How to handle risk and uncertainty

How do you cope with the risk and uncertainty that are built into markets,
and are you coping effectively?
In this and my next article, I will be
tackling these important questions.

The topic of coping actually begins with the notion of stress. Stress
is a characteristic set of physiological, cognitive, and emotional responses to
threat. Generally, these responses speed up such bodily functions as heart
rate, galvanic skin response, muscle tension, and rate of respiration. For
this reason, the stress response has sometimes been called the “flight or
fight” reaction. In the face of threat, our bodies prepare us for
action: either to attack the source of danger or to run from it.

What constitutes a source of stress is highly dependent upon our
perception. If we define something as a threat, we will experience it as
threatening, and that will trigger a stress response. For some people,
public speaking is an everyday activity, not to be feared at all. It might
even be something enjoyable. Others view public speaking as a potentially
humiliating event. Their perception of threat triggers the stress response
that we call performance anxiety. Cognitive psychologists, however, remind
us that it is not the public speaking event itself that is generating the
anxiety, but rather our processing of that event. Take away the perception
of threat and the anxiety diminishes.

Some of us view the world through lenses that emphasize the threat in life
events. Perhaps we grew up in an unstable home, perhaps we were
overprotected and never experienced life’s hard knocks, or perhaps we learned to
anticipate negative events as a way of handling multiple setbacks during a
difficult period of life. All of these scenarios can lead to situations
where stress becomes a way of life. Once we acquire habitual thinking
patterns that emphasize life’s dangers, we fall into a chronic mode of flight or
fight. Continually mobilized, we can experience ongoing high blood
pressure, muscle tension, and jitteriness.

Psychologically, chronic stress is experienced as dis-stress. Anxiety,
depression, and anger are common consequences of viewing the world through the
lenses of threat. These emotional reactions, in turn, produce typical
behavioral consequences, such as indecision, lack of self confidence,
impulsivity, and interpersonal conflict. We know from cognitive
neuroscience research that high levels of distress shift regional cerebral blood
flow away from the frontal cortex–our executive center of judging, planning,
and reasoning–and toward motor regions. This is why it is so difficult
for people under chronic stress to calmly work out their problems. Their
perceptions of threat create physical and emotional arousal, which in turn make
it difficult to access the cognitive capacities most needed at those
times. Every trader knows how easy it can be to abandon a well thought out
trading plan in the heat of adverse market activity!

The term coping refers to the actions we take to deal with sources of
threat. Broadly speaking, there are three coping styles:

  1. Emotion-focused coping – Dealing with dangerous and threatening
    events by processing one’s emotions and engaging others for support;
  2. Problem-focused coping – Handling threats by focusing on the
    situation and ways of dealing with it to reduce danger
  3. Avoidant coping – Avoiding sources of threat or choosing to not
    think about or deal with a problematic situation.

None of these coping styles are good or bad in and of themselves. Each
can be used effectively, and each can be misused. We know that a coping
style is effective when it reduces threat and produces positive outcomes.
There are times when it can be effective to sort out our feelings and deal with
these, such as after the loss of a relationship. There are occasions when
it is very helpful to be problem focused and directly deal with an immediate
emergency. Other times, we need to suppress feelings of upset and
problematic situations in order to get by in a job or as a parent. In many
respects, the best coping style is one that flexibly incorporates all three ways
of handling situations.

While all of us do cope at times by dealing with feelings, attacking
problems, and removing ourselves from situations, most of us have characteristic
ways of dealing with threat. Those are our typical coping patterns, and
they are integral to our personalities. For instance, if I have a
significant problem, I very often will cease interaction with others and become
extremely task focused. At such times, my attention narrows considerably
and is concentrated on the problem at hand. This is useful in that it
generally accelerates the resolution of the problem. It is not useful in
other respects, particularly if it leads to others feeling shut out in a
team-based work situation. If I become locked into particular ways of
coping that worked for me in one setting–or during one period of life–and then
bring these to new situations, there is a real risk that the coping will no
longer ward off threat and may even create new conflicts. My colleagues at
work who feel shut out by my problem focus, for example, may stop collaborating
with me at times when I want and need their assistance.

This situation is much more common than people realize, and it is a source of
untold trading problems. Coping strategies that worked well at one time or
in other situations are brought into the trading arena, where they wreak
havoc. Very often this occurs when the emotions evoked by our perception
of trading situations (perceptions of failure, danger, invincibility,
etc.) trigger coping actions from an earlier life period where those emotions
were problematic. Perhaps, for example, I felt like a failure in my
growing up years because I could not make friends or develop
relationships. This led me to cope by avoiding social situations and
retreating into my own fantasy world where I didn’t have to deal with
others. As a child, this may have helped me through a painful and awkward
life period. Now as an adult, however, responding to market losses with
feelings of failure–and then retreating into fantasy–is not
constructive.

Very often, our most problematic coping occurs when we deal with threatening
situations in ways that greatly differ from our normal coping styles.
During normal trading, I might be highly problem focused. In a volatile
stretch of trading where I take large losses, however, I find myself coping by
exploding emotionally and then feeling guilty over my outburst. Such
out-of-the-ordinary coping generally is a sign that an earlier coping mode is
being activated. Something about the day’s trading is triggering old
memories, feelings, or conflicts. As a result, we’re no longer using our
constructive, adult coping capacities. Instead, we’re mindlessly repeating
a pattern from the past.

If you find yourself overreacting to a situation, there’s a good chance
it’s not really an overreaction
. You are reacting to the
situation–*and* to something previous in your life that is being stimulated by
the situation. The first step of progress you can make in this
circumstance is to remind yourself that you’re not really reacting to the
situation at hand. “This isn’t about trading,” you tell
yourself. “Something else is going on.” Such a reminder
does not, by itself, eliminate the threat response, but it starts the process of
putting threat in perspective. That is important. Remember:
threat–and stress–are functions of perception. As you alter your
perception, you alter your responses.

In my next article, I will focus on some ways of modifying stress responses
and improving coping.

Brett

P.S. BTW, join me for a free online chat that
will cover stress, coping, and much more at Woodie’s CCI club on Thursday,
October 20th at 5:00 PM EST (4:00 PM for us Chicago types).

Click here
for more information

Brett N. Steenbarger, Ph.D. is Associate Clinical
Professor of Psychiatry and Behavioral Sciences at SUNY Upstate Medical
University in Syracuse, NY and author of
The
Psychology of Trading
(Wiley, 2003). As Director of Trader Development
for Kingstree Trading, LLC in Chicago, he has mentored numerous professional
traders and coordinated a training program for traders. An active trader of the
stock indexes, Brett utilizes statistically-based pattern recognition for
intraday trading. Brett does not offer commercial services to traders, but
maintains an archive of articles and a trading blog at
www.brettsteenbarger.com.