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A Trader's Guide to the Science of Gratitude

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“Piglet noticed that even though he had a Very Small Heart, it could hold a rather large amount of Gratitude.”
                                                      --A.A. Milne, Winnie-the-Pooh

***Warning — A personal challenge is about to be issued.  That’s because there are traders and investors who read this weekly missive, study Van’s materials and STILL believe that the psychological aspect of trading isn’t that important.

Here’s my challenge — do the two exercises at the end of this article.  If your trading and your experience of life (i.e. your happiness) aren’t significantly enhanced, I’ll personally donate $50 to the charity of your choice.  If you knew the size of Van’s newsletter subscriber list, you’d understand how confident I have to be about the usefulness of these exercises!  I make this challenge because I’d love to find a way to have a massively positive influence on everyone reading this newsletter as my Thanksgiving gift to you.

My Experience With Gratitude

Almost 21 years ago, I experienced a day of gratitude that was so special and affected me so deeply that it is still vividly etched in my memory. Our daughter Meg (our first born) was only a few months old, and she was being baptized at our church.  We had invited friends and family, some traveling great distances.  Our pastor graciously allowed me to deliver the message that day.  I spoke about God’s love for each of us, a love so deep that it is pursuing us even before we are aware of it (John Wesley called it God’s prevenient grace).

Until that day I had experienced parenting at a perfunctory level — helping with chores like diapers and baths, etc.  But it wasn’t until I explained what parenting meant to me, how I felt about parenting and how this little miracle of a girl had changed me and the very way I look at the world that I really understood what it meant to be a dad.  And the gratitude that I felt for that experience — for my awakening to the joy of being a parent — was overwhelming.

So in the spirit of this season of gratitude and thanksgiving, I hope that you find some enjoyable and useful information here!

The Thanksgiving holiday in the U.S. is coming fast upon us.  There are many distractions that can keep us from being truly thankful. For example, we could argue over whether the first Thanksgiving celebration was attended by pilgrims in Massachusetts, English settlers in Jamestown 15 years earlier, or Spanish explorers in Texas or Florida years before that.  We could also worry about the perfect way to cook the turkey and gravy, whether or not our relatives and in-laws will behave themselves or if anyone over age of 7 will watch the Macy’s Thanksgiving Day parade.  And last but not least, the NFL will certainly wonder why fate would give them three almost unwatchable games: two games will feature quarterbacks that started the season as third stringers (or lower) and the third game gives us a rivalry between two past Super Bowl champs that are struggling to stay relevant this year.  I guess we’ll actually have to talk to our visiting relatives for a change…

Yet I digress — Thanksgiving really does kick off the holiday season (although the fact that Christmas ads have been running for four weeks might argue otherwise…) and sets our mind to one of the most useful of all human expressions — gratitude.

We All Know Gratitude Is a Good Thing but… Can We PROVE it?

Robert Emmons is perhaps the world’s most prominent researcher in the study of gratitude.  In one of his early papers, he defines gratitude as “a felt sense of wonder, thankfulness, and appreciation for life.” Most discussions or articles on gratitude become, for me, an exercise in anecdotes and platitudes.  Happy anecdotes and platitudes, mind you, but somehow unsatisfying.  We all seem to know intuitively that what our grandmas told us is true: saying “thank you” is a good thing.

Now, thanks to Dr. Emmons and his contemporaries, we have a sound scientific footing that proves the usefulness of showing gratitude.  The early studies from Emmons (and his various co-authors) showed that people who are consistently grateful are happier, more hopeful and more energetic.  In addition, they are less likely to be neurotic, lonely, anxious or depressed. While these early papers did not conclusively show causality, subsequent studies have done just that.

In a study designed to get at causality, a group did an exercise similar to the one outlined below.  The results showed significant improvements versus the control group in both outlook (feelings of happiness, optimism and satisfaction) and physical health (reduced incidences of everything from acne to headaches).  The same exercise was given to both young and older people with chronic illnesses.  Similar results were achieved for the “gratitude group” including getting more hours of quality sleep.

Okay — Psychologists Proved Grandma Was Right.  How Does This Help Traders?

