The REAL Reason You're So BAD At Trading | Trading Psychology

Hello and welcome back to lesson two of the advanced psychology course for high performance trading. This video is looking at decision evolution. How our decision and judgment systems came to be the way they are and why do they seem to make trading so hard. Most traders have at some point questioned whether there's something wrong with them because they're so frustrated with their lack of success. What I'd like to show you in this lesson is that there's nothing wrong with you if you you can succeed at trading. You just need to realize your mind developed long before capitalism or financial markets. And so some of your decision systems are maladaptive for the trading environment. In which case, understanding how your mind works and learning to retrain your decision systems is the key. And this video will deal with the first part of that, how and why you make the decisions you make. In the last video, I introduced the hyper simplistic model of the Brain with System 1 and 2 and how these two systems differ in their approach to making decisions. System 1 is faster to think and act, but relies on automative and instinctive reactions. System two is much slower, but it's more methodical and it prefers to check everything. System two is your self control, forward planning and general oversight system. It's also a relatively recent addition to our brain's development, meaning it's way more fragile and easily knocked out if you're not aware of how to use it or how to look after it. Without question, the oldest, the most powerful part of the brain is system one. And given that its functioning is almost entirely unconscious, it does leave us wondering exactly who is in charge of our decision making. Without self awareness, self control and oversight, system one can be running a show 24 hours a day, leaving us impulsive, emotional, defensive and at the becking core of our most basic needs and fears. Not what we need when we're trading, it's like trading like a chimp when system one is in control. But how has this come about? Why does system one have such power and control over us? Why isn't it the logical, rational and methodical system two, which more control? Well, until relatively recently, humans have existed in an unpredictable, chaotic and threatening environment. Humans not only had to hunt for food, but were themselves liable to become lunch. For another animal, survival meant making rapid decisions when faced with threats. Do you stand and fight, freeze and hope you go unnoticed or run away? System 1 is primarily designed to quickly evaluate threats and then prepared a body for for a physical response. People who made quick and appropriate decisions survived and they crashed on their genes and their decision making systems to their children. As a result of that, over time our brains have prioritized basic survival and reproduction above all else. Obviously it makes sense it wouldn't be able to reproduce at all if it didn't. All of your ancestors, stretching back forever, have put survival and reproduction before everything else. Therefore, as we'll learn in this video, your brain has developed the capacity to override slow conscious thought. And it regains almost total control of your mental and physical responses if it thinks your survival or your ability to reproduce is in question. System one is online 24 hours a day and scanning for perceived threats when it's faced with uncertainty or incomplete information, which in this picture, incomplete information means low light. What System one has become incredibly good at is trying to ascertain whether it's faced with a threat or an opportunity. Sometimes it might be both, of course, or a close call. But most of the time, System one has learned that it is best to assume that every unknown is a threat rather than an opportunity until proven otherwise. It's behaving like an oversensitive smoke detector, preparing you to react at the slightest unknown stimulus. It's white thights seem to erupt in bars out of nowhere. Alcohol has knocked out System 2 completely, and System 1 is left standing for assumed threats, overreacting to the slightest nudge, look or comment. But it makes perfect sense that threat evaluation would be oversensitive. Would you prefer an over or an under sensitive smoke alarm in your house? Putting up with the occasional false alarm from burnt toast is much more preferable than to be in burnt alive yourself. The first time the real fire breaks out, you will have experienced this oversensitive threat perception at work in trading. By definition, we have incomplete inclination because it's impossible to know exactly what's going on behind the scenes. And the non stop stream of price data presents unlimited opportunity and unlimited risks. It's the perfect environment for System one to be on high alert. And in the face of too little information and a lack of certainty, it's safer for System one to assume this is a threat rather than opportunity. And then you're left with fight, flight or freeze. Now, when humans are forced to fight, either because the opportunity for food was critical to our survival, or it was an obvious physical threat against us, System one concludes that it needs to throw everything at it, kill or be killed. Historically, threats of almost all being physical ones, and the only way out of a physically threatening situation is a quick, decisive and extreme physical response, not a slow methodical or logical one. There's no Time to sit down and make a plan. So this next part is one of the video's first big lessons. Under threat, System one takes more risks. In a way, it becomes more optimistic, fancying its chances against far bigger and stronger opponents. Without this form of hormone induced optimism, we'd simply do what