If a data source held valuable information, why would you want to limit your access to it? If information that you needed was there for the taking, why would you try to suppress it? If the same information served as a vital entity in your brain, wouldn’t you want to know about it? If we have to have a feeling to see, to know, and to decide, how can controlling feelings be beneficial?
But yet the manta drones on: “control your emotions, control your emotions, and control your emotions …”
In and of itself, even the mantra lacks any real objective perception. Really now, can an emotion alone do anything? And I do mean any “thing”? Can an emotion enter an order to buy 5,000 SPYs? Can a feeling alone sell an entire portfolio at the low of the day, month, or even bear market cycle?
An emotion alone never lost a dime!
In order for anything to happen, one’s physical body has to move even if it is only to type a few strokes on a keyboard. We used to need to call a broker who called the floor. So we used to have to exert more physical energy, in the form of picking up the phone and moving our jaw, than we generally do now. Regardless, our bodies have to move for something to happen. Bodies moving equate to action, and actions or taking action is the only thing that logically and literally needs to be controlled.
Somehow, somewhere, the thinkers of the ages failed to notice that feeling something and doing something truly are two separate psychological events. Yes, emotions do tend to have an urgency to them—they make us feel as if we want to act. But does wanting to act mean we have to act? Are they the same? Given that we can all learn to feel something without doing anything about it and given that we all learned many of those lessons just to get to adulthood, when exactly does the supposed re-merger of emotions and actions occur?
It doesn’t matter what the feeling is (fear, frustration, hurt, anger, joy), all of them can be felt, examined, described, and understood without an action—or really without an “acting out” ever taking place.
While the role of emotions has been debated at least since the Ancient Greeks, we really do need to ask ourselves how we continue to mistakenly combine feeling and acting into one event? They are two and one—the emotion—doesn’t automatically mean the second—an action.
Critics and proponents alike will say that the observations of our behavior gives us just that, a set of observations; but that behavioral economics or behavioral finance, the compendium of observations of our purported irrationality, lacks a coherent theory. And it does. For the same reasons we have been discussing—the dismissal of emotion in deference to the other psychological phenomena of thinking and acting.
If you have to have a feeling to make a decision, then all decisions have a feeling fueling them—it is as simple as that.
This acceptance of the idea of the essential context of emotion—the eC, if you will—offers a satisfying explanation for the perceived irrational behaviors listed in the compendium of the field of behavioral finance. Framing, priming, and antecedent events induce certain feelings and it is those feelings, now unconscious to most of us, that steer decisions and behavior. By systematically subjugating feelings and emotions to the other psychological categories of cognition and behavior, we miss their critical messages.
Damasio and his co-researchers were among the first recent thinkers to notice this when he wrote, “I now turn to emotion and feeling, central aspects of biological regulation, to suggest that they provide the bridge between rational and non-rational processes.”
Right now, we don’t stop to understand what we are feeling, so we simply end up unconsciously sending the energy of our feelings into actions. This process reduces the “static” or distraction of the feeling we experience on a physical level but if we learn to analyze instead, we find that that energy cannot only be tolerated but that it holds maps, clues, and directions. 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.
Sometimes the best ideas are the simplest—add feelings and emotions back into the conundrum about thinking and behavior and you have a coherent theory. All one needs to do is look at the context of the feelings, and the behavior will always be explicable. This doesn’t mean you will like the behavior but at least you will understand it. It isn’t that we are wired to be irrational; it is that we misunderstand and therefore misuse our so-called wiring.
In a world of research that is moving toward theories centered on multi-factor emergence and contexts as the dominant new themes in psychological theorizing, putting emotional contexts in their proper place will pay off.
This unconscious acting out of emotional contexts creates risk in the classical sense.
Attempting to circumvent that risk, via numbers, again does not come even close to the source of the event—the feelings—that we believe we should be controlling but which our perception actually needs in order to operate. We may think we have deferred or eradicated them, when a moment to years later, we find ourselves acting exactly according to the feeling we tried to rid ourselves of. Just as Darwin suggested, this viewpoint transforms fear and anxiety into valuable early warning tools instead of discomforting nuisances or panics.
Think about children. We know what it means for them to “act out.” We mean that they are crying or screaming because something feels bad. We understand that their behavior only reflects their feelings put into action. Why do they do it? Well, yes, they haven’t learned not to—but what haven’t they learned? They haven’t learned other mechanisms to express or deal with their feelings. They don’t have the power to enact any other strategy, as they don’t know how to get on the bus by themselves (or calmly say “Mom, this isn’t working right for me right now”), so they simply audibly, usually with decibels for amplification, “act out.”
A very public, very painful adult example for all of us lies in the story of Hank Paulson and Ben Bernanke allowing Lehman Brothers bank to fail. In short, their fears of public outcry over government bailouts provided a context of feelings that prevented them from seeing how such a failure would reverberate. If both a social context of markets as well as an internal context of “emotions as data” had been the standard operating procedure, then the decision makers would have had a much higher chance of understanding their own motivations as well as seeing the potential consequences.
The Wall Street Journal reported, however, that FCIC Chairman Phil Angelides said emerging evidence shows government officials made a conscious policy decision not to rescue the investment bank. Apparently the then-Treasury Chief of Staff Jim Wilkinson (who would have worked directly for Paulson) wrote on September 8, 2008 that he couldn’t “stomach us bailing out Lehman. Will be horrible in the press.”
