Can Trading with Emotion and Instinct Give You An Edge?

Recently I’ve become increasingly fascinated by the idea that intuition, emotion and instinct could be the most reliable tool we have to profit from trading. I’ve read so much over the last 6 months and in almost every case, the one thing I’m constantly told not to do is to let my emotions play any part in my trading. I believe that is the biggest mistake you could ever make.

Since March 2012, I’ve traded about £1500 worth of positions. Right now, as I write this, I’ve got exactly £489 in my IG Index account (I had £500 but I lost £11 in a long position on Sports Direct earlier today).

Anyway, that means I’ve lost £1000.

But I don’t consider it a loss at all.

I’ve spent £1000 to trade for 6 months and during that time, every trade, chart and reason for opening or closing a position has been stored away by my subconscious mind. I believe every consecutive trade I’ve opened, I’ve opened with the knowledge of the previous trade being taken into account – even though I wasn’t aware of it.

As time has passed by, I have noticed my trades getting better; and later in the week I’ll post up October’s results in full to prove it. I believe the longer I continue to trade, the better I will get. What makes this possible? Experience, clearly, but also something else. Something more powerful and, somewhat controversially, emotional.

This secret Jedi force is known as intuition.

Intuition is the result of the way our brains store, process and retrieve information on a subconscious level. It is the psychological manifestation of our brains quickly drawing on past experiences and external cues to make decisions on a non-conscious level. In other words, it happens so fast that we’re not aware that the intuition actually stemmed from a supercharged burst of logical thinking.

Intuition = Logical thinking? Really?

Edward de Bono’s work on how the brain learns and processes information goes some way to supporting this viewpoint, and other pseudoscientific theories postulate that it is the long-term accumulation of ‘logical’, hard-won knowledge that, once acquired, enables the brain to make ‘leaps’ in judgment, bypassing the A,B,C process and jumping straight from A to F.

One of my oft quoted and favourite traders, Jesse Livermore, if the story is true, once made a hugely profitable trade based entirely on intuition.

“In April 1906, Livermore was on vacation in Atlantic City. As luck would have it, one morning, while strolling along the boardwalk with his friend, Livermore came upon a brokerage office. Being naturally curious, he went inside to see how the market was doing. He had been out of stocks at the time and was just there to enjoy a well-deserved rest.

Livermore shot a glance over to the quotation board when his eye suddenly caught Union Pacific (NYSE: UNP). The stock was rallying, which was no surprise because it was a market bellwether — the most bullish name in a roaring bull market. UP was deemed impervious.

Suddenly, without hesitation, Livermore picked up a ticket and wrote out an order to sell 1,000 shares of UP short.

His friend let out a nervous laugh and said to him, “I think you made a mistake. Shouldn’t that have been an order to buy 1,000 shares?”

There was no conscious reason for Jesse Livermore to be selling Union Pacific short. He didn’t know anything about the company that anyone else didn’t know. Its earnings were strong, its outlook bright. Freight and passenger revenues were on the rise. Its capital position was strong. Yet deep within him, there was the feeling that all was not well.

The next day came news of the great San Francisco earthquake. The entire stock market remained strong, giving up only a few points at first and then rebounding. Union Pacific stock just would not go down. His associates urged him to cover.

Sure enough, as the full scope of the disaster became apparent, the market began to slide. At first, it was a measured, orderly retreat without any indication of panic. Then it utterly gave way into the full-fledged crash that Livermore had been expecting. Incredibly, he held off still, deciding instead to double his ante by unleashing wave after wave of selling. The bulls were on the run. On the following day, he covered, making a killing in the process.

Was this luck? Or was it many years of trading and logical hard won knowledge that gave him the edge?

I guess we’ll never really know in this case, but there are still trades happening today where emotion and intuition are the edge and many examples of it exist on the web if you look. The bottom line seems to come back to the idea that traders who have been in the game longer can make snapshot intuitive decisions that often turn out to be correct, whereas new traders use the same intuition to make losing trades.

The conclusion from this is that the hard won knowledge and experience of the older trader has simply given him more logical boundaries from which he draws his intuitive snapshot decisions from.

I believe that if you embrace these feelings of intuition and emotion within a framework of tight risk management and post-trade analysis, you will eventually be able to make snapshot decisions on positions that turn out to be proftable – based entirely on instinct.

I think I’m a better trader now than I was last month and I’ll be posting up my October trading results in the next couple of days so check back for those or follow me on twitter if you want to know when they’re up.

Also, in November I’ll be starting my intuitive trading experiment with my £500 which I want to compound at 20% per month so make sure to favourite this page or bookmark or whatever and come back for that.

In the meantime, happy trading!

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8 Replies to “Can Trading with Emotion and Instinct Give You An Edge?”

  1. Hey Lee

    Just read above article. Have to say I do admire what your doing. Going against the grain or whatever the saying is. 🙂

    Personally though I can’t help feel that if one trades without a system and only emotion/intuition aren’t you therefore ‘gambling’?

    I can’t see how it’s any different to walking into a bookies and picking a horse by name.

    I follow a handful of successful millionaire traders that all made their money from trend following. I’ve learnt from them and one thing that is obvious is that they all have different rules but each of them preach never to trade with emotion. Many of these successful traders probably haven’t met as I follow a guy from Australia, one in France yet they all preach the same fundamental theories. I figure there’s a reason for that and a reason all these people have a lot of money as a result.