sheep do and we would just sit down and wait to be eaten by whatever. It seems like an overwhelming threat. This is the exact same mechanism that can be seen in sports teams when they become more optimistic about taking risks when they're behind or they're on the back foot, so to speak. Now, of course, this strategy doesn't automatically lead to survival. But those that did survive passed on their genes that prioritized extreme risk taking and optimism in the face of extreme threats. Those that didn't stand and fight, those that cowered or sat down to work things out logically and methodically were routinely removed from the gene pool. Now, System one's approach to risk taking wasn't just shaped by physical threats. It Humans have evolved almost entirely just above the level of subsistence, meaning that we were only just a few meals away from beginning to starve. So unlike today, historically supplies of food have been scarce and unpredictable. When food levels fell below the levels needed for our Big six survival, we learned that we needed to take more risks to obtain food at any cost. If we were malnourished, it was our only option to take more risks and go on perilous expeditions or risk poisoning from from an unknown plant to survive. Again, taking risks didn't guarantee your survival. But those that didn't take massive risks to find food by any means, definitely did not survive. They sat down and withered and they didn't reproduce. So when faced with scarcity, System one has learned that excessive risk taking is its best but not guaranteed chance of survival. It's also learned that in this situation, long term goals and planning are completely irrelevant. The objective is to survive in the short term. Let's just live another day. So you can see why System 1 functions the way it does when you're trading. If you're in a losing position or your account is in a drawdown, System one is going to make you take bigger risks and engage in much higher risk behavior, like adding to losing positions or doubling up your position size. And when System one perceives a threat, it prioritizes the immediate short term with absolutely no consideration for the future. It makes you hyper focused on the success or failure of an individual trade and you end up neglecting what would be best for your long term success. Now, although System 1 has learned to prioritize survival and reproduction above anything else, there's obviously more to it than that. Protection of itself is the highest priority, but it's also concerned that you're making decisions that ensure that your mate, children, tribe and species overall survive. It works as a kind of constant advisor and motivator to ensure that your actions are directed towards finding a mate, reproducing, and then protecting your offspring. And beyond that, given that humans are not the biggest or strongest creatures on the planet, we've developed highly complex social structures. We've learned that we are much more likely to survive in numbers and to form tight communities of people who we can trust and come together to defend ourselves. Now, if you're wondering how that's got any relevance to trading, let me just give you an example. If you have a family that you are financially responsible for, and the money that you're trading with could affect them for better or for worse, that will impact your trading due to System One's priority to protect those relatives. And even if you don't have a family, in that sense, your status within a social group becomes the focus of system 1. Telling your friends you've just lost your hatch because of a bad trade or investment is going to damage your standing within the group. But showing how you just made a million dollars due to your intelligence and skill will elevate your status within the group. That kind of thing matters to System One. You only have to look at trading forums to see the extent to which most people spend more time defending or, or promoting their status, rather than focusing on actually improving their trading. But why? Well, for most of our history, our membership of communities and our status within them has been a critical survival strategy. Surviving in communities enabled us to collect, store and process more food, as well as enabled us to divide up jobs so we can become more specialists in tool making, hunting, childcare, medicine, and better shelter. Without secure membership of these protective communities, we ran the risk of being chucked out beyond the city or the village walls to be once again exposed to the elements, creditors, and having to be entirely responsible for our own food supply. So System One prioritizes membership of a community at all costs. But staying a member of a community for protection is, is not as simple as getting along with everybody. Membership requires competition within it. There's always been fierce competition for status, roles and mates. And by gaining status and power, you decrease the likelihood that you'll be rejected and left to fend for yourself. Take a look around you in the modern world and you can see the deep drive people have to gain status and be respected within their groups and communities. The pursuit of specific careers, fashion, appearance, concern over what other people think, reputation and the quest for control and power. They are all System 1's biological effects on our judgment and decision making. The need to be right and more importantly to be seen to be right is one of System One's ways of trying to maintain our status and self respect. Admitting that you're wrong is very hard. For this reason, System 1 has a tendency to defend its opinions at all costs to maintain status. Trading is a great example of lots of smaller communities who defend their approach and their systems and their indicators and philosophies at any