Friday, January 22, 2010

The long-term effects of making decisions when you’re upset

Dan Ariely, a behavioral economist and author of Predictably Irrational, has an interesting column in the most recent Harvard Business Review. Entitled “The Long-Term Effects of Short-Term Emotions,” he recounts the results of an experiment he conducted with Eduardo Andrade. The hypothesis they wanted to test was whether poor, emotionally driven decisions guide later so-called rational decisions.

They showed one group of subjects a film clip designed to annoy them, the other group a happy clip. Immediately afterward everyone played the ultimatum game in which the investigators, who have $20, offer the movie watcher a portion of the money. Sometimes the split is even, other times the movie watcher gets less than half. The movie watcher can either accept or reject the offer. If he rejects it, both sides get nothing.

Predictably, those who had just been annoyed rejected far more offers than those who saw the happy clip. The investigators then waited until the emotions evoked by the clips had subsided to the point of irrelevance. Nonetheless, the group that had been annoyed initially still rejected far more offers.

Ariely brings this home to the financial and business world. “So now I’m thinking of the manager whose personal portfolio loses 10% of its value in a week. . . . He’s frustrated, angry, nervous—and all the while, he’s making decisions about the day-to-day operations of his group. If he’s forced to attend to these issues right after he looks at his portfolio, he’s liable to make poor decisions, colored by his inner turmoil. Worse, though, those poor decisions become part of the blueprint for his future decisions—part of what his brain considers ‘the way to act.’”

Apparently, “as research going back to Festinger’s cognitive dissonance theory suggests, the problem with emotional decisions is that our actions loom larger than the conditions under which the decisions were made. When we confront a situation, our mind looks for a precedent among past actions without regard to whether a decision was made in emotional or unemotional circumstances. Which means we end up repeating our mistakes, even after we’ve cooled off.”

This research could go a long way toward explaining why traders keep repeating their mistakes. Early on, perhaps, they nervously exited a trade the moment it went ever so slightly against them. The trade then turned around, annoying them. Perhaps they then took a trade in the opposite direction, with the same effect. They got even more annoyed and reversed once again. This bad trading practice might then become entrenched in their repertoire. Unfortunately, the best Ariely has to offer, but maybe it’s good enough, is to “take a deep breath. Count backward from 10 (or 10,000). Wait until you’ve cooled off. Sleep on it. If you don’t, you may regret it. Many times over.”

* * *

Sometimes even I listen to my own “advice” column. I intended to post this piece yesterday morning. However, a dead internet connection didn’t start the day off well. At least this time a Comcast tech was here by 11:30 a.m. And, unlike the last one, he was both competent and thorough. After all the in-house fixes failed, he went up the pole hidden among the trees and found that the signal was horribly degraded. He replaced the antediluvian hardware on the pole and ran a new line to the house. Well, that seems to have solved the problem although tomorrow a bucket truck will come out to the road to check the signal at that level. Moreover, it seems that at my leisure I can visit the Comcast store in New Haven and swap out my Docsis 3 modem for the new and improved Docsis 4 variety which features three frequencies instead of one. Let’s just hope it’s not three ways to fail.

The upshot? The market sank without my assistance. By the time I was back online I decided I wasn’t fit for any serious work. No sense compounding the morning’s frustration with bad trading in the afternoon.

2 comments:

  1. Been there, done that; been there, done that; been there, done that;...
    Anon.

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  2. Hi,
    Thanks for the post, I think poor judgement in trading is due to a lack of clear goals and the how to achieve them here is my learns
    http://fx-scalptrader.blogspot.com/2010/09/highest-level-in-trading-discipline.html

    ReplyDelete