How To Overcome the Most Stressful Trading Situations

As a newb trader analyzing his past trades, I've noticed that I struggle with sticking to my trading plans/rules and overcoming stressful trading situations. I realize that I'm not alone with this problem, and so I decided to do some research that might help me and other traders identify ways to improve upon these weaknesses. This post is about what I've discovered.

First, I wanted to turn to professionals for insights on overcoming these problems. This is where I discovered what the Navy SEALs do to overcome stressful situations:

“Information from our senses [visual, auditory, etc.] reach the amygdala almost twice as fast as the frontal lobes."

The amygdala is the main culprit for our fight or flight response and the frontal lobes are responsible for rational thought and problem solving.

"The speed of the different brain signals means that, unless we instinctively know how to react to a potential threat, we may freeze in fear waiting for the frontal lobes to catch up to figure out the right response."

The key point here is "instinctive" reactions to a potential threat. How does one create and develop specific instinctive reactions to a potential threat? The answer: research, practice, and execution.

Before we talk about creating our instinctive reactions, let’s first figure out how the best of the best are doing it--the U.S. Navy SEALs--and see if we can learn from their best practices:

Navy SEALs perform specialized exercises over and over again that help them improve their brains’ reactions in stressful situations. Why? Because the most common reason for failing in stressful situations is panic--losing composure.

The SEALs have learned that constantly practicing exercises of stressful situations--and cementing the proper reactions to them--empowers SEALs to generate fast and accurate reactions in real combat. In other words, instinctive reactions. They don’t wait for the pre-frontal cortex to catch up to the amygdala’s response.

SEALs identify, practice, and develop the exact responses to stressful situations that then become automatic after a certain amount of practice. Outside observers describe these automatic responses as almost robot-like, or as though the SEALs are in a “state of flow.”

For traders, let’s use a specialized trading exercise that hits more close to home. For example, try performing the following stressful scenario in your head (a visualization technique suggested by the psychology literature).

Let’s say you’re in a stock that begins to go against you, and to make matters worse, it starts to really go against you because of other panicking traders. This stock blows past your mental stop. What do you do? Before you answer that question, first imagine all the emotions flooding your mind and their effect of clouding your judgment.

The amygdala is now in overdrive, activating the fight-or-flight response, and degrading your pre-frontal cortex’s essential rational decision-making power. At this point, your instinctive reactions become vital to overcoming this stressful situation.

An instinctive reaction is the clear and correct course-of-action to take in this situation. The instinctive reaction is based on your trading methodology, trading rules, and past experience. If you don’t have a clear reaction in mind, then you are just like a deer when it freezes in the road in reaction to an oncoming car.

The deer probably hasn't had prior interactions with an oncoming car, and therefore, it probably has no clear reaction in mind to respond to this highly stressful situation. To make matters worse, the deer’s senses are overloaded with perplexing bright lights and confusing loud noises coming from the car—just like a trader overwhelmed by the price action, ticker tape, level II, Twitter traffic, etc.

So how do we select and develop our instinctive reactions? Firstly, we have to employ a trading methodology that has a definite edge in the markets, research and analyze our performance, identify our strengths and weaknesses, setting goals to maximize our strengths and minimize our weaknesses, and most importantly, adapt and abide by our trading rules that keep us within the confines of our trading edge.

Secondly, practice, practice, and more practice. Through practice, we learn the value of our reactions to stressful situations—did they work effectively, or not. If they did work, we use them again and again in the future, maximizing our success rate to stressful situations. If they didn't work, we try to learn why they didn't work and try to discover other ways to react that we could try instead. We then try these new reactions in future trades, and determine their value. Rinse and repeat.

We eventually identify the best reactions to the worst situations, and practice these reactions and situations in our head before they ever happen to help turn them into instinctive reactions. This visualization technique is almost as good as the real thing/live trading, and provides us with the confidence that we need to overcome absolutely anything thrown at us.

To sum up, here is what your go-to guide for overcoming the most stressful trading situations might look like:

1. Set short term/easily attainable goals
• Brings structure to chaos, keeps the amygdala/fight-or-flight response in check
• For example, if the price action starts going haywire, set a simple goal such as "I’m going to hold my shares until my stop is hit period. I'm going to put trust in my stop and get out no matter what if it's hit, but until then, I'm going to hold until my price target is hit."
2. Mental rehearsal/visualization/simulation
• Continually simulate bad/worse/horrible trading scenarios in your head
• This makes the real world version much easier to handle, enabling you to keep your cool
3. Self-talk
• Your self-talk should be “can do” instead of “can’t do” because it helps override the fight-or-flight response that leads to irrational/emotional trading mistakes
4. Arousal control
• Slow/deep breathing, with long exhales and relaxed muscles (mimics relaxation)
• More oxygen gets to the brain so it can perform better

One last but very important note. Dr. Brett Steenbarger wrote an excellent post about working memory, and how recent research suggests that “the amount of information that we can hold in our minds at one time--is more limited than previously thought.”

Therefore, traders with overly detailed trading rules/plans (and traders trying to keep track of too many things such as market data, patterns, signals, Twitter, and news traffic) might be overloading their working memory, and as a result, undermining their mental ability to follow trading rules/plans.

So my key takeaways from Dr. Steenbarger’s article in conjunction with advice given by some of the most successful traders on the planet are:

1. Create a concise list of trading rules that are within your working memory abilities, which in turn facilitates your ability to instinctively react to stressful trading situations (here are mine)
2. Put this list somewhere as conspicuous as possible (e.g., post-it-note on your monitor) and always stick to your trading rules and plans, period. You can always analyze your trading rules/plans after-the-fact and see if they need tweaking. But tweaking them in real-time is recipe for trading inconsistently, not profitably.
3. Focus on an amount of stocks that you can comfortably track within your working memory abilities (just remember: overestimating your working memory abilities is a recipe for disaster, err on the side of caution)

And as always, let me know your 2 cents in the comments below and thanks for stopping by FTG!
Jory