cost, even in the face of massively overwhelming evidence that proves that they are wrong. Their need to be seen to be right and remain in their selective community is more important to their System one than updating their beliefs and ultimately becoming a better trader. That plays havoc with a trader's mind. The trouble is, our Brain and System 1 have developed in a very physical environment. And our communities worked with the land as the ironer's picture. Not tapping away on computers, it was housekeeping, making, repairing, building, agriculture, hunting and fighting. System One's judgment and decision making systems are really geared towards preparing the body for physical work. For physical tasks. System 1 has learned that more work leads to greater output. Obviously, the more we hunt and forage, the more likelihood we will find food. The harder we work in the fields, the more productive the land will be. The quicker we build, the more shelter we can provide, and the harder we fight, the more likelihood is that we will conquer our opponent. And when we work harder and faster, System One rewards us with addictive euphoric chemicals such as dopamine. It has learned over millennia that the more work you do, the more likelihood you will survive. So it motivates us to push on. But the modern world demands much less physical activity and puts a lot more emphasis on pure thinking such as trading. The problem with that is that when we find ourselves facing a risk, System 1 still defaults to hard and fast work equals better results. And this can be a massive problem in trading. If you've been in a losing street, System 1 will automatically encourage you to work harder, take more trades to dig yourself out of the hole you're in. But if you're losing because you're just not very good, or your system is bad, or the market is bad, taking even more trades is only going to increase your losses. Similarly, if you've been on a winning street System One will tell you that if you've got good results doing this much work, if you work twice as hard, you'll get double the rewards. That's obviously not true. In trading. The market conditions dictate the number of opportunities you have. So if you increase the number of trades you take, you inevitably end up taking substandard trades and you get worse results. Now, when looking at these workers sat exhausted under a tree, it's difficult to appreciate how the world must have looked to them. We take it for granted that we understand why the sun comes up, why what stars are, how animals and plants develop, and what causes natural disasters and weather patterns to the average person. Even a few hundred years ago, let alone a thousand years ago, the simplest aspects of our existence would have seemed mysterious and unexplained. But actually, we did make sense of it. Maybe not the right sense, but we did make a sense of it. One of System 1's primary functions is to see patterns in the chaos and make meaning from it. System one is a pattern spotting and learning engine, trying to see repeating patterns and movements in animal migration, the weather, the stars, human behavior, and create theories and explanations for all of these patterns. Now, while System One is exceptionally good at spotting repeating patterns, we don't always understand why or how those patterns exist. Take animal migrations, for example. We might have assumed that the migration patterns were driven by spirits, rituals, or the results of our own mistakes. We thought that mental and physical illnesses were punishments in response to past transgressions. So although we are incredibly good at spotting patterns, the patterns may be false. And even for true patterns, we're uncomfortable with not understanding why the patterns exist. If we see a pattern, our systems immediately and fiercely try to explain it, even in the face of incomplete information. Their pattern recognition is obviously a key requirement in trading. And it's also, unsurprisingly, one of the things that traders are spectacularly bad at. We see false patterns everywhere and we apply meaning to them. We make trading decisions based off them, and we tie ourselves in knots. Lesson 11 of this course is dedicated to pattern recognition, specifically as it applies to trading, so I won't go into any more detail on that bit just yet. The last thing I want to consider from a historical perspective is, is that humans were negotiating and trading way before the introduction of money or even writing. Humans kept mental records of what they borrowed, lent, bought and sold, and at what costs. System One has therefore developed an incredible internal mechanism for keeping records, which we're going to try and explore in the next few lessons. You've experienced this capacity when someone does you a favor or you lend a friend $50. For these small social transactions, we don't have to keep written records. We keep intuitive mental accounts of what we owe and what we are owed. And this mental skill has ensured that transactions are largely fair and equal and were not taken advantage of. And most importantly, it's been the mechanism by which we have cooperated towards common survival goals, such as collective agriculture. For instance, if your farm has an excess one year, you might be happy to offer the excess to another member of the community, knowing that if you have a bad year, you can always fall back on those you've helped previously. These mental accounts have also allowed us to swap like for like tools for corn or a day's labor for medicine. It's incredibly useful in managing social relationships, but it really wasn't designed for trading. In trading, System one keeps a very simplistic record of your wins and losses, particularly in the short term, like today, or maybe the week, or this month. But as I keep saying, trading