Some statisticians might argue that purely based on odds,
streaks are a mathematical certainty.
But, it turns out there is much more to a streak. There are actually some deeply-rooted biological
dynamics involved. Anyone who has read
what I write knows how important I think evolutionary biology is; it is
everything, and understanding it can provide a huge edge.
I want to take a look at the “Anatomy of a Losing
Streak.” Having experienced a brutal
losing streak in my own trading during the month of September, I took away some
lessons, and was also fortunate enough to stumble upon some new knowledge that
helped tie everything together.
The specifics of my losing streak certainly defy all
statistical possibilities that would be a result of just “bad luck.” No question, there was something seriously
wrong with my perception of the markets.
I was not seeing what was going on in an objective manner at all. I perceived the market as a threat, as
opposed to the opportunity that it really is. So what had changed inside of me? What biological mechanisms were at play?
“Financial risk taking is as much a biological activity,
with as many medical consequences, as facing down a grizzly bear,” says John
Coates, in The Hour Between Dog and Wolf.
It is worth noting that Coates is a
Research Fellow in Neuroscience and Finance at Cambridge University, with
experience in the financial markets.
There might be no better source on this topic than him.
He goes further in stressing that trading is also a physical task, and how could it not be? Our mind and body is one; a cohesive organism that provides feedback within itself. “Few professions, with the exception perhaps of air-traffic control or the military during times of war, compare with finance for the amount of information that must be sifted and processed in real time,” says Coates. Information is processed physically, not just mentally, as many seem to believe. This has very important ramifications in understanding the anatomy of a losing streak: when you are in a losing streak, serious physical changes are taking place.
During short-term stressful situations, we experience a
release of cortisol and dopamine in our brains.
Small amounts of moderate stress are actually quite healthy. However, long term stress that comes from a
losing streak turns on the cortisol drip and leaves it on. When you are in this state, your body is
prepared for an immediate emergency, but stays that way for an extended amount
of time. Humans are really not meant to
deal with this sort of prolonged response.
Our stress response is meant to turn on, and then turn right back
off. So, when it stays activated, your
immune system weakens, digestion becomes much more difficult, and your sex
drive diminishes. The reason is that
when your body perceives an immediate threat, all resources go to dealing with
that threat – so metabolically expensive processes like those mentioned above,
shut down.
At some point, after a certain amount of losing trades or
losing trading days, my stress response turned on and stayed on. This helped to exacerbate the “streak” that I
found myself in. Instead of looking for
opportunities, I looked for ways to AVOID risk.
I was looking for trades where I wouldn’t have to take risk, which is of
course not possible. So I was making
foolish decisions in the hope of avoiding further damage.
I also found myself seeing patterns where there were
none. This is very common in trading,
and is often referred to as forcing trades.
“Shell-shocked traders…become pray to rumor and imaginary patterns,”
Coates explains. To use the basketball
analogy, it would be like a desperate point guard trying to take a foolish shot
under heavy coverage. The boxer takes
wild swings without using proper technique and defense. Our
minds (and bodies) start desperately searching for patterns when under the
stress response; and this literally caused me to start interpreting meaningless
noise as opportunity. Armed with this
knowledge now, I am much more equipped to recognize when I am prone to making a
decision based on desperation, rather than one based on sound technique.
Another important consideration is the “winner effect.” This is another very real phenomenon. “When two animals face off they experience a
pronounced rise in their testosterone levels…Testosterone thus prepares an
animal for a competition, but it is what happens next that drives the winner
effect. After the fight is over, the
winning animal emerges with even higher levels of testosterone, the loser with
lower levels…if you have just lost a fight, you had better retire into a bush
and nurse your wounds; while if you have won, you can expect an increased
number of challenges to your newly elevated status in the social hierarchy,”
explains Coates. So what is the
implication for trading? Well, if you
are experiencing losses, you are actually becoming more prone to more
losses! The response your body has is
one of caution, so you are naturally going to be more risk-averse!
Hopefully, this provides more insight into what actually
happens during a losing streak. Winning
streaks are similar. The importance of
recognizing our biological reactions to either winning or losing cannot be
understated. Realizing when you are susceptible
to making desperate decisions based on noise that, because of the stress
response, appears to have meaning, can save the trader a lot of money. Escaping the dregs of a losing streak
requires a trader to gain their confidence back, but you will keep making
foolish decisions unless you are able to compensate for your distorted
perception.
