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Your Trading Brain: Expert or Novice

We had the for­tune to inter­view Dr. Brett Steen­barg­er on Enhanc­ing Trad­er Per­for­mance and The Psy­chol­o­gy of Trad­ing as we launched our Neu­ro­science Inter­view Series.

Below, Expert Con­trib­u­tor Dr. Jan­ice Dorn pro­vides an in-depth brain-based dis­cus­sion of the top­ic, con­clud­ing that “The brain is the most pow­er­ful struc­ture in the known uni­verse and the only trad­ing tool that the trad­er needs to become an expert.”

No mat­ter whether you are a Pro or Ama­teur Trader…this will cer­tain­ly exer­cise your brain! (Dr. Dorn is prepar­ing more arti­cles on trad­ing per­for­mance and the brain…so stay tuned).

This is Your Brain On Trad­ing

– By Dr. Jan­ice Dorn

The open­ing bell sounds, and six­ty mil­lion traders enter the great­est are­na in the world to do bat­tle with each oth­er. They put their mon­ey, beliefs and skills on the line as they make deci­sions to buy and sell. Wel­come to the finan­cial mar­kets where bil­lions of dol­lars are won and lost every day. Volatil­i­ty com­pels all to engage their brains in the con­tin­u­ous process of deci­sion mak­ing. What sep­a­rates the win­ning from los­ing traders is the way they use their most pow­er­ful trad­ing tool—the human brain.

The aver­age time and effort required to achieve exper­tise in trad­ing is 10 years and 10,000–20,000 hours of prac­tice. More­over, it is the qual­i­ty of the prac­tice, the com­plete immer­sion in the sub­ject and the abil­i­ty to prof­it through ever-chang­ing mar­ket cycles that sep­a­rates trad­ing win­ners from losers. It takes a lot of falling down, mak­ing mis­takes, learn­ing, re-learn­ing and get­ting up again to make an expert trad­er. Most of all, it takes pure pas­sion and total com­mit­ment to the process.

How do excel­lent traders become that way and stay that way? How do they per­ceive, inter­pret and act on the bar­rage of infor­ma­tion they receive dur­ing the trad­ing day? How do mas­ter traders make deci­sions in a rapid­ly mov­ing, ambigu­ous envi­ron­ment where they are con­front­ed with mas­sive amounts of infor­ma­tion and data? These ques­tions pose more ques­tions as we attempt to under­stand and mod­el the thoughts, feel­ings and behav­iors that are pat­terned in the brains of suc­cess­ful traders.

YOUR TRADING BRAIN 101

The human brain is the basis for deci­sion-mak­ing in every aspect of trad­ing, from the ini­tial desire to learn to trade, choice of trad­ing instru­ment, devel­op­ment of trad­ing plan, strat­e­gy and trade exe­cu­tion. It is the human brain that makes deci­sions and caus­es these deci­sions to be put into action. Trad­ing is, from start to fin­ish, 100% neu­robe­hav­ioral, and the human brain is the most pow­er­ful trad­ing tool. To even begin to under­stand what sep­a­rates the excel­lent trad­er from the rest, we must look for answers with­in the brain. The human brain is the most pow­er­ful, com­plex and sophis­ti­cat­ed infor­ma­tion-pro­cess­ing sys­tem in the known uni­verse. One hun­dred thou­sand years old and weigh­ing about three pounds, it is a dynam­ic, oppor­tunis­tic, self-orga­niz­ing sys­tem of sys­tems. It sits qui­et­ly inside of a closed, dark space and knows noth­ing except what it is told by elec­tro­chem­i­cal impuls­es stream­ing into it. The brain con­tains some 100 bil­lion nerve cells called neu­rons (Fig­ure 1, to the rightbrain synapses) which branch out to form over one quadrillion con­nec­tions called synaps­es. (Fig­ure 2, to the left). The eas­i­est way brain synapsesto con­cep­tu­al­ize this is that there are more synaps­es in the human brain than there are stars in the known uni­verse. Mem­o­ry and learn­ing occur when the neu­rons and synaps­es reor­ga­nize and strength­en them­selves through repeat­ed usage.

Although the exte­ri­or of the human brain is quite unre­mark­able with few vis­i­ble land­marks, there is a long tra­di­tion of draw­ing the brain with labels indi­cat­ing dif­fer­ent “areas” of struc­ture and func­tion (Fig­ure 3). the brainAlthough high­ly over­sim­pli­fied, these offer a road map for begin­ning to under­stand brain local­iza­tion and orga­ni­za­tion.