is a probabilistic activity where edges only balance out over the much longer term. But System one doesn't really understand this because it's designed to keep short term generalized emotional records. The next figure in this series, lesson three of the course, delves into that topic in much more detail. I want to move on now to System One's six main priorities. I started by saying System one has two priorities, to protect itself and to reproduce itself. But as I said earlier, VAR is an over simplistic description. To achieve those aims, it has developed a broader set of priorities which you must understand if you want to be able to trade effectively. If you don't, these will disrupt every part of your trading. There are six to be aware of. The first one is to defend oneself from physical harm. We've talked about that already. The second is to make friends and be social. The third is to maintain membership of a network or community. The fourth is to attract a reproductive mate. The fifth is to keep that reproductive mate. And the sixth is to ensure that your offspring survive. These are all judgment and decision circuits that are introduced sequentially as we grow up, but they continue to function in the background as new layers are introduced. In a way, these are independently operating circuits of the brain with different priorities. We'll refer to them as sub selves from now on. So let's start first by looking at how these unfold developmentally. At one years old, we're simply concerned with our own physical safety and existence. Being fed, watered and Trying to avoid physical harm from animals and siblings. This physical harm sub self remains the most powerful circuit in system one. From two years old, we tried to form bonds with other children. We are concerned with learning how to make friends, communicate and form strong bonds. From about five years onwards, our efforts extend beyond individual relationships and are directed towards memberships of groups and our status within them. This is our tribe and our status sub self is concerned with being a secure member of a group that is particularly amongst our own age group. And then from approximately 12 years old, the attract mates sub self begins to stir and boys and girls start to consider not only how they're being perceived by a social group, but by potential partners and mates. Concern over appearance, extra monitoring of behavior, trying to evaluate how potential mates perceive us become a more and more powerful force which continues well into adulthood. Then at some point in adulthood, we may see a new sub self. The Keepmates subself is launched in order to maintain intimate relationships, not just acquire them. And this is crucial in order to create an environment in which children might survive. Negotiations, selflessness, empathy and compromise are all strategies that this sub self deploys to try and retain mates and create a stable environment in which to reproduce. And of course, if and when children do arrive, the the caring for family sub self prioritizes the needs of our children. We feel competitive and defensive of our own children and we become determined to give them the best schooling, the best toys, the best experiences and so on. These sub selves have their own independent objectives and in adults they are running simultaneously. This can create internal conflict as each sub self tries to get heard, comes online and offline and advises, pressurizes and sometimes even hijacks our judgment and decision making. For instance, the attract mates and the Keepmates subselves may come into direct conflict and there are obvious consequences for people who lack control or oversight. A person lacking awareness might be victim of the tribe and status sub self which could dictate their whole life and at the expense of them looking after their health or family. Or a person who feels under physical threat can be dominated by fear and paranoia at the expense of all the other sub selves. So who is in control? Well, the idea that the brain is the puppet master and the body does what it's told is almost entirely false. If anything, it's the other way around. Take hunger for instance. Our body runs low on food. It tells system one it needs food. System one then sings a powerful signal that advises, if not pressurizes you to go and get some food. And then system two has a vote on whether to act on it or not. Or in extreme circumstances, System 2 will not be given a vote at all. And you'll just be on the rampage uncontrollably looking for food at any cost. In this case, the body is the puppet master, System one is the motivator and System two is the last to get involved, if at all. These sub salves are all biologically driven by the body. They are triggered by hormones and in turn they act as powerful influences that drive certain behaviors. So what does all this have to do with trading? Well, absolutely everything. When real money is at stake, System 1 and its defense mechanisms and survival instincts wake up. When hormone levels are high and system two is weak, System one will always win the tug of war. In particular when it detects risks as it would with a real money trading account. These sub selves have the ability to inhibit blood flow to System two and restrict rational thought and self control. System one can literally cut off blood supply to the very mechanism that has the power to govern it. It's like a car engine having the power to cut its own braking system. When you're trading, these sub selves exert continuous pressure on your judgment and decision making whether you realize it or not. So let's look at each one individually, starting with physical harm. This is what we refer to as the oversensitive smoke alarm. It triggers the fight flight or freeze response. You can fight by doubling