Trading Psychology & Emotional Intelligence for Options Traders

Greed, fear, FOMO, anxiety, panic, over-confidence, stubbornness, impatience. These are just a few of the many emotional and mental states that traders find themselves in. And while we cannot avoid these emotions and thought processes, we can learn to manage them through emotional intelligence. This week’s podcast was curated to help you learn how to more effectively recognize and manage the dozens of emotional and cognitive responses you’ll encounter in your trading career.

  • As traders, while we cannot avoid negative emotions and thought processes while trading, we can learn to manage them by developing higher emotional intelligence.
  • Today’s show is about trading psychology and how to develop emotional intelligence. This show is designed to equip you to recognize and manage the dozens of emotional and cognitive responses that you’re going to come across in your trading career.
  • You’ll learn to make better, non-subjective decisions so you’re not being thrown around by your emotions, the market, and things you hear in the news, and become a more consistent and profitable trader.

A Lesson: Experiences can only be judged in hindsight

  • We cannot recognize the difference between positive and negative experiences when we’re in the moment.
  • While we might experience negative emotions during an experience, that experience that felt negative can turn out to have positive consequences for us.
  • 2020’s market swings are an example of this.

The Difference Between EQ and IQ

  • Intellectual intelligence (IQ) is all about being able to process data, remember, and make sound, rational decisions.
  • Emotional intelligence (EQ) is your ability to process emotions that you feel and that others in your sphere of influence feel because of the energy they give off.
  • As traders, the market and related media sources give off a kind of emotional energy that can affect us emotionally. If we are bad at processing this emotional energy, we will be negatively affected by market swings and make poor decisions.
  • EQ and IQ are not the same; too much intellectual intelligence without enough emotional intelligence can be a recipe for disaster.

The Example of Astronaut Lisa Nowak (High IQ/Low EQ)

  • Lisa Nowak was an astronaut that had high IQ but poor EQ. This was proved by the story where she drove 900 miles in a diaper to attack her husband’s lover.
  • Her intelligent, rational decision making is evident in her wearing a diaper so she could make the journey quicker. But, the decision to do the proves that you can be incredibly smart, but if you let your emotions get the best of you, make poor choices.

The Example of Trader Peter Brandt (High IQ/High EQ)

  • One of Peter Brandt’s talents is the IQ-related task of charting patterns. He got listener questions during a webinar where people wanted to know the perfect entry, trigger, or chart pattern.
  • His answer was there’s almost no edge in doing all of this charting work. Instead, what matters is how you manage a trade once you get into it, manage your emotions around that trade, and properly manage your capital and risk.
  • Peter Brandt is really good at the rational side of his craft. Still, he stresses the emotional capital management side while having the ability to be firm, consistent, predictive, and understanding about how one’s emotions are going to play out after making a trade.

How to Develop Higher Emotional Intelligence

You have to practice self-awareness. Some of what we do is deliberate, and some of what we do is subconscious.

  • The first step in practicing self-awareness is to understand why you’re doing something, whether it’s on autopilot or deliberate.
  • The second step is asking yourself how you feel about doing a particular thing in the way you do it.
  • The third step is finding out what you don’t know yet about yourself, i.e., how you would respond to a situation you have not been in yet. Developing a game plan for future events can help you not be caught off guard when they happen.
  • If you have a level of self-awareness, you know why you’re doing something, what you’re doing, and how it’s making you feel. When you’re practicing these mental models of future scenarios, you get to a relative level of calm.

Accept all the emotions that come in. Rather than being consumed and having a new emotional reaction to the emotion itself, watch them as you watch a river, ask why you’re feeling this way, and label it. Don’t be consumed by the emotion or try to suppress it. In this way, you can understand how you’re reacting a little better and make more rational decisions than just letting the emotion take control of what you’re doing.

  • As parents, it is our job not to suppress our children’s emotions but rather give them tools to recognize them for what they are and a safe space to feel them and let them out.
  • As traders, if our parents didn’t help us in this way, we might not have the tools to do this ourselves. Often, traders suppress their emotions, and then they build up until an explosion happens.

Figure out what you can control in the moment. Don’t react emotionally to things you can’t control.

