders who know themselves well attend to their own patterns. To paraphrase Robert Pirsig in Zen and the Art of Motorcycle Maintenance, the real market you're trading is the market called the Self.
One truly accurate market indicator is my own hubris, or pride, in making a successful trade. The setup begins with a series of winning short-term trades. I'm pleased with my success and find myself wanting to get back into the market quickly, to continue the streak. I place my trade—sometimes increasing
my size—picking my entry carefully. In this particular scenario, the trade does in fact work to my advantage, and now I have a nice string of successes behind me. Without forethought, I begin to feel my oats. I project my future profits. I start to talk about my positions with others. I entertain wild fantasies of authoring an advisory service or managing a larger portfolio. Before I know it, my emotions have made a high volume move to the upside.
When that happens, the current trade, which is now profitable, very often will reverse. What is more, my subsequent trades are apt to have a poor batting average. It is almost as if I have jinxed myself. What is going on?
In any sport, whether it is basketball, track, or boxing, a successful competitor cannot be a scorekeeper. When I am counting my profits and focusing on my track record, I am no longer attending to the market. I am like the Woolworth man, filled with my inner voices, badly out of sync with the outside world.
How can I escape this trap? Should I make an effort to tune out my feelings? Absolutely not!
The key to self-control is to trade less from the ego and more from the therapist's couch. If I will be a truly successful trader, I will emulate the successful therapist in such a situation. When a strong emotion hits in therapy or trading, the challenge is to activate an Internal Observer. The Internal Observer is a part of myself that stands apart from my moods and calmly observes the situation. If I can identify with the Observer—and not with my grandiosity—I have a chance to profit from the information contained in my emotions.
It takes practice to cultivate the Internal Observer. Practitioners of meditation have long understood that it is easiest to stand apart from the emotional flow if you slow your breathing and your bodily movements and isolate yourself from external stimuli. The mind is apt to be most quiet when the body has slowed down. If I can sit in a darkened room with my eyes closed, breathe deeply and slowly, and focus my mind on a single image—eliminating as many stray thoughts as possible—I will begin to unwind. If I continue the exercise, I will become bored. My mind will hunger for stimulation. That is when real change can occur.
The key to activating the Internal Observer is to stick with the sensory isolation, deep breathing, and focused concentration beyond the boredom threshold. When your body is itching to move and your mind begins to wander, and you think you just can't tolerate a moment's more meditative quiet, stick with it several minutes longer. What will happen is quite remarkable. Like a runner who "hits the wall" and becomes exhausted, only to gain a second wind after forging on, your consciousness will find a second wind beyond the boredom threshold. It will take effort, and it will take practice, but the payoff is great. Beyond the boredom threshold lies the Internal Observer.
I always know when I have found the Observer because it feels as though there is quiet inside my head. I feel in the world but strangely separate from it. Things that may have upset or stressed me a few minutes earlier no longer seem so important. When I first tried this exercise, it took quite a few minutes to reach the Observer. Now, more familiar with my mindscape after considerable practice, I can evoke the Observer with just a fixed gaze and a few deep breaths. It's a handy skill in the midst of frenzied trading.
It is at those points of feeling removed from the world, on the heels of indulging in my trading successes, that the Internal Observer pipes up and says, "You know, Brett, you've been feeling awfully good. You've made quite a few good trades, and now your emotional chart is in a parabolic rise. You know what happens to parabolic rises; they end in crashes. This is your signal: The trade you're so happy with is likely to reverse."
If I can heed the Internal Observer, I have an opportunity to keep the focus away from myself. That permits me to become especially attentive to indications that my current position is not working out. Instead of approaching the market as if I'm invincible, I reverse my psychology and intensify my concentration and effort, as if I've lost money on the most recent five trades and can't afford to lose more.
Feeling overconfident thus becomes a cue that triggers cautious behavior—the opposite response from the one that normally would arise. In trading, as in therapy, the best response is very often not the one that comes naturally. If I'm feeling anger toward a client, that's usually a time I need to think about being supportive. If a client seems boring during a session, that often is a sign that I need to pursue a more fruitful line of discussion. Therapists think of it this way: The responses that come normally and naturally are what clients have been getting from people all their lives. If those had been therapeutic, you can be sure they wouldn't be wasting their time in your office!
