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 right) which branch out to form over one quadrillion con­nec­tions called synapses. (Fig­ure 2, to the left). The eas­i­est way to 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). Although 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 fMRI 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) is 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. He 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 pat­tern;
– 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.

For 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.