up on your risk and trying to win back the losses. You can over trade or you can take revenge trades to try and win back the losses. You can run away by taking a profit early or you can freeze and do absolutely nothing. As you watch, the loss gets bigger and bigger. And don't forget that when there is a perceived risk, your System one knows that taking greater risks may actually be your only or best hope. So you are far more likely to take bigger and bigger risks when you're under that threat perception. The sub self for social that makes you want to be part of a tribe together with other traders with the same beliefs as you have and you don't want to be ejected from that tribe. So you can form. You don't challenge the beliefs or the teachings because you don't want the rest of the group to turn on you. So you just fully commit to it. You see other tribes as a threat or direct competition. It's it can make you very very close minded and almost track you in a way of trading using certain methods or indicators that may be completely useless or even harmful to you. The status of self can be one of the most damaging. You can view losing trades as a loss of status or a sign of weakness or your incompetence. So winning trades make you look like you're right, so you'll take profit early or you'll design a system that has a high win rate but a negative long term expectancy. It can make you take too much risk by doubling down on losing trades so you can win that money back and you can say, look at me, I made it all back because I'm a winner, I'm not a loser. It can also stop you taking any risk at all actually, because you're so afraid of failure, if you don't enter the trade, you can't lose, you can't be wrong and therefore you can't be judged. It's better not to try than to try and fail. Attracting a mate is a funny one because this can mean you take excessive risk. There was an interesting experiment with teenage boys performing tricks or stunts on their skateboards. When it was just the boys evident was pretty normal. But the experimenters got an attractive teenage girl to come and sit on the bench and watch them. And with her present, the boys started trying to take much more difficult and more dangerous stunts and basically showing off. And as a result they had far more falls and way more accidents. They put themselves a lot more danger. Statistically we know that teenage boys are much more likely to kill themselves doing something stupid. Showing off. And adult males in the trading environment can be exactly the same. And then wanting to keep a mate, the next sub self can have a very similar effect. If you're afraid of losing your partner, maybe because you're having financial difficulties, you may take greater risks. You have something to prove and you want to impress them and show them that you've got what it takes, you can provide for them. But that sub self may also do the exact opposite and induce you to take less risk to become too conservative. You don't want to risk doing something stupid that jeopardizes your relationship or your ability to provide. So you may end up not being prepared to take even the small necessary risks that you have to. If you want to be a speculator in the markets and then under the influence of the caring for family sub self, you may experience a very similar risk aversion. You need the money to put food on the table and keep a roof over their heads. So don't take any chances with it. And in this case of getting you may be too risk averse. There's loads of examples of well known traders who only make trading decisions at the office, they never do it at home. At the office, their status and attracting the mate sub selves are far more in control, so they are way more aggressive. And this works well for their style of trading. But then when they get home, their family sub self is in charge so they become more concerned with protecting them and playing it safe so they can't make the aggressive decisions or take the required risks. And of course some people are the complete opposite and they trade terribly when their status sub self is in control, so they can only trade from home when they are calmer and they are concerned about providing for their family. It's really about understanding yourself and your sub selves to know which factors are influencing your decision making. But don't think for a minute that good traders have found the off switch for these sub selves. There isn't one. What they've done is develop enough awareness to recognize what these systems are trying to achieve and what their purpose is. And most importantly, differentiate between these rather primitive motivational priorities and and genuine measured threat detection and intuition. There is of course a group of people who really understand our sub selves and how they influence our decision making. Advertisers. This is nothing new to them. They know that sub salves can be woken up very easily by targeting their unique priorities and anxieties. They call it priming. Priming is simply a stimulus that activates the sub selves and sub selves are easily primed. Have a look at this advert and pause the video and make a guess at which sub self or selves you think Vase was targeting. The thing is that priming caps into system one priorities and anxieties that run very deep. They may prime your physical harm sub self in order to sell insurance. Like here for instance. The physical protection sub self is, if you remember, one of the earliest to come online. So it's easy to prying and prioritize. If you're not physically safe, then you can't look after anyone else, let alone reproduce. So inducing fear for one's own safety is incredibly easy and it can never be ignored. Politicians of every persuasion are also incredibly effective at priming this sub self to get folks. It's