Random Rewards is one of the primary causes of trader failure.
In the course of learning to trade, you will have losses and they will cause you pain.
You may not remember the details of those painful experiences, but your brain stores details about everything that ever hurt you and tries to avoid those things in the future.
A trader’s relationship to the market worsens for the same reason marriages tend to get off track: too much pain and not enough reward. If the balance of pain and reward is poor, your mind begins to associate key market patterns with pain. In marriages, the ratio of positive to negative experiences needs to be around 4:1 for the marriage to last. The same ratio holds true in trading.
The Tipping Point
If the balance of reward vs pain is around 50-50, most traders will not be able to stay emotionally balanced. If you win and lose about equally, the trading environment becomes “randomly rewarding.” What this means is that Action A sometimes produces a Reward and sometimes produces Pain. The brain of the average trader (and of mammals in general) is not at all happy with that 50-50 ratio.
The randomness of reward causes us to try harder to figure out a more satisfying solution. Rats that are rewarded randomly press the lever in the cage faster and more frequently. Ultimately, however, a randomly rewarding environment becomes a terribly demoralizing situation, even for a rat.
Neither humans nor animals can tolerate being powerless to act consistently in our own best interest when the consequences of failure are painful. Prolonged random reinforcement is so toxic to the mind that it has been applied as a brainwashing technique to break down psychic cohesion and resistance in prisoners of war.
It is not unusual for randomly rewarded traders to feel as though they are literally being tortured by the market. And they are. No wonder so many traders quit. But before they do, they typically enter a debilitated state in which they trade poorly as they try various desperate measures to rescue themselves.
Random & Senseless Acts of Trading
In this highly ambiguous situation, a trader’s own behavior becomes more random in an attempt to sync up with the market. As uncertainty becomes more and more uncomfortable (because it becomes increasingly associated with painful consequences) traders come to over-rely on analysis, intuition and gut feel.
Randomly reinforced traders shift focus on their trading plan and focus on trying to predict what the market will do next in order to avoid the painful consequences of being wrong.
If rewards from trading remain at a random level, the emotional damage increases to the point that a trader’s behavior becomes increasingly chaotic and results in an account blow up. On average, traders re-fund futures accounts 3.8 times before the torturous “wash and rinse cycle” is complete and they are hung out to dry.
It is crucially important for 96% of traders to increase the ratio of wins vs losses well above 50-50. For about 4% of traders, it does not matter.
Until next time,
Dr. Kenneth Reid holds a Ph.D. in Clinical Psychology. He is currently a trading coach and has published articles for Forbes, SmartMoney, and SFO Magazine. He has also appeared on CNBC and writes a column on The Trading Psychology for Trader Planet. Kenneth Specialized in trading stock and futures and is working on a futures trading book.