The Role of Adaptive Unconscious in Trading

The adaptive unconscious is thought of as a kind of giant “computer” that quickly and quietly processes a lot of the data we need in order to keep functioning as human beings. Psychologist Timothy Wilson describes it as follows: “ the mind operates most efficiently by regulating a good deal of high-level, sophisticated thinking to the unconscious, just as modern jetliner is able to fly and automatic pilot with little or no input from the human, “conscious” pilot”. This new notion of adaptive unconscious is not to be confused with the unconscious described by Sigmund Freud, which is a dark place filled with desires, memories and fantasies that were too disturbing for us to think about consciously.

When you are crossing a street and you suddenly realize that a car is about to hit you, do you have the time to think through all your options? Of course not! The only way that the human race could have ever survived as a species is by developing a sort of “computer” that is capable to make very quick judgments based on very little information.

A group of scientists at the University of Iowa made the following experience. They asked people to play a very simple gambling game. There are four decks of cards, two of them are red and the other two are blue. Each card in these four decks either wins the participant a sum of money or costs him some money. The participant is asked to turn over cards from any deck in a way that would maximize his profits. What the participant doesn’t know is that the two red decks are a minefield; the rewards are very high but when he loses on the red cards, he loses a lot. The trick is that the only way to win is to only take cards from the blue decks that offer medium rewards and modest penalties. The question was how long would it take an average person to figure this out?

The experience showed that most of us would need to turn over around 50 cards in order to start getting a hunch of what is going on. What is interesting is that we will never know why we prefer the blue decks, but we are almost sure, at that point, that they are a better bet. Only after turning out an average of 80 cards, most of us would be able to explain exactly why it’s better to avoid the red decks and just take cards from the blue decks. In other words, it took the average person 60% (30 cards) more tries in order to be able to explain why we chose to take cards exclusively from the blue deck.

As traders, we sometimes got out of a trade just because we felt something was “wrong” in the markets. Most of the time, we feel glad that we took our profits out before a quick reversal of the markets but we are unable to explain such a decision. Our adaptive unconscious stores market scenarios, data and patterns since the very first time we opened a chart. These patterns are recognized whenever they happen. A signal of distress is sent to our conscious and body and makes us close a trade out of fear but without a clear explanation why.

One of the first lessons we learnt on the psychology of trading was to build a fixed trading system that would keep us as far as possible from our feelings and more importantly as far as possible from what we think. In the case above, we demonstrated that our unconscious is faster, has more data stored and is able to take decisions long before our brain can explain it.

These kind of “unconscious” decisions (or gut decisions) are not always right. Depending on the experience of a trader, the unconscious part can have more or less data (or experience) stored. This would explain the variation of the success rate of these decisions between a trader and another. To go back to our first example, an adult man has more experience that would increase his chances of taking the right decision when faced to the car threatening his life compared to a young boy.

Whenever a trader gets out of a trade because he felt that a reversal is about to start and it happened that he is wrong, he should never regret his decision and the fact that he disobeyed his trading system. Most of the times, something “wrong” was occurring in the markets but it finally went the other way. He would be better out of that market behaving weirdly than staying with all the risk involved. From a risk-reward point of view, it is better to get out of a trade that would have ended in profits than being exposed to a market that was giving unexplainable signs of risk but clear to our adaptive unconscious.