the oldest trick in the political playbook. And of course news and media stories that prime this sub self will always get your attention and therefore increase the advertising revenue that is attached to that story. That's why the news is always negative and deliberately trying to stimulate your fear response. I'm not saying that advertising is all bad by the way, the product or service may indeed bring greater utility to my life. But like trading, we must have some basic awareness of these mechanisms in order to retain oversight. From a System 2 perspective, without oversight, we will inevitably be sold things that we don't need or make trading decisions that are not statistically optimal. Advertisers may also try and target our biological drive to give our children the best chance of survival. Guilt and competition are very successful tactics. Those of you with kids will be very familiar of the pressure of advertising PR when it comes to giving your children the very best. They can even target your selfless drive to put your family before yourself again. With respect to this advert, I'm not saying that buying life insurance is bad, but if the priming of your care of family sub self is very strong like this advert, it may possibly stop you doing the right calculations to weigh up whether this is actually a good deal or not. If the insurance policy has bad terms and conditions and it's altogether a bad deal, the best way to get new customers is to hit them hard with priming and get them to act emotionally and impulsively. Get that signature and the payment before system two can step in and do the boring weighing up and the comparative shopping around. And of course we couldn't talk about priming without talking about sex. Given that our reproductive drive is an overarching priority for system one, advertisers lean on it an awful lot to sell us things that really have nothing to do with sex or shouldn't do anyway, like salad dressing. In this picture, the next time you're watching adverts, try and guess which sub selves they are trying to prime, and in particular how many of them are trying to tap into drives or anxieties around reproduction and retaining sexual partners. And it gets even more interesting when they start to mix things up and target multiple sub selves. Here they've attempted priming of attracting the mate and the social status in one hit. In a way, these adverts are targeting hormonal releases to change or impair our judgment and decision making systems unconsciously. And if this has been successful, System 2 will be recruited to come up with logical and rational reasons as to why you want to buy this car. By the time you walk into the BMW garage, you may have convinced yourself that you want to buy this car because of fuel efficiency or good navigation systems. And that's a really important point to remember for trading. If system one has decided on what it wants because of these primed responses, then system two will Actually begin a project of collecting evidence to support that decision if you like. It's become a slave to system one. I mean, nobody's ever gone into a BMW dealership after repeatedly seeing an advert like this and told the salesperson, look, I'm just buying this car because I reckon it will improve my ability to attract a good genetic partner to reproduce with. The decision is made based off emotions. But system one recruits system two to manufacture a believable logical reason so that you think you're making a sensible rational choice. It's extremely clever. So let's look at how priming of subcells can affect trading. What you see, hear, feel and think before you trade will most certainly influence your judgment and decision making in trading. It may seem far fetched, blind, deadly serious about the potential for unconscious priming of your trading decisions. For instance, having a picture of your partner or your children next to your trading screens is almost certainly a bad idea. Unconscious priming of your biological drive to provide for your family or keep a mate is certainly not compatible with thinking probabilistically. You're far more likely to be thinking in the short term and worrying about the consequences of individual wins and losses. All of these subselves work on a very short time frame and the picture is only going to make you think of the results today rather than in more long term probabilistic perspective. Perhaps the biggest and most common form of priming is listening to other people's opinions. If you pay any attention to the news, the talking heads, the analysts, you will be influenced whether you like it or not. System one will be looking for whatever move or conditions they predicted. And when the market does something completely different. Instead of trading what you see, you will be trading what S1 is expecting to see. You will be in conflict with the market instead of aligned with it. You can also be primed if you open your mail in the morning and there's a huge tax bill or other bad news. Even watching or reading non trading related news can easily upset you, worry you or make you angry. All of those things will prime you and they will influence how you trade. And it's for that reason that your pre trading routine is so important. You your actions before trading should be consistent and designed in a way so as to neutralize any of those prime and effects as much as possible. My pre trading morning is identical every single day. I do the same thing in the same order every single day. And the trade environment in my office is the same every day. My desk looks the same, my pens are in the same place, my drink coaster is in the same position. There are no pieces of paper left out or anything like that. And I never ever read my mail or check news sites or any social media. I want as sterile an environment