Monkeys, Marshmallows and Markets - 3 Simple Steps to Better Trading
May 2, 2016
16 Min Read
In this article you'll learn:
- A key predictor of success that's linked with trading.
- How and why we sabotage our trades and struggle to stay disciplined.
- 3 simple steps to enjoy more consistent trading results with less frustration.
In the late 1960s, 16 boys and 16 girls took part in a series of studies. The surprising outcome would go on to provide remarkable insights into human psychology and, more specifically, the psychology of success.
The kids, with an average age of 4 years and 6 months, would be individually led by the experimenter into a room with a table and chairs.
One by one, the children would sit down at the table, be instructed on what they needed to do and then be left alone by the adult.
On the table in front of them, was their only challenge in this whole experiment…...A marshmallow.
Before being left alone, the kids were told that they could eat the marshmallow as soon as they wanted. However, if they were able to wait for 15 minutes… they would get a second marshmallow.
On their own....
Sitting in a room.....
With a marshmallow.........
What could possibly happen?
**Cue dramatic music**
The outcome of what has now been called “The Stanford Marshmallow Experiment” was both fascinating and hilarious. Walter Mischel, who conducted the experiment, recalled that some of the kids would "cover their eyes with their hands or turn around so that they can't see the tray, others start kicking the desk, or tug on their pigtails, or stroke the marshmallow as if it were a tiny stuffed animal”.
As you can imagine, the footage from this experiment was pretty funny.
Of all the children that took part, a small minority gobbled down the treat the instant the experimenter left the room. The rest of the children attempted to delay, but only one third managed to resist temptation for the full 15 minutes and enjoy the reward of a second marshmallow.
The experiment was intended to investigate delayed gratification. But the follow-up studies revealed something far more important.
Unexpectedly, the results began to show an unusual connection to other areas of the subjects' lives.
The first follow-up study showed that 10 years later, as teenagers, the kids who delayed eating the marshmallow longer were described as "significantly more competent".
A second follow up study in 1990 took it a step further; it found that the ability to delay gratification also had a connection to higher SAT scores.
To put it simply: the ability to resist instant gratification in exchange for something more valuable, was found to be linked to intelligence and success.
Pay Attention Traders - These Results Impact Us Too!
In 2004, Dr. Thomas Oberlechner - a behavioural finance psychologist - reported the results of a survey in The Journal of Behavioural Finance, which showed Forex traders ranked 'discipline' as the second most important characteristic of a successful trader ('quick reaction times' were ranked first).
(Side note: this may come as a shock to those of you that follow 'traders' on Instagram and Twitter and thought having a rented Ferrari, fake Hublot and an over-inflated ego were the secrets to trading success!).
In other words, having the discipline to be able to resist the 'marshmallow in the markets' is perceived to be a defining attribute for a successful trader.
But what is the marshmallow in the markets?
The answer to that is easy...
The 'marshmallow' (detrimental instant gratification) for a trader is the temptation to focus on trying to achieve short-term wins rather than long-term achievements.
Which is an oxymoron really - because chasing short-term wins usually leads to losses in the short-term AND the long-term... Go figure!
This focus on short-term 'wins' typically presents itself in two forms:
- Aimlessly seeking a 'Holy Grail' trading strategy.
Today we're not going to talk about Holy Grail trading strategies...
If you fall into the category of someone that is searching for a magical black-box system that you can switch on before you sit down to watch Jeremy Kyle and instantly become a millionaire - I think you should stop trying to trade right away (so you have more time to focus on developing some common sense!).
Let's talk about point number 2: over-trading.
This article is going to be very, very different to what you've read before on over-trading.In fact, you may even be sitting there thinking "well I don't over-trade, I stick to my system. So this article is useless to me".
If that's the case, keep reading anyway - you may just end up discovering some home truths about your trading, which could be the tipping point for you reaching a more dependable and consistent level of success.
Marshmallows Reveal an Interesting Insight into Our Over-Trading Problems
We all know the thought process we're meant to take when we open a trade. Typically it should be something along the lines of:
"Does the current setup match the criteria for opening a trade as per my trading strategy? Is the profit potential big enough to open a trade? Are there any potential negative factors that could affect this trade?"
By taking that approach, with a solid trading strategy, you're looking at a consistent and sustainable career as a trader.
Sounds great, right?
But there's a problem... as humans, we tend to be incredibly irrational at times (particularly under pressure) and can end up making decisions that we later want to kick our own asses for.
If you've traded before, you'll know the type of decision I mean:
"Hmmm that looks like it might be a good trade setup. It doesn't fit perfectly to my strategy, but if I just adjust things a little bit, it could be an entry. Wait... OH NO! Sh*t... the market is starting to move. Quick, I'd better enter the trade - something is happening!"
This is typical FOMO behaviour - Fear Of Missing Out.
And isn't it funny how those trades always seem to end up being a disaster too?!
Surprisingly, there are logical reasons for us sometimes behaving in this way. And what's more - there are ways for us to avoid it and take more control over our decision-making process and our path to success.
The starting point is for us to take another look at the Stanford Marshmallow Experiment...