    Even the cock sure penny stock trader Tim Sykes swears by leaving emotion at the door when it comes to trading. And he’s as emotional as they come.

    I know you quote Livermore, but if we took enough guesses we’d all be right sometimes dont you think? The trick is trying to build consistency an maintain a ‘positive expectancy’. That’s what gives you an edge in my opinion. Knowing that even when things go wrong, your system is right and what you are doing will make you your money back. I lost 7% a few days ago when the Dow fell. It hurt, but I carried on, kept my trades open and continued opening new positions. I made it all back 3 days later 🙂

    I’m truly interested in your approach as it goes against everything I believe in as a trader and I’m sure I’d have made a loss if I had followed my emotions as there have been times I’ve wanted to get out but stuck to the rules and made massive profits. This is why most Traders can’t trend trade because they can’t hack the periods of losses or can’t beat to lose profits they are yet to bank.

    If you make this work it’ll blow my mind 🙂

    I notice you also mention that your October profits are testament to your new technique. Are these positions opened before your change in approach or since? as I noticed this change In direction was only a recent development right? Can your Oct profits prove your theory works? I’d be more inclined to look at the results over a lover time period. Are you just randomly picking trades now? No rules at all?

    I do wish you luck cause your a nice chap and I enjoy chatting to you. I think it might fail but then that will make you all the more determined to prove me wrong I suspect 🙂

    Good luck out there.

    1. Hi Chris,

      Thanks for the comment, appreciate your thoughts. Pleased to hear the new stuff I’m doing is of interest, I’m hoping to offer some original (profitable) insight into things with these new experiments.

      Also, it’s important to understand that I’m not trading without a system.

      I still have my entry points and exit points, and will still try and run my winners long but where the new system will differ from the old is in the granular detail of selecting stocks. For example, in the 12 Step PVT System which I wrote about a few weeks ago, there was 12 clearly defined entry rules that could be attributed to positions as ‘points’. Only when a position scored more than 6 out of 12 points did I consider entering it.

      In contrast, the new intuition-based system will only require a quick glance at the chart to check for an entry signal and then intuition will decide whether or not I will enter the trade.

      You asked if it was like picking a horse by name and gambling on a position and in actual fact, I think it is very similar to that process. My own view is that I think most trading is very similar to that process, regardless of what system you use. What seperates the winners from the losers does not seem to have as much to do with how you enter a position, but more about how you exit it and, like you say, your expectancy.

      In the Livermore example, I also think you’re right, and agree with you that if I picked 10 stocks at random, chances are that some would be winners. My question to you though is could those winners outstrip your losses if risk was managed properly and you let those winners run?

      Do systems really matter if you understand the more important factors of risk and running long and rely solely on chance and intuition to pick your trades? I guess we’ll find out over the next year or so 🙂

      Also, I think you may have slightly misread my comments on my October trades. What I said was that I believed I was becoming a better trader, and that this was evident in the difference between the trades I made in September and the trades I made in October. The only thing this proves is that I traded better in October than I did in September, but it had nothing to do with intuitive trading and certainly doesn’t prove anything along those lines. I’d need hundreds, maybe thousands of trades over years of trading to prove that, so the better performance in October could only be attributed to implementing a stricter, more controlled trend trading system.

      I’m not disputing that the trend trading approach works, and your millionaires prove it, all I’m suggesting is that I believe I can get an even greater edge by listening to the beat of human instinct instead.

      I’ll start applying this theory to all my new trades I make from now on, which should be all the trades in the November Analysis.

      It’ll be fun, I’m sure!

  2. Ahh. I think I’ve misunderstood then as your clearly have a defined strategy behind this. I was of the impression you had no money management and had no defined entry/exit.

    If we are just talking about the selection of trades then what your doing isn’t too dissimilar to myself. I can decide on a chart to trade within 1 second as I know what I’m looking for. I believe pickin certain types of trades, such as highs and lows give me a greater chance of finding a trend about to start, but I agree if you picked 10 random, cut your losses and let winners run you’d probably break even or make a small profit. Maybe even a big profit if you we’re lucky.

    Apologies, misunderstood your intentions. 🙂

  3. whilst i believe any method can work, be it fundamental, charting or intuition (which could actually encompass anything) it pays to be able to replicate it year after year.

    how do you ensure you’re using the same intuition trade after trade?

    at least with rules based systems you know you’re trading on the same basis each time. this is why ive recently started playing around with automated systems.

    1. Definately agree with Paul’s view here. I feel far more reassured that my back tested system has worked for many many years and therefore I have a positive expectancy that it will continue to do so should I be able to control my emotions and stick to the rules.

      This is especially important when you hit that losing run. It’s then easy to quit unless you have that knowledge that what your doing will be profitable in the long run.

      My worst run of losing trades so far is 11. If I didn’t have a positive expectancy of my system I’d have found it hard to continue trading after that.

  4. Hey Lee

    Great article! I like what you’re saying.

    As soon as you say you’re listening to your intuition, alarm start ringing for a lot of people but it depends on what they define “intuition” to be.

    I’m coming at it from a slightly different angle when I say intuition is us, calmly observing the chatter in our mind. Mindfulness is other great word in my humble opinion. Being mindful of what we are thinking, of our emotions. Then we can learn to tell if an urge to take a trade comes from negative emotions (fear, greed) or from experiential learning (what you can intuition right?)

    Great stuff, looking forward to more of your posts! 🙂

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