You don’t have to be a shrink to realize that the phrase “couldn’t stomach” means it will feel so bad that at least metaphorical upchucking, if not the real thing, would be in the cards.
Just then, Michael’s phone vibrated, notifying him of a text. It was Renee asking how the trading psych lecture was going. They hadn’t talked nearly as much as they had before he moved to New York, but calling her to let her know that Denise Shull was a speaker had seemed innocuous enough. He typed in: “Seems quite well.” She is saying that there were what she calls feeling or emotional contexts that drove the ’08 financial crisis.” “Really, how well is that going over?” she immediately replied. “No one’s head is nodding for one,” typed Michael. “LOL, Great!” she texted just as Michael realized he really couldn’t get away with—as much as he wanted to—typing under his desk.
Could this be where portfolio managers and traders of all stripes have gone wrong? I submit to you in no uncertain terms that this misunderstanding of the role and usage of of feelings and emotions is indeed the source of market and money management blow-ups.
Everyone has not only discounted but overtly disdained a role for feelings. We consciously have attempted to throw out any knowledge or analysis of the most important factor driving our perceptions and decisions.
Linking together otherwise distinct arenas of cutting-edge research declares that the more uncertain a situation, the more our brains turn to context to make sense of what we are perceiving. Again, think of trying to find a place for a jigsaw puzzle piece. The more contextual puzzle-piece picking gets involved, the more influential one’s beliefs, and feelings of confidence or fear, become. Feelings pre-stage perception and perception morphs into reality through the decisions resulting from it.
While of course humans can analyze numbers in ways that Yorkshire terriers or cucumbers evidently cannot, do we in fact even “do the math” in the absence of a feeling of confidence or even the feeling of desire to have some piece of insight or understanding? The feeling of belief in one’s chosen mathematical approach, the natural desire to be correct, the parallel discomfort of discovering one made a mistake or circumstances have migrated so dramatically that work must be redone—all of these provide a highly relevant fC to what superficially looks like a logical, “rational” process. What we call cold data never exists in a vacuum.
The net message of the research into our behavior with investments proves beyond a shadow of a doubt that no matter how “smart” we may be, we repeatedly make the same perceptual mistakes. While believing in the supremacy of what we thought was intellect, we have been intentionally, although maybe inadvertently, circumventing our best clues. Thinking harder has not worked. It turns out that that this strategy may be like trying to nurture a successful garden by applying sun block to all of the plants, and then being mystified at the development of mutant vegetables!
We can’t even identify the relevance of a number if the emotional processes in our brain fail to kick in. Leveraging this deconstruction of perception delivers not only a more cogent and useful explanation of how the 2008 crash happened but it sheds light on crisis after crisis that preceded it. In the future, it will provide a context into which a more comprehensive risk management paradigm can fit. It illuminates the new path we must take to protect ourselves and even profit from the next “dislocation.” If one understands more of the process of perception, one can win a psychological war. If they don’t, well … they get left essentially fighting on a flat Earth. Turning what seems ephemeral into data (internal data for managing risk and external data for seeing opportunities) presents a challenge that can indeed be met. Analyzing the elusive dimension of the non-quantitative while not necessarily easy at first can nevertheless be attacked in a systematic fashion.
Knowing your fC is the key.
I say this radical thing regarding the contexts of feelings and emotions with confidence because after years of lecturing, teaching, and coaching, I have simply had way too high a percentage of professional traders tell me something to the effect of “I am so glad I heard this! I thought it was just me! I’ve always suspected it, but everyone kept telling me to stay 100% in my ‘head,’ control my emotions, and not listen to my feelings. This makes so much more sense to me.”
In fact, 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. And, in fact, I have heard variations on this hundreds of times now.
In fact, one could argue that Harry Markowitz had this rule in mind when he began thinking about the mathematics of a new way to construct portfolios. Returning to his stage one, bringing one’s beliefs to the forefront and systematically uncovering the relevant fC, completes the objective he seemed to have had in mind. Knowing the feeling context you bring to any uncertainty decision effectively vaccinates you against ever being in the position of losing all of your capital.
The second way the primary derivative of fC, mark-to-market emotions, enhances your mind game occurs when you understand your own psychological position. 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.
Well, we’re just about done, gang, but if I can leave you with one thought, it would be this. As you begin to think about how to know, analyze, and capitalize on this fC or feelings context, think first in terms of managing risk by reducing unnecessary trades. As you become more and more comfortable with using an awareness of all that you are feeling—on a physical as well as emotional level—you will find that you make fewer poor decisions. In turn, there will be fewer times you need to recover from a bad day or drawdown. This alone will change your bottom line.
But it gets better than that. The more self-aware you become, the more easily you will be able to see waves of acting out occurring in the market. The fundamental job of trading the markets through “theory of mind” or understanding other people will naturally get easier.
We all know that the traders who make money year in and year out (and there are plenty of them out there) always work the game in this order anyway—manage risk first, seize opportunity second. It may sound a lot less sexy than shooting rounds of ammo into the enemy camp, but it keeps you alive and available to trade another day.