A sim­ple map of the exte­ri­or sur­face of the brain. The occip­i­tal lobe serves vision, the frontal lobe is for move­ment and the pre­frontal lobe gov­erns high­er think­ing and pro­cess­ing.

LOOK INSIDE YOUR TRADING BRAIN

In recent years, these col­ored illus­tra­tions have been increas­ing­ly replaced by real-time depic­tions of the human brain in action. Through var­i­ous neu­roimag­in­ing tech­niques, such as fMRI (func­tion­al mag­net­ic res­o­nance imag­ing), PET (positron emis­sion tomog­ra­phy) and MEG (mag­ne­toen­cephalog­ra­phy), we have the oppor­tu­ni­ty to study the inter­nal struc­ture and func­tion of the liv­ing brain in the process of car­ry­ing out var­i­ous tasks, includ­ing those involv­ing deci­sion mak­ing for mon­e­tary rewards. Although not ide­al, and still in devel­op­men­tal phas­es, these stud­ies offer nov­el insights into the way the brain process­es infor­ma­tion and they promise hope for the future of unrav­el­ing the mys­ter­ies of the brain. Fig­ure 4 (right below) is an fMRIbrain scan of the brain show­ing areas that are believed to “light up‚ i.e. become acti­vat­ed, in the process of mak­ing trad­ing deci­sions.

THINKING AND FEELING WITH YOUR TRADING BRAIN

For our pur­pos­es, the brain has two major struc­tur­al and func­tion­al divi­sions: the think­ing brain (neo­cor­tex) and the feeling/emotional brain (lim­bic cor­tex). These two areas of the brain are in con­stant com­mu­ni­ca­tion as the neo­cor­tex attempts to inter­pret and mod­u­late pow­er­ful impuls­es from the lim­bic brain. Fig­ure 5 (to the right) limbic systemis a sim­ple draw­ing of the rela­tion­ship between the neo­cor­tex (beige col­or) and the lim­bic struc­tures (shown in col­or).

Lim­bic struc­tures such as the amyg­dala and hip­pocam­pus shown here in col­or lie deep with­in the neo­cor­tex (beige col­or). In the process of devel­op­ment of the brain, the neo­cor­ti­cal areas grew up and fold­ed over the lim­bic areas.

Thus, the lim­bic areas are called “old brain” and the neo­cor­ti­cal areas are called “new brain.” In terms of func­tion­al deci­sion mak­ing, the neo­cor­ti­cal areas are rea­soned, slow, delib­er­ate, and cog­ni­tive, i.e. they think (cog­i­tate). The lim­bic areas are fast, less than ratio­nal, appet­i­tive, and not self-aware, i.e., they feel (affect). There is a con­stant bat­tle going on between these two areas that may lead to agree­ment or con­flict. Such states are called dis­so­nance (which may be cog­ni­tive or affec­tive) and con­so­nance (which may be cog­ni­tive or affec­tive).

With this basic infor­ma­tion, we can now appre­ci­ate that the brain com­mu­ni­cates with itself through neu­rons and their synap­tic con­nec­tions that trav­el up, down and lat­er­al­ly from one brain region to anoth­er. More­over, the brain uses stored mem­o­ries to cre­ate, recre­ate and rec­og­nize pat­terns. These pat­terns allow us to solve prob­lems, make deci­sions and engage in effec­tive behav­iors. Cru­cial to this dis­cus­sion is that deci­sion pre­cedes behav­ior. For exam­ple, the motor activ­i­ty involved in click­ing the com­put­er mouse to send a trad­ing order is not the deci­sion; rather it is a behav­ioral response to the deci­sion that has already been made in the brain. Trade exe­cu­tion is, then, the end result of a cir­cuit of neu­robe­hav­ioral pro­cess­ing which goes on inside of the brain.

YOUR TRADING BRAIN: SYNAPTIC STRATEGIES

With this fun­da­men­tal back­drop, we may now begin to imag­ine the pos­si­ble course of pro­cess­ing and com­mu­ni­ca­tion that goes on with­in the brains of traders. The illus­tra­tions in Fig­ure 6 and Fig­ure 7 are high­ly sim­pli­fied and incom­plete. They do not show the myr­i­ad of synap­tic con­nec­tions, inter­nal feed­back, mod­u­lat­ing mech­a­nisms, par­tial pat­tern rep­re­sen­ta­tions or tem­po­ral aspects of brain pro­cess­ing. They are a tem­plate from which to begin the jour­ney to under­stand­ing that it is synap­tic strate­gies that dif­fer­en­ti­ate trad­ing suc­cess from trad­ing fail­ure.