as it's possible to get before I trade. And by having that same routine every day, my System one knows what's coming next and it knows that this is the build up to trade in. It's primed correctly and it gears itself up for that specific task because it puts everything else out of its mind and it focuses on the task at hand. My routine and my environment primes me to perform well. Now, I don't want you to fall into the trap of thinking that the power of System 1 and its defense mechanisms and sub selves are bad, redundant or they just need to be fixed. They are fast and powerful for a reason. They keep you alive and they are your secret weapon in trading. It's just that they're not well suited for trading straight out of the box. You've heard me describe them as maladaptive, meaning that they haven't been able to adapt quick enough for the trading environment. But in their intended environment, System 1 and its sub selves are incredible mechanisms, ensuring that we react before we had a chance to think consciously, logically and rationally about it. For instance, in the wild, when our lives were genuinely at risk, there was no time to be rational and work things out. System one needed to react without thinking, and it still would. If a car or a brick king hurtling towards you, you wouldn't pause to work out its actual mathematical trajectory. In a way, thinking comes later, after System One has taken action to save you. So System One's method for the evaluation of probability and risk is not a mathematical or methodical one. It's an automatic, intuitive and instinctive one. This is a very important point to remember for trading. When it's faced with a certain threat, like an obvious lion pension on you. In this case, System one takes the decision to react with ease. It knows it must do something urgently, but with uncertainty. When it's not sure whether it's a threat or not, it's unsure how to react and therefore it finds uncertainty particularly uncomfortable. It means it has to stay on full alert all the time having to assume the that it might be a threat. If you walked alone in a dark forest at night, there's a lot of maybe inclination. Your brain is saying, what's that noise? What's that movement in the bushes? What is that shape in the distance? It's Basically in maybe mode while it tries to analyze an unconfirmed potential threat. So system one has three settings. It's definitely a threat, which is certainty. It definitely isn't a threat, which is also certainty. And then maybe it's a threat, I don't know which is uncertainty, it is this maybe set in that is the most stressful. When system one is unable to evaluate the certainty of a threat, it keeps us in a high state of alert, ready to respond in case the threat turns out to be certain. This is your vigilance system that will run 24 hours a day, keeping you in a heightened state of stress. And as it waits for more information to confirm either way whether it's a threat or not, it's a great survival strategy because if you relax and it does turn out to be a threat, you're dead. Whereas if you stay stressed and vigilant and it turns out not to be a threat, oh well, you've been stressed out for a while, but at least you played it safe and you're still alive. Now it might be a good survival mechanism, but it's expensive from a calorie point of view and it's obviously uncomfortable. So we'll do anything to increase our sense of certainty in any given situation. System one will always try to get to the yes or no position of certainty. We don't like that maybe state. The trouble is there is no certainty in trading. You've chosen a career in uncertainty whereby you have to operate in the maybe state whenever you're in the market. I hope you're going to take a huge amount away from this course in terms of improving your self awareness and trading decision making. But understanding that trading is a navy state activity and accepting and managing everything else that comes with that is one of the central pillars of what I'm going to try and teach you. The obsession new traders have with win rates, predicting price direction and buzzwords like high probability are all signs that they are trying to avoid the maybe state and find the comfort of certainty. Unfortunately, it doesn't exist in trading. Okay, so I've talked a lot about the sub selves prime in and uncertainty. But what about system One's attitude to risk management? Well imagine you haven't eaten for days and then you came across a village that seemed to have stored food and other resources that you might need to survive. The risk in terms of trying to steal some of this resource is very high. The villagers will defend their own supplies, so the chance of you coming to physical harm is high. So why would you Ever consider trying to steal from them? Well, of course you're already in a loss, so to speak. You're already at risk for malnutrition and death. So System one will quickly deduce that you have very little to lose, so the risk is worth taking. It's not something that you would normally consider, but now it's your only option to try and get back on Top of. System 1's Risk Management System is very simple. If it feels comfortable or has a lot to lose, it advises you to be cautious and not take unnecessary risks. But if food is short, you're already in a bad way or you have nothing to lose, System 1 automatically increases your tolerance to risk and motivates you to take more. We are risk seeking when we're behind and risk averse when we're ahead. I've used the example of sports teams before. Winning teams play it safe and try to hold on to their lead that they already have. Losing teams have nothing to lose and they will take risks. They will attempt extreme plays and do just about anything to make it come back. The way System 1 motivates these behaviors