Jul

23

Watching emotional stocks reminds me of the behavioral patterns I see in the psychiatric patients I deal with every day, especially when it comes to the beginning or ending of a trend.

When a patient loses control of his behavior he often becomes a danger to himself or others, requiring intervention on the part of the hospital staff to keep someone from getting hurt. Having observed the buildup to acting out behaviors many times, I have noticed they usually follow a pattern.

First, there is an event that the patient perceives in a way that provokes anxiety, leading to a progressive buildup of tension. The tension can sometimes be released through safe means, like a private discussion of the situation or voluntary medication, but that is often rejected or is not enough, and the patient reaches a point where he explodes and must be restrained before he hurts someone (usually himself). The emotional peak usually lasts until he is restrained, either physically or with involuntary medication, but regardless of the means, he tends to act out until he reachs a point of maximum emotional outburst and is unable to continue further.

The change at that point can be dramatic, and even the most angry and violent patients usually have an emotional collapse at that point from the dissonance of wanting to act out but being unable to do so. The most common behaviors at that point are either crying uncontrollably or falling asleep, and often one leads to the other. It is the job of the hospital staff to guide the patient from emotional extreme to stability.

There are useful parallels between the emotional state and behavior of the acting-out patient and an emotional market. If you fight the trend you can expect a battle, but when the momentum and emotion can't move the market any farther or an event causes an emotional shock then you have a tradable opportunity, and can expect a regression to the mean (and maybe a lot more). At the least, one is likely to see a market stop trending and go sideways for some time. Once in a while though, the patient (or the market) fakes you out and continues the previous trend or behavior despite everything that happened. If that happens, either get out of your position fast or call the police for help — depending on which situation you're dealing with.

Learning to discern a significant emotional change from one that won't have a lasting effect is the art. I'd like to find a way to quantify these emotional turning points, but I haven't found one yet. Until then, intuition and experience will have to suffice.

Denise Shull asks:

Can we say for sure that quantification produces better results than intuition and experience?


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2 Comments so far

  1. Ward on July 23, 2007 3:42 pm

    Perhaps it would be useful to look for this behavior en masse when it is connected with some meme that the market is fixated upon, money supply, the book to bill ratio, housing starts…I would have thought that energy storage or the crack spread might have become the “love object” but maybe that won’t happen until there is a significant price break. Worth watching though. Then again maybe lower oil helps so many that desperate oil longs won’t have the same effect.

  2. Matthew Chlapowski on July 26, 2007 12:09 am

    I’m not sure I would say that quantification is better or worse. I suspect it depends on your personality type. In Myers-Briggs terms, most people are “S” (Sensory) people, and a smaller number are “N” (Intuitive)types. The S types are more likely to look on the known information and try to quantify, but the N types tend to go with their judgment and experience. I think this may be the major difference between systems and discretionary traders. I’m a very ‘N’ person, so discretionary works better for me. It’s who I am.

    Most people in the counseling/psychological field are intuitive “N” types and would likely have trouble quantifying their understanding of patterns, but many of them can predict behavior with a high degree of accuracy. Numbers people, such as accountants and visual chart readers tend to be “S” people. Go with your strength and you are more likely to be successful.

    If this interests you then I recommend you look up information on the Myers-Briggs typology. It’s helpful in many ways besides trading.

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