Fig­ures 6 and 7 use visu­al input to the brain because the major­i­ty of traders employ vision as their pri­ma­ry mode of per­cep­tion. One could sub­sti­tute audi­to­ry or per­cep­tu­al input, but I have cho­sen to use the visu­al mode. Also, I am mak­ing the assump­tion that the trad­er is using synap­tic and neu­ronal mech­a­nisms to visu­al­ize, inter­pret, process and respond to what is seen on the trad­ing screen as a sig­nal. The flow is as fol­lows:

The sig­nal is seen;
The sig­nal is remem­bered or not remem­bered;
The sig­nal is inter­pret­ed from a feel­ing (affec­tive) of either con­so­nance or dis­so­nance;
The sig­nal is inter­pret­ed from a think­ing (cog­ni­tive) state of either con­so­nance or dis­so­nance;
Bod­i­ly reac­tions of excite­ment or calm­ing occur;
The trade is exe­cut­ed or not exe­cut­ed.

THE EXPERT TRADER: SYNAPTIC STRATEGIES

Fig­ure 6 shows an expe­ri­enced trad­er who sees a sig­nal, process­es it through his brain and acts quick­ly to exe­cute. brain expert traderHe has seen this before, has gone through the same pro­ce­dure many times such that his synap­tic strate­gies are laid down and strength­ened through repeat­ed brain train­ing stim­u­la­tion. There is lit­tle or no cog­ni­tive or affec­tive dis­so­nance in the course of receiv­ing a sig­nal, pro­cess­ing the pat­tern, mak­ing a deci­sion and exe­cut­ing it.

In Fig­ure 6 (left), the synap­tic strat­e­gy is such that the sig­nal:

- Enters the brain through the eyes;
— Goes from the eyes to the visu­al area of the neo­cor­tex where it is rep­re­sent­ed as a pat­tern;
— Trav­els as a pat­tern from the visu­al cor­tex to the hip­pocam­pus where it is remem­bered;
— Moves from the hip­pocam­pus to the amyg­dala and lim­bic struc­tures where it is giv­en affect (mood and feel­ing). In this case there is affec­tive con­so­nance, i.e. the trad­er feels good about the sig­nal;
— Trans­mits between the lim­bic area and the hypo­thal­a­mus to send mes­sages to the body for calm­ing and qui­et­ing. Although there may be some anx­i­ety or fear involved, these tend to be min­i­mal. Blood pres­sure, heart rate and breath­ing, which are con­trolled through these mech­a­nisms, remain unchanged or slight­ly ele­vat­ed;
— Com­mu­ni­cates from lim­bic struc­tures to the pre­frontal think­ing areas where there is cog­ni­tive agree­ment. There is lit­tle think­ing time involved here and there is cog­ni­tive con­so­nance;
— Goes to the motor area of the neo­cor­tex where the sig­nal is sent to the hand to click the mouse;
— Is exe­cut­ed as a trade.

In this instance, due to repeat­ed, con­stant and intense con­scious prac­tice and expe­ri­ence in a vari­ety of mar­ket con­di­tions, the trad­er knows and feels the pos­si­ble out­come of tak­ing the trade. His synap­tic strat­e­gy caus­es him lit­tle if any bod­i­ly dis­com­fort and he is aware at all times that the mar­ket could prove him wrong. He knows this from con­stant rep­e­ti­tion and already has plans to exit if it does not work out. This is a win­ning synap­tic strat­e­gy based on con­tin­u­al con­scious prac­tice which trains the brain in such as way as to allow the synap­tic con­nec­tions to act rapid­ly and in har­mo­ny with each oth­er. There is lit­tle, if any, cog­ni­tive or affec­tive dis­so­nance.

THE NOVICE TRADER: FLAWED SYNAPTIC STRATEGY

In Fig­ure 7, the synap­tic strat­e­gy is that of an inex­pe­ri­enced, novice or poor­ly trained trad­er. In this case, the sig­nal:

