Decisions Driven by Emotions

Trading psychology books and blogs often talk about the need to “remove” emotions from decisions to get more consistent trading results.

But can you really remove emotions from decision making?

University of Bergen’s Hans-Rüdiger Pfister and Gisela Böhm argue that emotions are NOT external forces that disrupt an otherwise non-emotional process of making a decision.

In fact, they believe that decision making without emotional involvement is not optimal and maybe even impossible because emotions aid in four key functions in decision making:

1. Creating preferences

Any decision requires information and a trader’s emotional state about a decision’s possible consequences can help form preferences.

For example, a trader who is choosing between buying Bitcoin and buying the U.S. dollar will weigh the pleasure of making multiples of his investments against the pain of FOMO and trading a volatile asset.

Similarly, a trader who is thinking about closing his trade will weigh the attraction of maximizing an upswing against his dislike of giving back part of his profits in case price action reverses.

Whether the trader assigned the correct or incorrect emotion to the consequence is not relevant. What matters is that his beliefs provided evaluative information that helped him make a decision.

2. Speeding up information processing

From cavemen learning to run at the sight of a wild predator to consumers pressing the “add to cart” button like there’s no tomorrow on Black Fridays, our emotional state has always factored in making decisions within a window of opportunity.

Not all fast decision making involves emotional responses (think Tetris). However, emotions can help speed up information processing.

Let’s say an asset is approaching a key resistance level and Harry, who has a long position, is anxious about the bullish momentum weakening.

Because he’s already iffy about the trend continuing, he will find it easier to take profits once he sees resistance holding.

3. Assigning relevance

All decision-makers evaluate factors that they think are relevant to the situation. The choice of which factors are relevant is often guided by emotions.

For example, a trader who was happy about winning an SMA crossover trade will likely focus on SMAs over trying a different strategy.

Likewise, the regret of a trader who lost pips because he failed to identify a longer-term trend will prompt him to pay closer attention to multiple time frames in his next trades.

Whether or not the trader chose the correct or incorrect aspects to focus on, the emotions he/she attributed to specific factors contributed to reaching a decision.

4. Strengthening commitment

Another requirement in making a decision is sticking by it even when confronted with opposing motives.

Being confident in a trading plan, for example, will help a trader cut losses even when he/she is anxious about closing a trade at a loss.

Shame over burning an account can also motivate traders into using reasonable position sizes even when greed is pushing them to bet the farm on each trade.

The examples above have shown that emotions are so much part of decision making that we can’t just “remove” or “avoid” them.

It’s not emotions themselves that sabotage our trading decisions. Fear can make you cut losses and anticipation of a winning trade can motivate you to stick to a trading plan.

This means that the goal for traders is to not be unemotional but to adopt the appropriate emotions to preferences that will lead to profitable trading decisions.