One of the follow-up studies delved into a different aspect of the experiment and came up with some interesting results. These results begin to help us explain the irrational course of action that we sometimes take as traders.
How Unreliable Environments Affect Our Ability to Wait for Successful Trade Entries
The follow up study was conducted in 2012 by the University of Rochester. They took another group of children, but this time they changed the rules and divided the group in two: the 'reliable tester' group and the 'unreliable tester' group.
Before the marshmallow aspect of the experiment had even begun, each group was promised something...
I.e. "take item X, but if you wait for me to come back, you'll have a better version of item X".
The 'reliable tester' group had their promise fulfilled - the experimenter returned with a better version of 'item X'.
However, the 'unreliable tester' group didn't have their promise fulfilled - the experimenter returned without the item and gave them an excuse instead.
As you can imagine, the results of the subsequent marshmallow test were heavily affected by this initial interaction. The certainty or uncertainty of the environment contributed to the children's ability to stay disciplined and delay gratification.
To put it bluntly - the 'unreliable tester' group no longer believed the second marshmallow would ever be presented (cynical little kids!).
Because of this interference, the 'reliable tester' group were able to wait for an average of 12 minutes, while the 'unreliable tester' group were only able to wait for an average of 3 minutes! That's a VERY significant difference.
Of course, the financial markets can be extremely uncertain and unreliable environments too. As a trader, there will always be situations where:
- You decide NOT to enter a trade for XYZ reason and miss out on some huge profits as a result.
- You decide to enter a trade for XYZ reason and end up with a massive loss this time!
- You enter a trade and see it move into profit. You close your trade early and take your profit - but then see you missed out on a lot more profit by not waiting.
- You enter a trade and see it move into profit. You DON'T close your trade when you should have and end up with a losing trade on your hands instead!
As a result of these sort of situations, the environment becomes uncertain for us and we don't see it as reliable. We end up feeling all sorts of feelings that can be linked to the need for instant gratification.
For one, we hate to feel like we've missed out on something, which someone else in a similar situation has received. This is that FOMO feeling again - seeing the market move and not wanting to miss the profits 'everyone else' seems to be getting.
This has even been found to be true in studies on monkeys who were 'paid' unequally for similar work (psst... I guarantee you'll laugh at this video!):
It may seem like I've got a bit side-tracked here, talking about underpaid Capuchin monkeys. But in fact, it's more relevant than you might think!
You see, our issues with over-trading are largely due to our own monkey brain.
Over-Trading with Our Monkey Brain
You'd probably agree that most of the time, you're in control of your own actions.
(Apart from those times, like the picture earlier, when you go into a fit of rage after losing a trade and want to smash your keyboard with somebody's face).
Unlike the monkeys in the video, which operate more on instincts rather than our level of consciousness.
But in actual fact, you're not too dissimilar to them really.
You see, inside our own heads there are two very different aspects to our mind at play: the 'monkey brain' which is in your limbic system and the 'human brain' which is in your frontal lobe.
It's the 'human brain' that you typically associate with more and consider to be 'you'.
I won't be going into too much detail about how and why the brain operates in this way, as there are plenty of books out there that do a better job of that. The most famous one recently being "The Chimp Paradox" by Dr. Steve Peters.
Instead, let's quickly break down how the monkey brain affects our decision making when it comes to trading and then move on to actually understand what we can do to control this and allow our human brain to make our trading decisions instead.
Unlike the human brain which is very logical in its approach, the monkey brain is driven by emotions and can be very irrational. The monkey brain is also quick to react and will take over a situation instantly.
In the wild, a monkey only needs to think about the present moment. It knows it needs to eat, sleep and think about survival.
Therefore, to the dismay of traders around the world - it is highly focused on instant gratification. It doesn't care about the future.
What's more frustrating is that the monkey brain is quicker to react and is a stronger element in our mind than the human brain.
Ever had problems with procrastination? ...That's the monkey brain.
Ever met a hot-headed person who reacts angrily at any little thing? ...The monkey brain again.
Ever opened a trade because you got bored of waiting for a good opportunity? ...That bastard monkey!!
Of course, in our brain we also have a database of past experiences and knowledge that we can call upon to help us with our decision-making.
The human brain may access this database and come up with a rational decision; using past experience and knowledge, combined with the present situation.
Whereas the monkey brain will take the past experiences and react emotionally to the present situation, based on that past information.
For example, if you keep losing trades in GBP/USD, your monkey brain might refuse to open trades in that market ever again, because it assigns the losses to being "GBP/USD's fault".
Annoyingly, it's the monkey brain that gets access to this database first!
So when we take a look at our 'marshmallow in the markets', we can begin to understand how the unreliable environment that we experience is leading us to making rash decisions...
The monkey is reacting emotionally based on previous experiences in the markets and is therefore trying to gain instant gratification without any consideration of the future.
This is a topic I could talk to you about for hours and go into much deeper and more technical detail...
But it's already becoming clear that the only way to avoid making these wrong decisions is to control our monkey.
So let's stop beating around the bush and take action to solve that problem.