is by memory recall. When you're ahead, it recalls a disproportionate number of memories. We're taking risks and and giving you losing what you already have, essentially reminding you that taking risks is a bad thing and you should play it safe. But when you're behind, it recalls a disproportionate number of memories where taking risks paid off and you ended up making gains, essentially reminding you that taking risks is a good thing and encouraging you to do it again. Now, now, going back to uncertainty, System one has another strategy it uses to try and reduce uncertainty and get out of that baby state. And that is to learn as quickly as possible the cause and effect of our actions and environment. Imagine you lived in a jungle 10,000 years ago. A friend reported being bitten by a strange spider in the morning and was dead by the evening. System one would most certainly assume that the spider had killed your friend. It looks for and assumes causation, meaning the spider caused the death. It doesn't consider that the two events happened in proximity, possibly random, which of course we call correlation. Even if your friend had reported feeling unwell yesterday, the danger of not assuming that the spider was the cause of death is just too great. It's another survival strategy of assuming certainty even in an uncertain situation. It plays it safe. Avoid those spiders from now on, just in case they are poisonous. It's better to remove the uncertainty and System 1 is an incredible cause and effect. Scanning the machine, it's always going to assume cause and effect and learn a response rather than stay uncertain and not know how to respond. Of course, in reality, correlation is not proof of causation. Just because something happens after something else, it doesn't mean they are connected. Now imagine that you lived 10,000 years ago on a mountainous island like this. The world is completely mysterious and you don't even understand what drives the sun and the moon, let alone infrequent natural disasters. So imagine that one day, and for the first time in living memory, this happened. Now, given that this is not a routine event, there must be a reason that this is happening and we need to know why. I mean, it looks pretty threatening. Now, given our lack of information and dislike for uncertainty, it's highly likely that you will try and work out and explain what happened. So you rang up the village and you ask if anyone has seen or done anything unusual, or if anyone knows what the heck is going on. Then one of the villagers steps forward and reports that this morning his son have killed a parrot with a rock for fun. Now, given that the mountain has just exploded and the villagers never normally kill parrots for fun, a link is made and causation is quickly assumed. And as a result, a total ban on parrot killing is written up and forced in the village. And then generation after generation are taught about the effects of killing parrots. No more. Parrots are killed for fun. And children are taught from a very early age that killing parrots will anger the volcano. And sure enough, the volcano goes to sleep for another 800 years. And the volcano silence becomes further evidence that not killing parrots stops minglings exploding. Now, I know that might seem like a silly example, but from a survival and probabilistic point of view, assuming causation and learning a response, however far fetched, will always be a preferable strategy to stay in uncertain. And if you do think it sounds silly, let's look at a common trading example. We've all heard people talk about how the price bounces off a moving average. Well, a moving average is a delayed indicator that's derived from the price. In other words, the price must do something first and then the moving average is updated. So they are correlated for sure. But the price does not ever bounce off or in any other way respond to the moving average. New traders mistake correlation for causation all of the time. There's a correlation between the weather and the sale of ice cream. Increased sales of ice cream are correlated with hot summer days. But that doesn't mean that ice cream sales core cause the weather to get hotter. Silly mistakes like this happen all the time in trading. So now let's quickly review what we've covered in this video. We've learned that our brains evolved to cope in an uncertain, scarce and dangerous environment. 99% of our existence has been in the wild, defending ourselves against bigger and faster threats. We also discussed how System 1 is primarily optimized for survival and reproduction. And these overarching priorities are split into sub selves which can be easily primed and they all have the capacity to influence and strongly advise us using powerful hormones. The stronger the hormone release, the less control we have over our judgment and decisions. And I pointed out how System 1 is really an intuitive estimator of probability based on its own experience. It evolved to cope with uncertainty by developing a three staged model. Yes, no, and maybe. AMDIT assumes causation over correlation, but much of the time gives false causation when really it was only correlation. This video and the previous one form the core foundation for the rest of this course, and we'll refer back to this information often. But the next 10 lessons are going to be concentrating on how to retrain these decision systems to help you achieve high performance trading. The next lesson is judgment and decision making in economics, very specifically about why you make such bad trading decisions when real money is on the line. Keep your eyes open for that link for that video. It is an amazing lesson and it reveals the almost unbelievable and comical things that we do when we're trying to make decisions about money. So I'll see you there.