Sunday, December 17, 2006

Good Mood, Bad Mood

I was reading a sample issue of the MarketWatch Options Trader newsletter, and the last section on how your mood affects trading caught my interest:
Did you know that your mood can play a major role in determining your ability to stick with your trading plan? A study by Knapp and Clark (1991) [Personality and Social Psychology Bulletin, Vol. 17, No. 6, 678-688 (1991)] illustrates how feelings of emotional distress can influence your ability to maintain discipline. Participants engaged in a laboratory simulation in which waiting patiently resulted in greater profits. Specifically, participants were asked to pretend they were fishing in a lake, and that they would be given a monetary reward for each fish they caught. Taking too many fish out of the lake early in the game produced immediate profits, but when fish are taken out early, fewer fish are left in the lake to reproduce, and thus, fewer fish can be taken out for a profit in the long run. Thus, waiting patiently to take out fish later is the most profitable strategy. Participants' moods influenced their ability to wait patiently and fight the urge to take profits too early. People in a down mood had difficulty waiting. They wanted immediate gratification, and believed that immediate profits would make them feel better immediately.

When you are in an unpleasant mood, you may have a strong need to feel better. How can you feel better? Making money usually makes you feel better. You can either take profits out of a winning trade immediately or you can make an impulsive trade to get a quick thrill. Your mood can make all the difference. It is useful to make sure you are in a good mood while trading. When you are in a bad mood, you may act impulsively in order to make yourself feel better.

Maintaining discipline is vital for trading success but it is difficult at times. The best ways to keep disciplined are to trade with a detailed trading plan, but this may not be enough. You must also make sure you are in a good mood. A good mood can mean the difference between trading impulsively and maintaining discipline.

Actually, it got me to look back at my trading notes for trades that went bad. But I didn't write down in my notes whether I was in a good or bad mood. The technical details are there, but nothing along the lines of "how do you feel?" Well, obviously good trades mean good mood, and bad trades mean bad mood, but that's after the fact. But I have noticed that exiting what was a winning trade at break-even before it turned into a loss or exiting a loser when it briefly became break-even have both been effective at keeping a good mood from turning bad. So there seems to be a tie-in here to money management -- for better or for worse, account health and psychological health are linked in a positive feedback loop, with proper money mangement being the only defense against "for worse".

In the 2003 revised edition of The Intelligent Investor by Benjamin Graham, the commentary on chapter 1 by Jason Zweig starts with a quote linking unhappiness with impatience:
All of human unhappiness comes from one single thing: not knowing how to remain at rest in a room. -- Blaise Pascal
And Jesse Livermore supposedly said:
Money is made by sitting, not trading.
Tough to do sometimes, for sure! To sit or not to sit, that is the question. Going with a detailed trading plan, as mentioned in the Options Trader newsletter, definitely seems the right way to go. Or at least not allowing discretionary decisions unless I'm in a good mood, meaning only when trades are profitable.


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