  • There are some things you can control and others you have zero control over.
  • In politics, one can get mad about things that happen and at the chain reactions that the event caused.
  • The market is similar where it is easy to get mad about things that happen, things that happened because of that first thing, or things happening differently than what we predicted.
  • Saying, ‘If only this or that didn’t happen,’ is a form of using things we can’t control (exterior events) as a scapegoat for the negative effects something we can control (our responses) had on us.

Turn values into bumper guards. Use your values as if they were bumper lanes as you develop your EQ.

  • Have a growth mindset, the will to see the lessons in scenarios, and a desire to embrace calm can help you keep an even keel rather than get derailed during emotionally charged trading moments.
  • Remember that your future responses to triggers don’t have to be the same as past ones.

You have to build a constructive feedback loop.

  • Continuously evaluate and revaluate your performance as you go. Reviewing your past actions and comparing them to present actions can give you a lot of insight into how to respond in the future.
  • Write down possible moves to make and review them later. In the time between writing and reviewing, your subconscious is whittling away at the question.
  • Kirk has learned to value his time and doesn’t accept by default any invitation for meetings. Rather he snoozes things for five days, and if they still seem important after that, he accepts the invitation.

You are not your thoughts. You are your actions.

  • We all have terrible, negative thoughts, but, if we don’t act on them, they don’t define who we are.
  • Realizing this can make uncomfortable thoughts and emotions far easier to accept and help you not be negatively affected by these thoughts.
  • If you don’t feel like going to the gym but still go anyway, you reap the rewards of the action and make it a part of who you are. The negative thoughts then had no effect on what defined you in that moment.
  • You are not your thoughts, so don’t let your emotions manifest into your trading activity. Otherwise, you’ll fall into the classic fear, sell, greed, buy pattern.

Knowing, doing, being, then mastery. You have to know what you want to do. Then you have to do it in order to become something. Only then you can master it.

  • Before being good at something, you have to start, realize you won’t be good immediately, and do all the necessary steps to learn the necessary things to be able to start doing what it is you want to do. Only then, through practice, will you see your skill grow. If you can’t trust this process and don’t have patience, you’ll succumb to your emotions and quit.
  • People get an idea in their head and then try to inhabit it immediately. For example, they buy expensive running gear because they want to be a runner before doing the training required to justify that expense. They then start running, realize it’s harder than donning an outfit and end up quitting. They skipped some steps needed to be a runner – the ‘doing’ part!

Here is Mark Manson’s article on developing emotional intelligence skills: 5 Skills To Help You Develop Emotional Intelligence

A Final Thought: Whatever you resist in life persists by the virtue of that resistance.

  • These small, seemingly inconsequential things that we don’t do just sit and grow in a dark place in our mind and fester until they become unbearable.
  • If you don’t address these thoughts and figure out how they might impact your trading, investing, or psychology, you’ll become like Lisa Nowak and do the trading equivalent of driving 900 miles in a diaper to attack somebody!

Option Trader Q&A w/ Berto

Trader Q&A is our favorite segment of the show because we get to hear from one of our community members and help answer their questions live on the air. Today’s question comes from Berto:

Hi, Kirk. My name is Berto from Colombia, and my question is when setting up the automatic closing order for an Iron Condor or Iron Butterfly at profit target of 50%, for example, do I have to set a single closing order for puts and calls or can I create separate closing orders, one for the put and another one for the call, both at 50% of the profit? Which one is better? I’m finding your extreme commitment very inspirational, so thanks a lot for that.

Remember, if you’d like to get your question answered here on the podcast or LIVE on Facebook & Periscope, head over to OptionAlpha.com/ASK and click the big red record button in the middle of the screen and leave me a private voicemail. There’s no software to download or install and it’s incredibly easy.

Thank You for Listening!

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About The Author

Kirk Du Plessis

Kirk founded Option Alpha in early 2007 and currently serves as the Head Trader. In 2018, Option Alpha hit the Inc. 500 list at #215 as one of the fastest growing private companies in the US. Formerly an Investment Banker in the Mergers and Acquisitions Group for Deutsche Bank in New York and REIT Analyst for BB&T Capital Markets in Washington D.C., he's a Full-time Options Trader and Real Estate Investor. He's been interviewed on dozens of investing websites/podcasts and he's been seen in Barron’s Magazine, SmartMoney, and various other financial publications. Kirk currently lives in Pennsylvania (USA) with his beautiful wife and three children.