Emotion Analytics: The Missing Ingredient in Personal and Professional Risk Management

Contributed by Denise Shull, Author of Market Mind Games: A Radical Psychology of Investing, Trading and Risk

We have all heard it a thousand times: “take the emotion out of it.” We have heard it from our bosses, our friends, and certainly from our financial advisors.

Yet as far as investments go, analysts now give “conviction” ratings along with their buy and sell ratings. What’s with that? If conviction doesn’t imply an emotion – surety or confidence – what does it imply? Think about it: is confidence a feeling or a thought? It is a feeling, right? It may be based on thought, but when it emerges, it is a feeling – something we experience physically, like all feelings.

The fact of the decision-making matter is that no one, no matter what he or she claims, can make any sort of decision without emotion. There is no disputing the research on this matter. A top game theorist and neuroeconomist said, “it is not enough to know what should be done, one must also feel it.”

In Defense of Emotion

The ostensible wisdom of removing emotion arises out of mistaking a feeling for an automatic action. Clearly they aren’t identical psychological events. It is entirely possible to feel something, to analyze it and choose an action after parsing the meaning of the emotion.

In fact, when it comes to optimizing your own psychology around any risk decision – market, job or life – this welcoming of the feelings, versus attempting to set them aside, turns out to be a particularly useful strategy.

With anything uncertain, our brains search for context, and a large share of that context is the pre-existing internal one – better known as our beliefs and emotions. Harry Markowitz, the father of asset allocation, said step one is knowing what you believe. (Again, a feeling of confidence is part of a belief, is it not?) Step two is the allocation. He reiterated many times that his prize-winning paper started with step two!

In practicality, be on the lookout for two ends of the fear spectrum: The fear of being wrong or losing money and the fear of missing out or what really equates to the desire to avoid regret in the future. Pay particular attention to the fear of being wrong – now or in the future – as, first, there will always be some fear and second, beneath the superficial experience you can find a part of your psyche that is fractal, and therefore typically irrelevant to the decision at hand. It is the part where the feelings in your memories get projected on what you anticipate will happen in the future. Freud called it transference, but today the neuroscience of emotion and memory is revealing how the patterns that began early in life are infused into our perceptions in totally unrelated questions later in life.

When our brains search for context, some context is external, but most is internal. Research shows that 95% of what goes on in our heads happens below our awareness level. The trick to making better decisions involves bringing as much of that 95% as possible to the conscious and analyzable level. In fact, you can go a step further, by getting systematic about analyzing the reasons for your emotions in any risk decision and then walking away before making a decision. Give the question back to your unconscious and allow the answer to come to you – even with a stock investment.

Neuroeconomics of Women

As is said in neuroeconomics, “complex decisions are best made non-deliberately,” and the aforementioned itemizes the series of steps for doing that. In fact, with investment decisions, this strategy logically leads to your brain tapping into “theory of mind” or the ability to predict others’ behavior. No one stops to think about it, but this is the purest question of investing – predicting that others are going to value something at a higher price in the future than they value it now.

And again, new research shows that investors or traders who are tapping into their people-reading skills are better at predicting markets.

The science on whether women are technically better at theory of mind than men has not actually been established, but it stands to reason from other things we know about women (their tendency to collaborate for example) that women make a deliberate attempt to solicit others’ perceptions. Thus, one can logically infer that as our unconsciousness’ work on questions, we interject some data about what to expect from others.

The final question then becomes how you tell the difference between feelings that are intuitive – or what is really unconscious pattern recognition – and ones that are impulsive or driven by the fractal patterns of self-perception and expectation created early in life. The easiest way is to look at the urgency. The events or data that make us want to react immediately are probably impulsive. The much more serene feelings of “just knowing” are more likely to be intuitive.  The two can also be merged together, but taking the “emotions as data” and proceeding through the analytics of them untangles that problem.

It takes practice to successfully get the hang of using this qualitative approach to risk decision-making. It isn’t the curriculum of an MBA. It is however, the missing ingredient in effective risk-management – for your own portfolio or for the ones you manage for others.