Digging deeper into the work on gratitude, Dr. Sonya Lyubomirsky summarizes eight reasons that practicing gratitude is useful.  I’ve added commentary to each on how they are applicable to us as traders and investors:

  • Grateful thinking helps us savor positive life experiences.
    • I’ve known too many traders who beat themselves up over losses or bad trades and then could never stop to appreciate a well-executed trade.  Such imbalance actually pushes us toward bad trading behavior just so we can feel something.  Enjoying the process of trading, “the game” as it were, is a key to longevity in the business.
  • Expressing gratitude bolsters self-worth and self-esteem.
    • During tough periods, traders can go into a downward spiral where their confidence plummets.  It’s almost impossible to trade well when your confidence is shot.
  • Gratitude helps people cope with stress and trauma.
    • Traders are certainly exposed to stressful situations more than most.  Anything that can be done to cope better with the stress and uncertainty of the markets should be embraced!
  • Expressing gratitude promotes moral behavior.
    • Here, the researchers translate gratitude to mean kindness, helping others etc.  In a business that is the ultimate meritocracy, thinking outside of one’s self is a good thing.
  • Gratitude can help build social bonds (don’t use people as means to an end).
    • Trading can be a singularly lonely endeavor.  Building a social network, especially with other traders and investors, is useful for breaking out of the “me against the world” mentality.  That’s one of the most under-appreciated aspects of attending seminars!  Also, combining #4 with #5, trading is a cut and dried win or lose proposition.  It’s easy in such an environment to see people as a means to an end.  Do you have useful information for me?  If not, then away with you!  Practicing gratitude helps us to see every person we meet as a unique and valuable creation instead of as a binary entity — useful/not useful.
  • Expressing gratitude tends to subdue individual comparisons with others.
    • If you go around comparing yourself to Soros’ 40% annual compounding for decades, or to Paulson’s or Seykota’s records, you’ll have a long, tough go of it.
  • Practicing gratitude diminishes negative emotions (anger, bitterness, etc.).
    • It’s plain tough to do any cognitive processing while harboring negative emotions.
  • Gratitude helps thwart hedonic adaptation (just wait, it’s better than it sounds).
    • Here’s a quick summary of hedonic adaptation: in simple terms, humans act with an emotional thermostat, returning to a near baseline state after an outside change. So when we get a bad news, we are able to make the mental adjustments to adapt and carry on instead of feeling low or being out of commission for long periods.  That’s a good thing in most cases.  Unfortunately, the same thermostat is at work in our reaction to positive events.  When something good happens, this mechanism guides us over time back down to near our “happiness set point” that we had before the event.  In short — gratitude helps us keep that positive (and usually more productive) mental state for a longer time (this concept is so interesting, we’ll revisit it in a future article).

And Now for the Challenge

So the evidence is clear that giving thanks or being grateful is not just a good idea, it’s a way to live a fuller life.  Does science also give us ways to grow our “gratitude muscle”?  Thankfully, the answer is yes.

So here’s my challenge: complete both of these projects, and you will get two benefits.   First, you’ll find yourself in a happier, more productive state more of the time.  And secondly, your trading will improve (largely because of the previous benefit and the eight listed above). 

If you earnestly follow both parts of the challenge and don’t receive any benefit, I’ll gladly donate $50 to the charity of your choice.

Project Number 1: Weekly Gratitude List

  • Every Sunday night, for the next 10 weeks, follow this simple exercise (from Dr. Lyubomirsky): “There are many things in our lives, both large and small, that we might be grateful about.  Think back over the events of the past week and write down on the lines below up to 5 things that happened for which you are grateful or thankful.
  • ________________________________________________
  • ________________________________________________
  • ________________________________________________
  • ________________________________________________
  • ________________________________________________
  • It’s important that you only do this once per week!  Research shows that more frequent repetition diminishes the effect.  The researchers believe that a more frequent requirement turns the project into a “chore” instead of remaining fresh and meaningful.

Project Number 2: Express Gratitude Directly to Another

  • Think of someone in the field of trading or investing for whom you are grateful.  Perhaps a mentor, thought leader, coach, model trader, researcher, system designer, etc.  If this is someone you know, great.  For some it may be someone you know only through their work or reputation.  This works equally as well.
  • Within the next seven days, write this person a letter of gratitude telling them exactly what they have done that has impacted you in a positive way.  Also write the specific change it has made for you.
  • If possible, deliver the letter in person.  If not, mail or email will work as well.
  • Don’t be shy about asking your gratitude recipient for a response.  This will complete the gratitude circle and add to the experience.

