Emotional Utility: When Do Emotions Help?

Emotional Utility: When Do Emotions Help?

Jim hasn't made a winning trade in two weeks. He wonders if he is in trouble. He wonders if his current circumstance is merely a temporary setback or a permanent state of affairs? Understandably, he's disappointed and a little afraid. What if he can't trade under current market conditions? What will he do? There are times when our emotions help us, but there are also times when they get in the way. The trick is to know how to read your emotions and let them work to your advantage.

Emotions are adaptive. They communicate significant information quickly and efficiently. In relationships with loved ones, for example, when you see that someone is angry, you are shown in the clearest of terms that something has gone wrong, and that you better take some quick action to restore harmony. Emotions are often useful while trading the markets. When you see the price of a stock fall hard, and feel a little afraid, it may urge you to take decisive action. As long as your fear isn't too intense, or unfounded, it can help you react immediately.

But emotional reactions can often mislead you. Many times, it's much better to stay rational and detached. If we could only turn off our emotions and enter a Spock-like existence, acting logically at all times. It's possible. If you have a large amount of capital, risk very little of it on each trade, and truly believe that an outcome of a trade doesn't matter, you'll reach this ultimate state of mind. But what if you are down, like our friend Jim? It's hard to just put your fears out of your mind. It would be nice, but feelings of fear and uncertainty lurk in the back of your mind, ready to creep up on you at any moment. And if it creeps out at the wrong time, you'll react impulsively or find yourself frozen, unsure of what to do next.

It's hard to get an accurate read on your emotions. If you hit upon a run of good luck, you can feel overly enthusiastic. You may overconfidently take risks you shouldn't take and feel a sense of omnipotence. On the other hand, too many setbacks can create a sense of defeat. You may feel too discouraged to continue. Again, you can make matters worse by failing to manage risk. When too much money is on the line, money that you just cannot afford to lose, you'll always be on-edge, ready to react on impulse. If you manage risk, then you'll be able to stay calm. Managing risk is key. When you know that you can survive in the long run, you'll naturally feel better. That said, how could you use your emotions to your advantage?

It is useful to realize that certain emotions have little utility. If you manage risk, and are truly protected, then fear only distracts you. You have nothing to fear, so feeling afraid in this context is quite maladaptive; it's a possible form of a compulsive, "irrational" fear. Similarly, greed and overconfidence are also useless emotions. The only way to accumulate profits is to do so in a slow, steady, and methodical fashion. Taking bigger risks than necessary, out of greed or overconfidence, will be problematic in the long run. Disappointment also has relatively little advantage. If you are flat broke, it's important to take a break from trading, and save up more capital. But if your disappointment merely reflects a lack of confidence, the wise thing to do is to trade assiduously and build up your trading skills until you have rock solid confidence. Wallowing in self-pity will get you nowhere. Greed, fear, anger, disappointment and overconfidence aren't useful emotions. A good strategy for dealing with these emotions is to identify them, acknowledge them, and hope they quickly pass through your consciousness. These emotions have little utility. What about enthusiasm? As long as it is tempered, a can-do attitude can be useful. As long as you are not unrealistic, what's the harm in thinking positively? If you have the time and money to make a series of trades, for example, why have a bleak outlook. It's more useful to enthusiastically look for good trading opportunities, put in a heroic effort, and see how many winners you can get.

Handling your emotions is one of the biggest challenges traders face. Some emotions get in the way, and it's best to work around them. But winning attitudes, when used properly, can help put you in a peak performance mindset, and when you are there, profits seem to come your way.