In trading, you have to risk something to make something. No risk No return, it’s that simple. I will go into the statistics of this concept when I describe Myth 7 in my blog series. However, I want to make a wild suggestion, even by my standards.
I am currently reading a fascinating book called SOCIAL by Matthew Lieberman a Professor in the Department of Psychology, Psychiatry and Behavioral Sciences at UCLA. His main thesis in the book is that our brains have evolved to their current size and we have survived so successfully as a species through a social evolution. He postulates through brain imaging that, social drives are the key drivers to humans successful existence.
This is where things start to get a little exciting. Their studies prove that social pain causes the same reactions within the brain associated with physical pain. Let’s try and link that to trading pain.
There are numerous studies in the behavioural finance literature that quantify the amount of “pain” we feel with the financial loss versus the feeling associated with financial gain. These studies suggest that we feel the intensity of financial loss two times as much as we do financial gain. There are also numerous neuroscience studies that prove via brain imaging that financial pain is the same as physical pain.
To recap, it seems from the academic literature that physical pain = social pain = financial pain. We also know that pain is meant to be good for our survival as it tells us when things are not right with our bodies. Without these warning signs we could damage ourselves, ignoring the pain symptoms can even lead to death. This applies in a social context as well as in a financial context. Knowing that we are losing money is important for the ultimate protection of our financial existence. If we didn’t experience some sort of pain when we are losing money on a trade we will not take the necessary action to cut our losses or position sizing.
Professor Lieberman conducts an interesting study where they simulate an experience that creates social pain, with all the tell-tale markings in a fMRI brain study. Then they do something that would shock a medical doctor of yesteryear. They treat the social pain with Tylenol, a simple over the counter pain tablet and remarkably they witness a very noticeable improvement in the pain flaring in the brain.
Oh no, where is Berman going with this. Before I put forward my idea, let me repeat this is an unsubstantiated idea so don’t rush off to do anything I am suggesting.
We have already established that financial pain is a good thing as it helps warn us of potential impending financial disaster. We have also established that financial pain is felt twice as much as we feel financial gain. However, there is one more piece in the pain puzzle I would like to put forward. The degree that we feel pain is different from one person to the next. In fact our genetic makeup has a lot to say about our pain threshold. The mu-opiod receptor gene (called OPRM1) is what determines the intensity of the pain we feel. Ok let me bring it all together.
In my 16yrs of trading, I have noticed how different people react to small losses. I started this letter off by saying No Risk No Return. If you want to be a trader you have to make peace with the fact that losses are an inevitable part of your trading journey. A trader wishing to make those losses go away is missing the point. Every time you make a trade you are crossing a spread, you are paying a commission, you are by default starting off with a loss every time you trade. If we accept financial loss = pain and that people have different pain thresholds, then it is fair to say that some people with low pain thresholds are predisposed to incur too much pain and we know that people who experience too much pain, either physical, social or financial are likely to do things that may lead to irrational behaviour which tends to result in financial loss.
Perhaps traders who experience the pain of small financial losses too intensely should not trade or maybe they should pop a Tylenol or Panadol to help level the playing field. Who knows where research may take us, I think it’s quite possible we will see traders.