Use Your Emotions to Evaluate Risk. Don’t Be Too Rational.

Adams: So, as a poker player and from what I’ve experienced also as a trader, there’s the danger that you become completely numb to risk.  Many poker players we know, they literally feel no pain, no emotional pain from losing large amounts of their bankroll.  I mean, there are many poker players out there who can lose 10%, 15% of their bankroll in a day, in a session, and if you saw them after that session, you wouldn’t be able to tell, and they truly don’t feel much emotional pain from it because they’re just so accustomed to such losses, totally numb to the [variance].  I suppose there are some ways in which that might be good, because ideally you’ll want a sort of Spock-like, just complete objectivity with regard to risk, and you’d want no emotions to enter the equation at all.  But there’s another side to it.  There’s some value to still having some emotions attached to risk, because I believe that those emotions keep you risk averse, and risk aversion is what keeps speculators [solvent].  A truly risk neutral speculator has a risk of ruin 100%.  So, you need some of that risk aversion and I think you need some normal human emotions to maintain that risk aversion, and one of the dangers of being a gambler, being a poker player, is that you just become completely numb to risk and you’re willing to take oversized risk and basically you bring your risk of ruin to unacceptably high levels, and we see it in the poker world all the time.  It’s not unusual for a poker player to have tremendous success over a period of a couple of years and then literally lose his entire bankroll in, like, four weeks during the World Series or something like this.  It’s just not unusual at all for a poker player to go completely bust in a matter of weeks.  So, in trading, I suppose if you’re trading with other people’s money, it’s a particular problem when you’re numb to losses.  It’s a particular problem that we see today.  But if you’re trading with your own money, I think you have to be careful not to become completely numb to loss and I don't really know how you do it.  One solution is, like, in poker, you have the World Series of poker, which is a 6-week event during the summer, and that is the peak of every poker player season, and for most poker players, the risk that they’re taking on during the years is at a peak during those 6 weeks.  They’re gambling higher than they do at any other time during the year.  The danger is that you don’t step back from that when the World Series is over and you keep running in that high gear.  That could easily lead you to taking on acceptable risk and going broke.  So, you need to emotionally back away from that even though that will probably cause you to be a little bit bored and it will cause you to suffer some withdrawal based on lack of action.  You have to make that emotional adjustment, just as in the trading world today, in these very volatile markets, you have pretty much everyone who deals in the stock market, like, watching [IB] on a continuous basis and following things more closely than they otherwise would.  They have to reach a point where they back away from that and maybe lower their equity exposure a lot and quit paying as much close attention and go back to looking at things in a little bit more depth and looking at things a little more slowly because if they don’t they’ll probably just get into a mode where they’re just taking too much risk and being too short term. 

On Wall Street and in Vegas, Adams watched his most steely and calculating colleagues lose all their earnings in a single moment. Why? They had become dangerously numb to risk and believed that their intelligence would protect them from failure. But they were wrong: emotion is what keeps us solvent.

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