Stress is classified into two components. The first one is the biological response and the second is the psychological state of worrying. In this article, we will discuss how stress can affect information processing capacity.
Emotionality and trading decisions
What stress does is that it narrows down the alternatives for selection. As you might know from the previous article, the selective decision is disturbed. You always are exposed to loads of information every day, which means you need to have the ability to make a proper selective and closing decision. For this, you need to have a model developed to handle the information. The model, after developing, also cannot perform adequately under stress.
The biological response affects behaviour by producing energy. When traders are stressed, they put more effort into options which are causing the issue. They keep doing the same work in a much harder way. Emotionally, less information is filtered out, and the filtered out information causes stress.
Putting more effort into the few available alternatives will not make any money. Usually, a trader makes an irrational decision by not closing out a losing trade. He puts more energy on a losing trade and will not be willing to close the position. It ultimately results in a trading loss.
Worry and trading decisions
Successful traders have the amazing quality of being unemotional; they are also known as hard-as-iron traders. They execute their trades unemotionally, without worrying about one’s position. Worry affects trading performance much more than stress.
Nothing is stressful unless the situation is perceived as a threat. If an individual encounters a situation where it poses a threat to his self-esteem, worries show a large capacity reduction. For example, failing in an examination or performing poorly in the market could result in low self-esteem. The decision to invest itself can be a threat to self-esteem. Someone who has low self-esteem worries the most in tough situations.
“Worry” can drastically affect your trading performance. Traders who are concerned about their trading outcome and who have the fear the loss worry excessively. By this, they are lowering the probability of trading successfully. It may not lead to physical impairment, but excessive worry occupies time and processing capacity. As a result, they take bad trading decisions.
Trading conditions due to worry
Two important characteristics of worry are the incentive, accompanied by psychological barriers.
Current research suggests that incentives affect trading performance to a great extent. Rewards often impair, rather than improve trading decisions. From the way we understand, greed produces losses. If you ever realize, you trade better in paper trading than in real account. In a real account, actual money is an incentive. And every trade appears complex, even if it is simple. Incentives reduce your performance by reducing flexibility, by focusing on trade outcome rather than market analysis.
Incentives reduce flexibility
When a person is rewarded, he is worried less about the process. He reduces his efforts and the capacity to make sound decisions. Famous trader Edwin LeFevre said that he would have traded better if he had not traded successfully early in his trading career. Early success leads to bad habits, and it is difficult to quit.
Incentives impair performance in complex tasks
Incentives are more likely to affect trading performance when the task is complex. Due to stress, sometimes simple things also appear complex. Trading is clearly a complex business. The trader is too engraved on profits rather than the process of making successful trades. Thus, a trader who trades without worrying about profits is successful in the long run.
Incentives produce an inappropriate focus
People who are rewarded for a certain task, become answer oriented and do not focus on how the task is to be done. This is same in the case of trader also when he says “Just give me a strategy to make money”. Here, he is very anxious to make money and unknowingly gambles to make money.
Incentives produce arousal
When thought a little deeper, incentives increase the speed at the expense of accuracy. If they are told that, a solution to the problem would be given incentives; they increase the number of problems. Correspondingly increase the number of errors. Traders get hyperactive. This only brings more losses and few profits.
Often traders are stopped by psychological barriers from making huge profits. To overcome such behaviour, traders need to learn from their mistakes and develop a better system. If no work is done on barriers, it results in frustration. And frustration produces non-adaptive behaviour, which is vital for trading.
Trading barriers often bother you when you are not committed to your goal. You then get distracted from your path. It destroys all chances of making profits.
Barriers cause worry and produce behaviour deterioration. When he becomes frustrated, he reverts back to early trading techniques in an effort to make money from the market.
Most of the traders lose because they worry too much. Since worry is a critical mental state, it can occupy a large part of your brain and thinking capacity. As a result, you will not be in a position to make accurate trading decisions.
Trading decisions are prone to worry because it involves one’s self-esteem. The two major causes of worry are incentives and psychological barriers. Incentives lead to reduced flexibility, a focus on the outcome rather than process, and excessive arousal. Psychological barriers lead to frustration and rigid behaviour. All of this is not viable from a trading view.