4 Ways Emotions Enhance Trading Decision-Making

Discussions surrounding trading psychology frequently emphasize the necessity of eliminating emotions from decision-making processes to achieve consistent trading outcomes.

However, is it truly feasible to exclude emotions from our decision-making frameworks?

Researchers Hans-Rüdiger Pfister and Gisela Böhm from the University of Bergen contend that emotions should not be perceived as disruptive external influences on an otherwise rational decision-making process. Instead, they argue that emotional engagement is integral to optimal decision-making, as emotions serve four essential functions:

1. Formulating Preferences

Every decision necessitates information, and a trader's emotional state regarding the potential consequences of a decision plays a crucial role in shaping these preferences.

For instance, a trader deliberating between purchasing Bitcoin or the U.S. dollar will evaluate the potential gains against the anxiety associated with the volatility of the asset. Similarly, when contemplating the closure of a trade, a trader will assess the benefits of maximizing a positive trend against the discomfort of relinquishing profits should the market reverse.

The correctness of the emotions assigned to these outcomes is secondary; what is significant is that these beliefs offer evaluative insights that facilitate decision-making.

2. Accelerating Information Processing

From early humans instinctively fleeing from predators to modern consumers rapidly clicking "add to cart" during sales events, our emotional states have consistently influenced our capacity to make timely decisions.

While not all swift decision-making is driven by emotions (as seen in games like Tetris), emotions indeed expedite the processing of information.

Consider a scenario where an asset nears a critical resistance level; a trader named Harry, holding a long position, may feel apprehensive about diminishing bullish momentum. His existing uncertainty will prompt him to realize the ease of securing profits upon witnessing resistance.

3. Determining Relevance

Decision-makers consistently assess factors they believe to be pertinent to their situation, with emotional influences often guiding this selection.

For example, a trader who experiences satisfaction from a successful SMA crossover trade is likely to focus on SMAs rather than exploring alternative strategies. Conversely, a trader who regrets missing a long-term trend may pay closer attention to various time frames in future trades.

Regardless of whether the trader prioritizes the correct or incorrect elements, the emotions associated with specific factors significantly contribute to their decision-making process.

4. Reinforcing Commitment

A critical aspect of decision-making is the ability to adhere to one's choices, even in the face of contradictory motivations.

Confidence in a trading strategy can empower a trader to accept losses, even when apprehensive about closing a losing position. Similarly, feelings of shame regarding prior losses may encourage traders to adopt prudent position sizes, countering the urge to overextend their investments due to greed.

These examples illustrate that emotions are intricately woven into the fabric of decision-making, making it impractical to simply "eliminate" them.

It is not emotions per se that undermine trading decisions; rather, emotions such as fear can prompt timely loss-cutting, while the anticipation of success can reinforce adherence to a trading strategy.

Thus, the objective for traders should not be to suppress their emotions but to cultivate those emotions that align with preferences conducive to profitable trading decisions.