Validea is an advisory service which assesses stocks based on the investing criteria of many of the ...
How Memory Affects Your Trading
08/06/2014 6:00 am EST
Human memory can affect trading and sometimes that can become a big problem, but John Locke of SMB Training Blog breaks down how to trade without relying on your memories and potentially improve your trading experience.
The emotions we feel and the actions we take are largely dependent on how we remember things. This is because we use our memories to learn. We might think something like, “I remember the last time this happened. I did that and got a favorable result, therefore I will do that again.”
The challenge however, is that our memories aren’t as accurate as we think. Not only do we forget things but we often remember things incorrectly. This is especially true when the memories are vivid and we’re most likely to think they’re accurate.
Vivid memories are usually vivid because they happened when we were in a highly emotional or stressed state. Memories formed under these condition seem to very accurate and clear, however, this is very seldom the case. When we are under stress, two things happen, first the logical functions of our brains shut down resulting in illogical reasoning. And second, we become hyper focused on a specific element of what’s really happening. The result is a very clear memory that was derived from an illogically thinking brain that was narrowly focused on specific information and then altered that information with strong perceptual filters, missing most of the information available. And to make it worse, your brain literally makes up details to fill in whatever it missed resulting in a very believable inaccurate representation of what really happened.
This can be a big problem when it comes to trading. For example, it’s very common for someone to come to me discouraged when a trade doesn’t work out, wanting to switch trading systems. He’ll say, “I been doing this trade and it’s not working. I’m thinking of changing systems.” When this happens, I ask him if he followed his plan. When he says yes, I ask to see the plan. 99% of the time he cannot produce it. He has a memory of what he was going to do but nothing in writing. So I ask to see his trading and psychological or decision making journal. 99% of the time he cannot produce that either. He remembers what happened though.
When I get this response, I know right away the issue isn’t the trading system. The issue is a trader whose decisions are based off of inaccurate or missing information and memories that were formed under the stress of trading. As a result, he is trading and evaluating his trading system as well as his performance on perceptually skewed and made up information. Here’s why.
If a plan is not in writing:
- You will forget or alter trading rules to fit the irrational thinking that occurs when you are under stress.
- You will hyper focus on the problem. This causes you to not see possibilities and solutions that otherwise would seem obvious.
- You will experience confusion and increased stress which shuts down more and more logical brain functions resulting in increasingly irrational behavior.
- After you’ve altered your rules, you’ll conveniently forget that you did so and blame it on the system.
This not only results in poor trading and improper evaluations of how you traded, but it actually retards the learning process.
Fortunately, there is something we can do about it.
Always have a specific written plan prior to entering any trade. This way when stress starts to build and your logical functions shut down, you can go back to your written plan and follow the directions you laid out when you were thinking clearly.
In addition to your written plan, always record your adjustments and thoughts in a journal and review it regularly to help you properly evaluate your decisions and learn more quickly.
And finally, always retrade you position in back trader after the trade is closed to evaluate how you did following your plan and note what you can do better next time and improve your plan.
By John Locke, Contributor, SMB Training Blog
Related Articles on STRATEGIES
The Roman philosopher Seneca wasn’t talking about the stock market when he wrote that “T...
The Dow Theory was originally referred to as “Dow’s Theory,” since it was based on...
When stocks are selling at valuation extremes and consumer optimism is at one of the highest levels ...