It is exactly the same in the markets. If the normal, natural emotional response produced profits, the average trader would be making windfalls. Everyone would be making money, which, of course, is impossible. There would be precious little interest in trading psychology if people could go with the emotional flow and harvest dollars from the market!
INVOKING THE INTERNAL OBSERVER
It turns out that I am not at all unique in my battles against trading overconfidence. Although fear and greed tend to get top billing in the pantheon of trading emotions, researcher Terence Odean has found that retail traders typically suffer from an excess of confidence in their abilities. (It is interesting that he finds that men are more prone to such overconfidence than women are.) For example, in a survey of 10,000 trading accounts, Odean found that traders tend to be successful in their trading prior to opening their online accounts. Once they went online, they dramatically increased their trading frequency and proceeded to significantly underperform the market averages.
I have found a very similar pattern in following the Ameritrade Index (www.ameritradeindex.com), which is a daily tally of the buying and selling activities of Ameritrade's online retail traders. On a significant down day in the market, there is often a swell of buying among the retail traders, who apparently feel confident in picking market bottoms. But there is relatively little selling by these same traders on such down days, suggesting that many are initiating overnight long positions in the market. By activating my observing capacity, I can stand apart from the overconfidence of the majority and use the occasion to exercise particular caution. Indeed, many times I have been able to use the information to fade the majority and to benefit from continuation of the downside trend as the stops of the overconfident traders are hit, feeding the decline.
One tool I have found helpful in maintaining my observing stance in the markets is called a sound-and-light machine. There are many companies manufacturing such devices. My unit, the Nova 200 Pro, is made by Photosonix and is offered through many dealers at a discount.
The "sound" part of the sound-and-light machine plays two tones of closely spaced frequencies, one in each ear. The frequencies of these binaural beats can be adjusted to correspond to various brain-wave frequencies, from the low-frequency theta and alpha waves associated with relaxation to higher-frequency beta waves associated with alertness. The idea behind such a device is that, over time, one's brain waves will entrain to the frequencies played through the headphones, inducing states of relative calm or vigilance. This phenomenon is known as the "frequency following response."
The "light" machine utilizes a cluster of small lights attached to the inside of a pair of goggles. The lights flash in synchrony with the sounds presented to each ear. Wearers of the goggles keep their eyes closed, but they can perceive the flashes of light through closed eyelids. Each eye receives a frequency of flashing light matching the frequency presented to the corresponding ear. The flashing lights and binaural beats create an immersive stimulus that speeds up or slows down according to programmed routines. (This is not recommended for individuals with a susceptibility to seizures.)
There is limited research evidence to support the notion that brain waves actually do respond distinctively to the stimuli presented to each ear and eye. What I have found in my personal experience is that my biofeedback readings show meaningful shifts in the direction of
increased calm and concentration when I am connected to the machine. Particularly useful is the way in which the goggles and sound create a unique stimulus environment that captures the attention of the user. This is helpful because under emotional conditions people tend to become overly focused on internal cues and the self-relevance of events. By shifting attention outward and using the repetitive light and sound patterns as objects of sustained concentration, a trader can very quickly shift out of the fear state induced by a sickening market plunge and into a more neutral mind state.
This last point is especially important. The problem is not that traders experience unpleasant emotions. The problem is that such emotions tend to shift their modes of information processing, diverting the traders from attending to and acting on information in the environment. A large body of literature in social and personality psychology has found that continuously self-focused attention distorts a person's processing of events by activating negative modes of thinking. When traders experience negative emotions, they tend to focus on themselves and their trading—and not on the markets. At such points, they are more likely to abandon their trading plans, to impulsively enter or exit positions, and to otherwise trade in a manner that is contrary to their training and experience.
The value of meditation exercises or sessions with the sound-and-light machine is that the practices interrupt the cycle of self-focused attention that follows emotional events. This is a common psychological technique employed with people who experience traumatic stress. When people are required to perform eye-movement or finger-tapping exercises during periods of "flashbacks," the stress response is interrupted and does not generate a cascade of anxiety, depression, self-blame, and impulsive action. Similarly, interrupting self-focused attention following an adverse market event helps traders learn from the event, and even possibly profit from it.
The Psychology of Trading Page 8