Saturday, May 2, 2015

The Neuropsychology of Trading

Abstract: This is a lengthy posting on brain activity as it relates to trading. While recent
advances in functional magnetic resonance imaging are revealing important brainbehavior
relationships, such research is difficult to conduct with traders. Use of thermal
biofeedback holds particular promise in objectively quantifying the degree to which
individuals are engaging in executive cognitive functions. Preliminary data suggest that
such biofeedback accurately discriminates between haphazard/discretionary and rulegoverned/
mechanical trading methods.
One of the traditional challenges research psychologists have faced is the reliance upon
the self-report of experimental subjects for data on such variables as moods, intentions,
etc. With the advent of functional magnetic resonance imaging (fMRI), it has become
possible to track cerebral blood flow patterns among subjects as they perform various
tasks. This allows researchers to see which areas of the brain are activated during
standardized tasks that draw upon particular cognitive functions.
Such standardization is necessary when assessing the functioning of particular patients.
For instance, a task called the PASAT (Paced Auditory Serial Addition Test) presents
subjects with a series of numbers. Each number in the series is followed by n seconds of
silence before the next number is presented. The task is for subjects to add the series of
numbers mentally. This tests auditory processing speed, attention, and calculating
ability. By obtaining fMRI pictures of normal subjects engaging in the PASAT, we have
a sense for the brain regions that are activated when engaged in these functions. When a
brain damaged patient is asked to perform the PASAT, the fMRI reveals those relevant
brain regions that are not receiving adequate blood flow. Interestingly, when efforts at
cognitive rehabilitation are undertaken, the brain damaged patients can regain some of
their skill at tasks such as the PASAT. This is corroborated by fMRI pictures that show
new regions of blood flow to those brain areas associated with auditory processing and
attention.
The implications of this work are profound, suggesting that the brain is much more
plastic than has been assumed in the past. With imaging, we can now see the brain
develop new blood flow patterns. Obsessive-compulsive patients, for example, who
have
undergone successful behavioral psychotherapy reveal structural brain changes before
and after their treatment. In the future, such changes might even constitute an objective
measure of whether a pharmacotherapy or psychotherapy has been successful.
One of my longstanding passions has been to identify the brain regions that are activated
during trading, and particularly the patterns of brain activation that distinguish successful
traders from their less successful counterparts. It is reasonable to believe that traders who
experience emotional interference with their trading, for example, would display different
blood flow patterns under fMRI than traders who maintain a reasoned discipline in their
work. It is also reasonable to believe that neophyte traders might show different blood
flow patterns than their more experienced peers. (Research, for example, finds that novel
tasks tend to be processed in the right cerebral hemisphere, while routine tasks are
processed dominantly in the left. Intriguingly, negative emotional experience also tends
to be lateralized to the right).
There are significant logistical difficulties in studying trading with fMRI. Imaging is
very expensive, and getting on the magnet at busy medical centers is not easy. Perhaps
even more daunting is the challenge of placing an entire trading station inside an MRI
tube and creating realistic trading conditions. Finally, there is the challenge of creating
standardized trading tasks, so that different individuals can be assessed on the same
metrics.
I've mentioned on the List (and in my book) that one way I've tried to begin exploring the
brain/trading relationship is through a novel form of biofeedback. Most biofeedback
measures physiological arousal, and is used to track patterns of anxiety for the purpose of
relaxation. Forehead skin temperature biofeedback, however, evaluates minute shifts in
skin temperature on a real time basis. This reflects increases or decreases of cerebral
blood flow to the frontal regions of the brain, which are the mind's "executive center".
The logic behind the biofeedback unit is that skin temperatures should increase when
subjects are engaged in such processes as concentration, judgment, planning, and verbal
reasoning. Conversely, forehead skin temperatures should decrease when subjects are
frustrated or otherwise emotionally aroused and when they are physically active.
I commissioned an engineer to build such a machine (since none are commercially
available) and have been engaged in using it for research purposes. Most recently, I have
created standardized tasks for the unit that involve varying degrees of emotionality,
activity, attention/concentration, etc. By taking forehead skin temperatures every 10
seconds during task performance and calculating the standard deviation of the readings, I
can compare the distribution of temperature scores under one set of task conditions with
those derived from other tasks. The readings strongly support the underlying rationale of
the device: tasks requiring the greatest mental effort consistently generate the highest
temperature readings. The biofeedback unit appears to be an accurate means for
quantifying the degree to which subjects are exercising their executive brain functions.
An interesting side note: Very high skin forehead temperature readings that are sustained
over a period of minutes are invariably accompanied by major mood shifts, in which
subjects report feelings consistent with being "in the zone". They report an unusual
degree of clarity, focus, present-centeredness, and ease of thought. I should emphasize
that this is not a placebo effect: the digital readings of the machine are hidden from the
subjects so that they have no idea of whether their readings are high or low.
In my most recent experimentation, I attach myself to the biofeedback unit while placing
a variety of trades in the market. Unlike fMRI, there is no logistical problem with being
hooked up to the machine while trading. Specifically, I tried to create two very different
trading conditions: 1) uncertain, frustrating trading where I made decisions intuitively on
the basis of common technical oscillators and chart patterns, and 2) structured trading
where I traded a tested, mechanical system. To keep conditions constant, I traded over
identical time frames in similar midafternoon markets. During the seat-of-the-pants
trading, I started with relatively high forehead skin temperature readings, which
deteriorated over the course of the trade. In the structured trading, however, my readings
continued significantly higher throughout the trade. In fact, the average readings were
much higher than the highest levels recorded during my standardized concentration tasks.
Objectively (and subjectively) I was in the zone--but only when trading was structured.
The reason for this is a bit subtle. In the seat-of-the-pants trading, I didn't really know
what to look for to base my decisions and had to flit from screen to screen to pick up
(probably random) cues of strength and weakness. My attention was highly divided, and-
-because the trade duration was short (less than a half hour)--I felt rushed in my decisionmaking.
During the mechanical trading, however, I knew exactly what to follow on a
minute to minute basis and stayed glued to a customized screen that contained all the
relevant data for decision making. My attention was not divided, and I experienced no
sense of time pressure or frustration. (Yes, the mechanical trading has also been more
profitable).
Much more experimentation remains to be performed. How are the biofeedback readings
(reflecting sustained concentration and mental effort) affected by large increases in
market volatility or position size? By holding period? By the nature of the trading
system? Do successful traders sustain significantly different readings from unsuccessful
ones? How much individual variability in readings occurs during hot and cold trading
periods?
Perhaps the most intriguing questions involve training. Can we train people to sustain
mental effort and access "the zone"? Would such training improve trading performance
by enhancing trader discipline, pattern recognition, and problem-solving? Can
dysfunctional trading patterns (blaming self for bad trades, failing to take valid trading
signals, impulsively trading when valid signals are absent) be eliminated by reprocessing
anxiety during states of high frontal activation? This, I believe, represents an important
frontier for trading psychology.











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