Enters the brain through the eyes;
Goes from the eyes to the visu­al area of the neo­cor­tex where it is rep­re­sent­ed as a brain novice traderpat­tern;
— Trav­els as a pat­tern from the visu­al cor­tex to the hip­pocam­pus where it is not remem­bered or par­tial­ly remem­bered. The hip­pocam­pus becomes very “chat­ty” and starts send­ing the pat­tern up to high­er and high­er lev­els of the visu­al cor­tex ask­ing for help in the task of pat­tern recog­ni­tion;
— Moves from the hip­pocam­pus to the amyg­dala and lim­bic struc­tures where it is giv­en affect (mood and feel­ing). In this case there is affec­tive dis­so­nance, i.e. the trad­er feels bad­ly about the sig­nal;
— Trans­mits active­ly between the lim­bic area and the hypo­thal­a­mus to send mes­sages to the body for arousal. Phys­i­cal man­i­fes­ta­tions of anx­i­ety or fear may appear. Blood pres­sure, heart rate and breath­ing that are con­trolled through these mech­a­nisms may be ele­vat­ed and sweat­ing may occur;
— Goes back and forth from lim­bic struc­tures to the pre­frontal think­ing areas where there is cog­ni­tive dis­so­nance. There is a lot of think­ing, ques­tion­ing, sec­ond guess­ing and inter­nal cross-talk;
— Does not go to the motor cor­tex and is not exe­cut­ed as a trade;
— Due to lack of ade­quate prac­tice or a dearth of expe­ri­ence in this mar­ket con­di­tion, the trad­er is synap­ti­cal­ly short-cir­cuit­ed. There is so much going on inside his brain that the cross-talk caus­es both cog­ni­tive and affec­tive dis­so­nance. This is a state of con­fu­sion and “dis-ease”. The trade is not exe­cut­ed.

The process of pat­tern dis­tor­tion or non-recog­ni­tion in an inex­pe­ri­enced trad­er leads to “freez­ing” and not tak­ing the trade as shown in Fig­ure 7. There is one oth­er pos­si­bil­i­ty not shown in Fig­ure 7 that hap­pens with some reg­u­lar­i­ty. Owing to the large amount of con­fu­sion and anx­i­ety that is going on inside of his brain, the trad­er may actu­al­ly exe­cute the trade in order to alle­vi­ate his anx­i­ety. In actu­al fact, this process of attempt­ing to alle­vi­ate anx­i­ety like­ly leads to more anx­i­ety, more inter­nal ques­tion­ing and more cog­ni­tive and affec­tive dis­so­nance. In oth­er words, it can become a vicious cycle that leads to loss­es and may be one of the rea­sons that so many indi­vid­u­als do not stay the course with trad­ing.

TRAIN YOUR TRADING BRAIN

In sum­ma­ry, it is my opin­ion that all trad­ing strate­gies and deci­sion mak­ing are brain-based synap­tic strate­gies. Because the human brain has an infi­nite capac­i­ty to change, orga­nize and reor­ga­nize itself, pro­gres­sion to trad­ing excel­lence is pos­si­ble. It is only through intense, dili­gent and total­ly com­mit­ted prac­tice through many years and many mar­ket cycles that the trad­er advances to the state of dis­ci­plined excel­lence. This excel­lence is the result of train­ing the synap­tic con­nec­tions with­in the think­ing and feel­ing areas of the brain. As a con­se­quence of this train­ing, the trad­er will be able to rec­og­nize, process instant­ly and exe­cute the trade with lit­tle or no cog­ni­tive or affec­tive dis­so­nance.

The brain is the most pow­er­ful struc­ture in the known uni­verse and the only trad­ing tool that the trad­er needs to become an expert.

Janice DornFor the past twelve years, Jan­ice Dorn, M.D., Ph.D., has focused her atten­tion on trad­ing, men­tor­ing and com­men­tary in the finan­cial mar­kets, with empha­sis on Behav­ioral Neu­ro­Fi­nance, Mass Neu­roPsy­chol­o­gy and Trad­ing Neu­roPsy­chol­o­gy. She has trad­ed the gold futures mar­kets full time since 1996, and has coached and men­tored over 600 traders and investors. She is the Glob­al Risk Strate­gist for Inge­nieux Con­sult­ing Group Pty Ltd. You can reach Dr. Dorn at The Trad­ing Doc­tor. © Copy­right 2007, Jan­ice Dorn.

To learn about addi­tion­al ways to use this brain research to improve trad­er per­for­mance, check out these rel­e­vant posts:

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3 Responses

  1. guhan says:

    iam a stock mar­ket trad­er. i am keen to know more about this amyg­dala and emo­tion­al hijack­ing dur­ing the few tense moments where san­i­ty is most required.

  2. Stan Childs says:

    Fas­ci­nat­ing. I have trad­ed for years and have nev­er real­ly thought about the neur­al process.

  3. Steven says:

    Dr. Dorn,

    Thank you for unwind­ing the com­pli­cat­ed choic­es that we make each day, espe­cial­ly applied to mar­ket psy­cho-neu­rol­o­gy for traders. Great Con­tri­bu­tion!

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