How to Control Your Trading Monkey
As Dr. Peters suggests, there are three ways to stop your monkey brain from taking over the decision making process:
- Exercise the monkey brain.
- Control the monkey brain.
- Reward the monkey brain.
For each of these options, I've provided a practical and simple step you can put into action instantly. These will help you to delay your need for instant gratification and ensure your trading decisions are made correctly.
Of course, these actions don't need to be taken in isolation. In fact, if we commit to doing all three, we stand a better chance of controlling that gorilla in our head and resisting the marshmallow.
1. Exercise the Monkey Brain
No, this doesn't mean going for a run or hitting the punching bag for half an hour. I'm talking about letting the monkey brain exercise whatever emotional or irrational behaviour it needs to perform.
Have you ever had someone do something really petty but very annoying at work? You know it's not something worth getting worked-up over, but somehow your emotions take over.
In that situation, what do you do to feel satisfied?
Usually, you'll go and rant about it to someone and say all the things that have been on your mind in your emotion-driven state.
"Getting it off your chest" as we say.
This is exercising your monkey brain. And the same needs to be done when we're trading too.
However, in the case of trading, ranting isn't going to help the urge for instant gratification. Instead, we need to allow the monkey brain to perform the action it desires - to open or close trades.
This can be done proactively or reactively.
Proactive exercise can take place before you start trading with real money in the markets. While you're still in your learning phase. This way you store the experience in your mental database and avoid the future desire to make emotionally-driven decisions.
We've included this type of exercise as part of The Duomo Method, which we call the 'Wild Horse' approach.
On the other hand, you can also use reactive exercise.
This would mean you have either a demo account of a smaller portion of your live account and allow yourself to open any trades based on emotional decisions or sudden gut-feelings about the markets in one of these accounts.
This way, your monkey brain will be satisfied with the feeling of executing a trade based on the irrational decision-making process, while your 'main' account is protected from potentially being harmed.
2. Control the Monkey Brain
Trying to control the monkey brain is the toughest out of the three options.
Imagine trying to tame a wild monkey... yeah, that's what we're dealing with!
However, that doesn't mean it isn't possible.
The simplest way to control the monkey is to restrict the freedom you have to 'trade in the grey area'.
The grey area is the zone between the black and white. It's the area that gives you creative flexibility when opening trades - where your guidelines are open for interpretation, depending on the situation.
Instead, we want to restrict this zone by setting clear criteria for opening and closing trades, which we will then enforce by requiring ourselves to complete a checklist before opening a trade.
Think about how a pilot makes his cockpit checks before take-off. Sure, he might have done it hundreds of times and know exactly what everything is going to show him. But he still does his checks.
If you're following a strategy (which you should be!) then creating a checklist for your trade entry and exit criteria should be straight forward. This avoids any hint of the monkey getting involved in your trades, as the decision-making process is externalised.
3. Reward the Monkey Brain
Just like the Capuchin monkeys we saw in the video, the monkey brain will happily perform a task you want it to - if it's rewarded for it!
Luckily, unlike the Capuchin monkeys, we don't need to feed our monkey cucumbers or grapes. Instead we can reward it with something far more exciting for us.
In the case of trading, the reward should be straight forward - if you trade well, you make money!
However, it's never that simple.
Over the long-term, we want to realign our 'pleasure and pain' so we feel rewarded automatically when we stick to our trading strategy. This is something I discuss in detail in our full online trading course.
However, in the short-term we need to find our own reward for 'good behaviour'.
This might be something as simple as a walk in the park for a well-behaved morning trading session, or maybe even a glass of champagne to celebrate opening a trade that followed your criteria.
Side note: Just make sure it's at the end of the trading session... drunk trading never goes to plan!
Ideally you should have some smaller rewards that appeal to you, which can be easily provided after small positive decisions and won't distract from your trading day.
These can then be followed by bigger rewards for particular milestones, such as making it through the entire trading day without mistakes, having a successful week or sticking to your strategy perfectly for 10 consecutive trades.
Putting It All Together
If trading was mainly about finding the correct entry points in the market, every day-trader would be rich.
Learning the technique of trading isn't so tough, it just takes practice and a good method.
Unfortunately, trading is 80% psychology and only 20% technique - which is a shame, because the human mind is incredibly complex and frustrating.
However, understanding how our mind works and how we can control certain impulses, will allow us to join the successful minority of traders... Rather than the 95% of traders that lose their money in their first year.
Through the outcome of the Stanford Marshmallow Experiment we can see what effect delayed gratification can have on success, particularly in the follow up studies that involved unreliable environments.
When combined with our understanding of trading, this gives us a clue about what needs to be fixed in order to become a better trader.
If we can control the impulsive, emotionally-driven 'monkey mind' which likes to live in the present moment and craves instant gratification, we can stick to our strategy and perform a lot better.
Starting right NOW, we should all be taking the simple 3 steps outlined above, to get this part of our trading handled once and for all... Exercising, rewarding and controlling the disruptive monkey in our mind.
With a bit of practice, we can all transform our irrational, marshmallow-munching mind from a dominant gorilla to a mildly-protesting Capuchin.