Clearing Emotional Hurdles Leads to More Profits

Money managers aren't rescuing people from burning buildings, but their profession comes with plenty of anxiety nonetheless. Investing in the stock market is pretty much a zero-sum game: You're either winning or losing. More stress-inducing is the market's volatility — in the morning you're up a few million and by lunchtime you could be out that and more. Investors feeling whipped by the market's oscillations could find some serenity in Dr. Ari Kiev's counsel. Kiev is a psychiatrist and coach who works with professional money managers, including some hedge-fund managers whom he declined to name, to help them overcome the emotional hurdles associated with daily trading.

In his latest book, "Mastering Trading Stress," Kiev relies on case studies and conversations with traders he's worked with to illustrate, for example, "misapplied meditation and visualization techniques," and the difference between confidence and arrogance and how that can affect your trading.

Though it sounds a little touchy-feely, one of Kiev's pieces of advice is to embrace the anxiety and discomfort associated with uncertainty. In order to do that, he recommends some clients to record in a journal their emotional responses (panic) to market events (gold-mining stocks are tanking). That allows traders to, you guessed it, get in touch with their feelings. Breaking down overwhelming and complicated thoughts into their concrete parts makes them more manageable. Experienced and successful traders, Kiev says, learn to stand outside of their reactions and work hard to get control over their stress.

"Under stress, you're much more suggestible and easily influenced by extraneous factors," says Kiev, who has worked with professional athletes like former NBA players Isaiah Thomas and Kevin McHale, the U.S. Olympic bobsled team in the '80s and several figure skaters.

SmartMoney.com: Why did you focus on stress in this book?

Ari Kiev: In each book I've written I've had a little bit about stress, but I decided it was a good idea to do a book completely focused on stress. Much of trading success has to do with mastering stress, the psychological ability to function in the face of stress, and to recognize how you may be maladapting, how you may be trading inefficiently, making mistakes because of stress. You need to learn to recognize when your behavior is so influenced by stress that you're doing things for psychological reasons rather than for strategic investing or trading reasons.

[I give] examples of how people respond, misinterpret events or overreact to their own psychological responses. How they, in the face of their own stress, begin to go into default modes when they react like a deer in headlights. The more experienced traders, over time, learn to recognize their own responses, to detach their trading from their emotionality. Not that they stop feeling stress; they just don't trade in terms of their feelings.

SM: What are some of the most common mistakes traders make?

AK: The most common mistakes people make as a result of stress are to fail to recognize that something that's happening to a stock may be due to a real change in the stock or to the impact of the market. And so they bought a stock at $20, it dropped down to $17, and instead of analyzing the situation and saying the market is bad, this could get worse and paring down the position, they rationalize the position. "I loved it at $20, so I love it even more at $17."

They hold it or buy more. They say Warren Buffett looks for cheap stocks. They find rationalizations to stay in it. The more experienced guy says the market is telling me something. The smart thing to do is cut my losses, wait until the market turns, and get back into it at that point if the story is still a good one. The panicked person thinks you'll lose the upturn. It's more difficult to get back losses than to make money.

AK: I spoke to some [clients] today to ask how did things go in November. One guy said, "I made the most money in my high-conviction ideas," where he had done the work, where he knew something the rest of the world didn't. He analyzed everything about the company. And he lost money in low-conviction ideas; that's where he says it's only a 1% position, so I can't lose that much. That may be true, but if five of those go down, that could be substantial. The individual is governed by a desire to make money, by certain habits — not being as disciplined, not being as systematic, not reviewing how he's been successful in the past. All this sounds relatively easy to understand, but in the face of stress people don't do what is the most rational.

I was talking to a guy who had been shorting the subprime mortgages, and he made a killing this year. He had gotten to running a fairly substantial fund over time.... He said in these tough markets what he thinks differentiates winners and losers is that [the winners] have practiced their fire drills over and over again. They have done analyses of how they would play it for a variety of different scenarios. So he practiced what he would do in the event of certain circumstances. If you learn how to do lifeboat drills, you can prepare yourself to know how to handle a situation when it comes.

You have a procedure, you have a process. You have risk-management principles in place. You can ride through the storm, and not try to get it back while the storm is going full blast. You learn to be prepared to deal with difficult circumstances; you're waiting to see where the opportunities are. If you've never been in that position before, you start panicking and making mistakes, you start listening to the TV, or take a colleague's advice, without necessarily doing the work yourself. Under stress, you're much more suggestible and easily influenced by extraneous factors.

SM: You're a trained psychiatrist. How much actual therapy is involved in your work with money managers?

AK: In my first book I talked about the necessity of setting a goal and target, really committing to an outcome, very much like someone who sets out to win a gold medal. In creating a portfolio, you're generating a requisite number of ideas, hiring an analyst to help you do models, really understanding a unique view from the rest of world.... I spend a lot of time helping people stay true to their objectives; they're learning more about themselves, observing themselves, how to get out of their own way, how to be less egotistical, how to be more thorough, more cautious, and not to be impulsive.

People need to be open to that kind of dialogue, open to self-examination, so they begin to see successful performance in trading has to do with managing yourself. Trading is very much a signature activity; it's really a reflection of who you are. It's not just an academic, intellectual exercise. The best portfolio traders are not just smart; they have a combination of head, heart and guts. You have to be a risk taker, you have to be thoughtful, you have to really love what you're doing. The best guys do it in their own way, but what they share in common is they are willing to make sacrifices to make outsize gains.

SM: What are some techniques you offer to help people handle trading-related stress?

AK: One is to learn to differentiate your reaction from the interpretation of your reaction. Then look at what do you do in the moment of reactivity: you hold on, you get paralyzed, you overtrade, you start listening to other people. The more you can monitor this, the more you're able to differentiate between the event — things going on in the market, in your stocks — and your response. You begin to see there's an event, you're reacting to it, you're reacting to your reaction, you're doing something, which might be a habit you started early on in life. These are the kinds of conversations and principles I would discuss with people.

I suggest keeping a diary, getting over the need to be macho and covering it up. The best guys are comfortable with being vulnerable. The guys that I've known, amongst the most successful, are very much aware of themselves and are inclined to be able to acknowledge their own fallibility and their own humanity and to function independently of that, despite their reputation. You're always being tested.... You're better off without the ego. You're always measuring [your performance]. You have to learn to sort of stand apart from it. You have the goal and periodically you check where you are relative to the goal, but you're not so obsessed with it that you're paralyzed by it. And you have to learn how to empower other people, because you can't do this alone.

SM: You mention these techniques as a way to deal with "destructive emotions." What do you mean by that?

AK: Destructive emotions could be greed, panic, envy, anxiety. It's whatever you're feeling that takes you out of the game. It's no different than what you feel in other walks of life. People in the trading business, I think, are living many lives compared with someone who leads a more sedentary life. Even in a private-equity fund you're dealing with risk, but it's on a longer horizon. The hedge-fund world is much shorter term than the Warren Buffett world. So these people are dealing with volatility in their portfolios and emotionality. You really need to learn to ride it out. The more experienced people experience it, but can live with it and function independently of it.

SM: Insofar as they can be at all, how can your tips apply to the more average investor who perhaps is not dealing with market volatility on a daily basis?

AK: I think the lessons are really the same. The basic issues that professional traders are dealing with are the same issues ordinary investors are dealing with, but [professionals] are a little more motivated.... The way in which people respond to stress is sort of built into our DNA and biology. Whether you're a professional or amateur, you'll experience the same thing. What makes you a professional is you'll work harder to master the maladaptive ways you deal with the stress. You can work harder to stay cool. The ordinary investor has to learn many of these same principles.