It’s hard to imagine that anyone would not receive a positive experience from these two activities.  I hope that you’ll accept the challenge and reap the benefits.

May you and your family enjoy a Thanksgiving full of gratitude, love and joy. If you’re not in the U.S., take a few moments next Thursday to flex you gratitude muscles right along with us!

As you can tell, I really admire researchers who give us applied psychology tools (Van’s been doing it for decades).  I’d love to hear your thoughts and feedback — just send an email to drbarton “at” vantharp.com.  Until next time…

Great Trading,
D. R.

About the Author: A passion for the systematic approach to the markets and lifelong love of teaching and learning have propelled D.R. Barton, Jr. to the top of the investment and trading arena. He is a regularly featured guest on both Report on Business TV, and WTOP News Radio in Washington, D.C., and has been a guest on Bloomberg Radio. His articles have appeared on SmartMoney.com and Financial Advisor magazine. You may contact D.R. at "drbarton" at "vantharp.com".

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Trading Tip

RJTrading Brain

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If I don’t log into Twitter every week or two, I start to wonder if I might miss something interesting.  Sure enough, a week or two back, someone had tweeted a chart from a paper that looked genuinely interesting.  Thinking I could not really get the essence of a research paper from one tweet, I found the paper, read it, and can provide you with a summary, albeit a few characters longer than a tweet. 

Basically, a group of researchers predicted they would find evidence for several already well-researched behavioral finance theories by monitoring the brain activity of subjects in the process of making buy, sell, or hold trading decisions.*  Apparently, this newer area of neurofinance and neuroeconomics has been very big recently. 

Ancillary Yet Interesting 

Before I get to the juicy stuff, I couldn’t help but find the following points fascinating:

  • All of the trading test subjects were right handed and had no history of psychiatric illnesses.
    • OK, the illness part I get — but the right handed only criteria?  Why?  Do lefties suffer a slight handicap, enjoy an edge or do they just have potentially distinctive brain structures?  The authors did not say though I suspect it is the latter. 
  • The research team used a 3.0 Siemens Tesla Trio MRI scanner with an eight channel phased array coil. 
    • Wow that sounds hot!  Should I ever need an MRI, I’m going big and requesting this model.
  • The authors cited another research team who had studied the effects of exogenous emotional cues (e.g., erotic pictures) in the brains of people making trading decisions.  Those “cues” seem to alter traders’ risk tolerance. 
    • I’m trying to imagine a situation where . . . do traders and trading floors actually need rules about NSFW material during market hours? 

Two Relevant Findings (Vastly Oversimplified)

The researchers confirmed that the trading decision making process occurs in the ventromedial prefrontal cortex.  In vernacular terms, that’s the bottom, middle, front part of your brain.  You can actually see the sets of neurons where your decisions to buy, sell, or hold happen in Figure 1. 

image1
Figure 1:  The left MRI image is a top down view of the brain and the right is a frontal view.  Yellow indicates the area of interest in the ventromedial prefrontal cortex the researchers were watching.  The red and orange voxels indicate actual neural activity correlated with realizable capital gains.* 

So what kind of buy/sell/hold decisions were these test traders making?  The following chart sums up one of the major findings of the research:

image2
Figure 2: Sell Decisions by Decision Type and Optimality*

This chart shows the results of subjects being presented with four choices for long-only positions — sell at a profit, hold it with a profit, sell at a loss, hold a position with a loss.  Red indicates sub-optimal decisions and blue represents optimal decisions.  Two bars have very large red portions compared to the blue — “Realized Gains” or selling at a profit and “Paper Losses” or holding a losing position.  In these two cases, the subjects tended to err by selling profitable positions too soon and holding losing positions too long.

Named the disposition effect in previous research, this phenomenon has been long identified and well documented.  The new test and neural findings have added weight to the theory by filling in a neural component  to the puzzle. 

Applicability

So —

  • Trading decisions happen in the ventromedial prefrontal cortex and
  • Humans seem to be wired to sell their winners too soon and hold their losers too long. 

