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How to Avoid Brain Freeze

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June 1, 2014
How to Avoid Brain Freeze

Fear isn’t something you can mitigate by tinkering with watch lists or chart indicators. Even market veterans aren’t immune to the mental paralysis that can hit during tumultuous times. But there are ways you can get your mind right.

“Ninety percent of this game is half mental.”
—Yogi Berra

We can’t say for sure if dear old Yogi, the Baseball Hall of Famer, ever dabbled in the markets. But malapropisms aside, he may have been on to something investors can appreciate. There’s no doubt what your most valuable tool is (hint: it’s between your ears). Yet, the mind plays tricks, and during volatile markets when confusion and conflicting signals abound, failure to pull the trigger when needed makes you akin to that proverbial deer destined for a date with someone’s headlights.

Brain freeze can happen at most any time—right before you’re about to make a trading or investing decision, or maybe right after. Ask market vets such as Don Kaufman, Director of the Trader Group at TD Ameritrade, and they can recall vividly when this debilitating phenomenon gripped them. For Kaufman, the 2008 global financial crisis comes to mind.

It was October 10 of that year, Kaufman said, and the Standard & Poor’s 500 Index, the Dow, and pretty much everything else was down sharply. Kaufman had a large position in place and couldn’t evaluate the risk amid the wildly whipsawing market.

“It looked like the whole financial system was coming apart that day,” Kaufman said. “I just froze up. I just sat back, closed my laptop and walked away. I was frozen for a good 25 minutes. I felt like I was in a chess game with no way out,” he said. “Leaving your positions to chance is not trading!” Fortunately, by the end of that day, the markets had stabilized, and he lived to trade another day.

Fear is the biggest cause of brain freeze, said Brett Pattison, Educational Resource Manager at Investools®, a TD Ameritrade education affiliate. “Losing money hurts more than making money,” he said. So what’s the solution? Fortunately, there are several simple and straightforward principles investors and traders can follow to mentally prepare.

1. Keep It Small

Position size is “the number one thing,” Kaufman said. “Put risk at the forefront of what you are thinking, and your directional bias second. Size positions much smaller than you are actually capable of taking on.”

Patrick Mullaly, education coach and instructor for Investools, suggests risking no more than 1% to 2% of your total capital on any one position. Functions available on the tdameritrade.com secure trading site can help you monitor account balances and your “buying power” (see figure 1).

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FIGURE 1: Keeping Tabs. Click the My Account tab on the tdameritrade.com secure trading site for updated account balances and daily net changes (yellow circles), as well as the funds you have available to trade (red). Source: TD Ameritrade. For illustrative purposes only.

2. Define Risk Ahead Of Time

Before you enter a trade, have a preestablished exit price. “I take a lot of the psychology out of the market by taking defined risk option trades,” Kaufman said. “So, I always know going in roughly what the potential loss and potential profit could look like.”

Getting Vertical

A vertical spread strategy aims to counterbalance risks and rewards in a given stock by using options at different strike prices.

For example, a long call vertical spread, also known as a bull spread, is created by buying a call at one strike price while selling a call with a higher strike. A short call vertical, or bear spread, involves selling a call and buying another at a higher strike.

In theory, spread strategies such as these can provide a measure of protection from unexpected events for a limited amount of time by limiting the risk of being wrong, although the reward is also reduced.

One possible strategy is a vertical spread, which involves the buying and selling of two options on the same underlying security with the same expiration date, but different strike prices (see “Getting Vertical” sidebar for more).

3. Think Opposite

Take a step back to assess the landscape, and make sure you’re not following the herd over a cliff. “The wise person does things at the beginning of the trend, and the foolish or unprepared person does the same thing at the end of the trend,” said Mullaly. “Buy when everyone is fearful and sell when everyone is greedy.”

4. Separate Trading From Investing

Your entire portfolio “is not meant to be traded,” Pattison said. Take some of your portfolio, and think very long-term “and be prepared to hold through stormy weather,” he added. “Trade a smaller part of the portfolio.”

5. Relax, Seriously

If you feel brain freeze creeping in, deep breathing can offer a psychological and physiological antidote, according to Dr. Gary Dayton, a licensed psychologist and independent trader. Doing that “activates the parasympathetic nervous system and triggers the relaxation response,” Dayton said. “You will still feel stress, but you want to slow your physiology down so that your brain’s thinking centers—the prefrontal cortex—can open up.”

Dayton suggests taking in one continuous large breath—first, focus on breathing deeply into the lower lungs, then expand your rib cage in the middle and then into the top of the lungs. Hold it for a moment and follow with one continuous breath out. That tells your brain that “the threat is over and we can relax,” he said.

Ultimately, being mindful and aware is among the most critical conditions for traders and investors to learn—separating yourself from your emotions and physical sensations.

“We need to be mindful to help us to distance ourselves from all the stuff that is going on inside of us so we can manage the trade,” Dayton said. “We are frequent flyers to the past and the future. Having your mind in the present keeps you grounded.”

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