In technical terms, the researchers call this projected emotion, “anticipatory affect”. In simple terms, the results of this meta-analysis of the brain’s reaction to probabilities in risk goes like this:
1. A trader or PM takes in information about the expected mean, variance or skewness of a trade.
2. The PM or trader’s brain responds with an emotional reaction deep in the brain’s circuitry. It will be a positive or negative emotion depending on a high or low mean or variance. For example, high means and low variances create the signature for excitement. High variance likewise creates anxiety.
3. The deep brain emotional reaction modifies the next step of returning to the cognitive, intellectual or “analytical” thinking about whether or not to take the trade.
This truly groundbreaking work by Charlene Wu at Stanford (Frontiers in Neuroscience, 2012) explains much about the difficulty of trying to remove emotion from the risk decision! It should not be attempted because an emotional reaction is the first level of analysis your brain invokes.
This study comes close to unequivocally revealing the literal sequence of thought, emotion, thought and choice that occurs in the brain. 35 studies with a total of 663 subjects were included in the meta-analysis so this isn’t a fluke result. It offers seemingly the most accurate model and full brain picture of risk decision making as it actually occurs.
What Should a Portfolio Manager or Trader do with this?
- Resolve to learn the data set of emotions.
- Start with approach or avoidance, good or bad or I want more/less of this.
- It will require listening to your feelings which may mean listening to your body.
- Once you know the emotion in play, lean into the feeling and determine what about the decision is causing it.
- Decide if the cause dictates the need for more analysis or if it’s just a warning to be noted.
- In all cases, verbalize the feeling to detach it from automated action and turn it into conscious data.
If those steps sound too complicated, just take the step of dropping the attempt to NOT feel the emotions associated with a risk decision. The logic of doing so is SO outdated! Yes it’s what we have been taught and yes commentators and many risk psychology “experts” will still tell you to take the emotion out of it but they are wrong. It can’t be done. You couldn’t evaluate anything if you somehow accomplished this errant piece of advice.