Now's the time when Wall Street's biggest lie about trading can backfire

Right now markets are in complete and utter terror mode. The UK’s vote to leave the European Union has screens across Wall Street awash in red. No one knows when it will end.

And so now is a good time to talk about one of the biggest lies on Wall Street — a lie traders are told from their very first day on the desk.

The lie is simple: Do not trade with emotion.

The Wall Street trader, at least in Wall Street’s imagination, is a cowboy swaggering with silent confidence. Knowledge and logic are their guides. Emotion, whoever is teaching you will tell you, distracts your mind from solid facts — and in trading, they say, those are all that matters.

As a trader, the idea is that you’re Dr. Spock on steroids.

But there is a significant amount of psychological research that indicates just the opposite. It tells us that without emotion, too many facts can cause a breakdown in decision-making.

“It’s not that we’re saying that reason is not important and that knowledge and logic are not important,” said Dr.
Antonio Damasio, a professor of neuroscience at UCLA.

“On the contrary, what is important to say is that you cannot have normal decision making without the emotional factors and certainly not by the time you’re an adult without having all that wisdom that comes from your accumulated experience and that categorization of what is good and bad, not only factually and emotionally.”

So everyone, lets all get in touch with our feelings.

Feelings vs. emotion

I felt that collective shudder from you, Wall Street.

Damasio doesn’t mean you should all sit in a circle and hold hands though. To him, there is a difference between what we think of as “feeling” and what he, for research purposes, considers “emotion.”

Emotion, he told a crowd at The Aspen Ideas Conference a few years back, “is a collection of automated actions that are aimed at a particular effect that will have importance for the regulation of life.”

Feelings, are on the other hand are how we learn about that emotion.

“Feeling is like the sea level that comes from this under the water operation… of the non-conscious brain,” he said.

Damasio was able to track what happened to someone who was unable to use emotion to make decision making. It’s in his book, Descartes’ Error. The book follows a patient named Elliott who had a tumour that damaged frontal lobe tissue in his brain. Before the tumour, Elliott had a normal job, wife and family.

After the tumour he stopped being able to use emotion to judge decision-making. He couldn’t go to work and hold down his job. He got divorced, and then got married a second time. His second marriage ended in disaster. In event after event he could come up with a range of options for what he could do (yes, even in stock trading) but he couldn’t pin down exactly what his decision should be.

“It is emotion that allows you to mark things as good, bad, or indifferent in the flesh,” Damasio said during his Aspen talk. “When you are making decisions any day of your life… you do not only remember what the factual result is, but also the emotional result is.”

When you put those memories together, they create wisdom. And wisdom is critical for navigating the decisions that seem to come up repeatedly through life.

Margin callscreenshot/’Margin Call’You are not Spock. (This guy was Spock, and not in this movie, which is Margin Call.)

Repression obsession

Of course, none of this happens if you suppress emotion. That’s what can happen in the macho cowboy Spock world of Wall Street.

“What happens is that traders/PMs [portfolio managers] try to set the emotion aside. That becomes a direct line to acting purely on it — with no other motivation,” said Denise Schull of The ReThink Group. She’s a neuroeconomist and Wall Street trading coach.

“PMs will over-analyse, re-analyse — anything to try to calm a fear — when a fear or doubt is often telling them something they would profit from — if they could listen.”

The infamous JPMorgan London Whale is a great example of this. Back in 2012 a JPMorgan trader named Bruno Iksil blew a $2 billion hole in his portfolio. Naturally all of this didn’t happen at once. Iksil noticed that he was losing money, but instead of admitting that he was scared, he doubled down on the logic of his trade.

You see, rationalizing can be just as dangerous as getting emotional. Sometimes you have to actually listen to your feelings.

“I have a CTA right now who has to work to not get too logical. Every time he does, he realises he is rationalizing a position when his sense of the market — his confidence or lack thereof — is telling him where price is headed in the short term,” said Schull.

So forget when your boss told you during your first summer internship at Morgan Stanley.

He’s probably scared as heck right now anyway.

NOW WATCH: The best and worst months to rent an apartment in major US cities

NOW WATCH: Money & Markets videos

Want to read a more in-depth view on the trends influencing Australian business and the global economy? BI / Research is designed to help executives and industry leaders understand the major challenges and opportunities for industry, technology, strategy and the economy in the future. Sign up for free at research.businessinsider.com.au.