Will this knowledge help anybody trade better? 

I can’t imagine any specific use for the neural findings at the moment from a trader’s perspective.  In an unrelated article last week, however, the WSJ reported on other brain research revealing that it works similarly to crowdsourcing software — amalgamating and integrating multiple sources of varied input.  There’s no simple wiring diagram capable of explaining human decisions. Rather, the combination of neural pathways and the programs that run on them make us do what we do.    That set of conclusions sounds a lot closer to Van’s NLP model (neuro-linguistic programming) for the top tasks of trading where traders act based on three primary factors: their beliefs, a mental state, and a mental strategy. 

On the other primary finding, the authors offered that the test subjects would have been better off having used more patience with their winning positions and more impatience with their losing positions.  That sounds fairly close to what you have probably heard for a long time, “Cut your losses short and let your profits run.”  My trading systems’ exit rules help me get out of losing positions and winning positions at appropriate points in order to minimize losses and maximize profits.  Some of the exit rules keep me in profitable positions longer than I feel “comfortable” but the rules have proven to work better than my intuition.  This topic may be old news for you but being reminded of good trading fundamentals always has some general value. 

Finally and if nothing else, the paper reminded me how important our brain is to trading and to life.  Keeping it in good health through aerobic exercise (see this article from a past newsletter) and a healthy diet will allow you to continue performing at a high level.  For that reminder and a fascinating report overall, thank you to the authors — Frydman, Barberis, Camerer, Bossaerts, and Rangel.  I wish them luck in their continued research. 

*  From the paper “Using Neural Data to Test a Theory of Investor Behavior: An Application to Realization Utility”. Download the paper from the SSRN site here.

About the Author: R.J. Hixson is a devoted husband and active father. At the Van Tharp Institute, he researches and develops new products and services that help traders trade better. Even though he has never sent out a tweet, somehow, he has accumulated 11 followers on Twitter.  He can be contacted at “rj” at “vantharp.com”.

 


Mailbag

Response to "Data Mining Bias" by Dave Walton

We received a question in response to an article we ran a few weeks ago. Article author Dave Walton commented, "Many people do not understand the difference between a sampling distribution (distribution of the means of samples) and the distribution of a given sample of trades.  It makes a huge difference actually and I think is important understand upfront before something like data mining can be understood." So we wanted to share Dave's explanation below.

Question: The standard normal ['bell'] curve does NOT apply as the likely shape of trade outcome distributions.

Virtually all effective traders try to let their winners run and cut their losers off.  This almost always produces a one tailed curve with a sharp cliff at or near -1R.  To this we must add the expected outliers [which likely aren't in any data sample] such as the 'flash crash' and their -5R or worse trades.  [And if you have multiple trades underway all at once, as is common, ALL of them might be negatively affected at once and by far more than -1R.]

Best regards,

R., Florida

 

Dave Responded:

You are 100% correct that a given sample of trade results is not likely to have a normally shaped distribution.  The article, however, primarily discusses the shape of the sampling distribution (many samples of trade results) rather than any single sample.  You may recall the central limit theorem — as the number of samples increases, the shape of the sampling distribution approaches that of a normal distribution when values are unbounded (stats geeks will also note that draw-down is a bounded value with an upper limit of zero and is not likely to show a normally distributed sampling distribution). In the article, I talked about a sampling distribution with each sample size at 100 trades.  Yes, each sample of 100 trade results will likely have a non-normal distribution shape but a large number of those 100-trade samples will likely be normally distributed.  

Also, the number of simultaneous trades does not really matter when talking about the shape of a distribution if you have enough data.  The distribution of trade results does not provide any information on timing or clustering of trade results you are likely to see.  I think the point you raise may relate to predicting live trading results using back-tested results.  If you are able to compensate for the data mining bias adequately (as well as other biases and mistakes), then you have an unbiased estimate of what you could expect under similar market conditions in the future.  This unbiased estimate is effectively a mean value.  Actual results will vary within certain bounds defined by the characteristics of the sampling distribution (mean, standard deviation, skew, kurtosis).  To get a good estimate of timing and clustering of trade results, you would need to use a very advanced simulator.  Standard Monte Carlo simulations are insufficient for this task.


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November 20, 2013 #656

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