Are You Seeing Too Much Red?

03/28/2013 6:00 am EST

Focus: TRADING

Can something be subtly influencing your emotions that then adversely affects your trading? Joshua Belanger of OptionSizzle.com suggests there might be one factor you should check out.

Over the years, I have traded my own account, managed accounts for affluent clients, and mentored many traders. I know what really matters in running a successful trading operation.

When I managed a million dollar account, I quickly learned that self-discipline was more important than my overall strategy. Many new traders think they need a trading system to become profitable, but that is only partially true.

I was lucky to have instant success in trading from the beginning, but that success jaded me because I never experienced large drawdowns or saw red on my trading screens. That is because I started managing accounts in the beginning of the 2008 financial crises and you couldn’t help but make money after such a monumental drop in the market.

Having to answer client calls, while trying to concentrate on trading, put a big strain on me. My thinking became unclear and my mind began to fill with self-doubt. I lost sleep and confidence in myself as stress consumed my days and nights. Clients during the time of the crisis wanted answers instantly to every piece of headline news. I quickly learned that hand holding and talk therapy was not my strongest asset. It took away my focus from trading.

Many trading books tell you to check your emotions at the door when it comes to trading. I always thought that to be very unrealistic as we are naturally emotional as part of our human nature. Ignoring our emotions is like an alcoholic in denial of his condition. So I began a journey to try to understand myself better and what actually influenced my trading decisions.

Researchers have long known that color can affect your mood. Artists and the people who design restaurants have always used color to subtly manipulate the emotions of their clients. Red evokes passion, excitement, anger, danger. Blue and green promote calm and serenity. Yellow screams optimism. Orange increases the appetite. White is clean and pure, while black is forbidding and scary.

Colors have an actual physical effect on the human body: Certain colors have been shown to raise blood pressure or increase the body’s metabolism. Other colors promote a soothing environment for stressful situations.

The color red is an especially strong influence on mood and emotion. Red attracts attention. Red is associated with strength, power, and sex appeal. Your face flushes red when you get angry as blood rushes to the surface of the skin.

Red has been shown to contribute to poor test-taking on the part of college students who have been exposed to the color prior to the exam. Associated with failure (teachers generally use red ink on school papers to indicate an error), the color seems to evoke anxiety and fear that impairs performance. In a study, students who saw red scored 20% lower than students who were shown a different color.

In another study conducted by Science Daily in 2011, researchers discovered that test subjects displayed more force and a quicker reaction time when faced with red instructions as opposed to black. Red tends to enhance physical reactions, to mobilize extra energy, and acts as an inhibitor for mental processes. The color evokes emotions, which detract from mental clarity. At the same time, red provokes quick, forceful action. Taking quick action while mentally distracted is not the best combination for intelligent decision-making.

What does this mean for your trading results?

NEXT PAGE: Fear & Greed in Trading

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Traditional candlestick charts typically use red and green candles to indicate price movement. Even though they are very common to see, they could be a reason behind some of your trading losses. Think of how these colors translate to an everyday item such as a traffic signal.  Red means STOP and green means GO. Red means SELL and green means BUY. Red gets your attention more so than any other color because red basically screams LOOK AT ME!!  

The neuropsychologist Denise Shull has done a lot of work on the psychology of decision-making among financial professionals. Her unconventional theories about trading and risk psychology fly in the face of everything you may have already learned about trading.

In her 2012 book, Market Mind Games: A Radical Psychology of Investing, Trading and Risk, she proposes that the common investing strategy of conquering or negating emotions is precisely the wrong thing to do. She argues that as human beings, we can’t eliminate or control our emotions in the decision-making process. In reality, our emotions are an inherent part of everything we do. Rather than try to eliminate them, we should understand them, harness them, and make them work for us.

Red, which represents fear, and green, which represents greed, may have unconscious effects on your trading simply by being present in your field of vision. Because fear tends to be a stronger motivator, studies have shown that people are generally 2.5 times more afraid of taking a potential loss than they are of making a potential gain.

If you offer test subjects the choice between losing or winning money, the win has to far outweigh the loss before the subject will choose it. For this reason, many people will sit on the sidelines during a bull market. The fear of taking a loss overrides their greed and supersedes the desire for any potential gain they may make.

Both fear and greed can make us act irrationally. Both emotions need to be acknowledged and controlled. You need to understand that if one of those emotions is driving your decision-making process, you may not be making the best choice that you can.

These two factors are so prominent in trading and investing situations that CNNMoney even displays a Fear & Greed Index that depicts which emotion is leading the market. The Index is calculated based on seven different numerical inputs, such as market momentum, action in put and call options, and market volatility. These factors are distilled to a single number, which is represented on a chart as either green (greed) or red (fear).

With a high greed index reading, you see a steadily rising market with occasional declines and plateaus to mark short breaks in the greed. When the index changes to a fear reading, however, the declines are generally quick and sharp. Fear causes a much more aggressive activity level because people are more inclined to sell out of fear than they are likely to buy out of greed.

Denise Shull acknowledges that the colors red and green on candlestick charts may have unconscious effects on our trading decisions. She even suggests eliminating these colors, especially the red. Try switching your charts to solid (up) and open (down) black-and-white candles and see if it makes a difference to your emotional reading of your charts. This simple change could have a profound impact on your trading success.

My trading approach is to always look for that edge. I try to find the small things and fine tune my strategy to help avoid that one big mistake that could put me in a slump. I have actually changed my colors to pink/purple, pink/blue and pink/green to study my emotional reactions and which combinations work the best for me.

Try it for a couple of weeks and see if the lack of colors makes a change in your emotions and your trading performance. You may find yourself surprised by the results.

By Joshua Belanger, Founder, OptionSizzle.com

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