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The Power of Negative Thinking

The Power of Negative Thinking

When the market takes a dip, as it did on Tuesday after the rate hike, it's hard not to feel a little beaten if you lost money. It's at times like these when you must buck up your spirits, and face the challenges of the markets earnestly. A positive outlook can often do wonders. Psychological studies, however, have shown that some people do best while thinking positively, while others actually do better with a defensive and negative attitude.

The very influential book "The Power of Positive Thinking" implies that optimism is "good" and pessimism is "bad." Similarly, Dr. Martin Seligman argues in his book "Learned Optimism" that success is associated with optimism. Optimists are more likely to persist when faced with severe setbacks, while pessimists tend to give up easily, after only a minor setback. Dr. Seligman has documented that across a variety of occupations, from sales to athletics, optimists are more successful. But towards the end of his book, Dr. Seligman also notes that pessimism has a time and place. Whereas optimists tend to see the world as overly rosy, even when it isn't, pessimists are especially realistic, even if it means feeling bummed because all they do is focus on the negative. That said, traders could benefit from a little pessimism occasionally. Optimism is often a problem for traders. For example, behavioral economist Dr. Terrance Odean argues that traders are often too optimistic and too overconfident. They overtrade, and by overtrading, they take risks that they should not, and end up with lower amounts of capital than if they had been more conservative. There isn't a simple answer when it comes to being overly optimistic or realistically pessimistic. Both strategies have their advantages and disadvantages. The key is to discover what works best for you.

Drs. Nancy Cantor and Julie Norem argue that people differ in terms of whether they prefer a pessimistic or optimistic attitude when solving problems. Many people can be classified as either rosy glow optimists or defensive pessimists. Rosy glow optimists view the world as challenging but not especially overwhelming. They have rock solid confidence and are fully aware of their superior skill level. Thus, they take setbacks in stride and expect to perform well, as they always have. Defensive pessimists, in contrast, view the world as a slew of difficult challenges, which are an endless source of stress. They believe that unless they put in a lot of effort, they will fail. They underestimate their performance, setting low expectations despite the fact that they had done well in the past. According to Dr. Norem, pessimism can actually have a positive impact. The defensive pessimist imagines the worst-case scenario and prepares for it. A pessimistic outlook actually prevents them from becoming overly confident and not taking precautions. You may see that there are times when a defensive, pessimistic attitude works well for trading. For example, how well did you do on Tuesday after the Federal Reserve raised short-term interest rates and signaled further hikes were possible? Did you anticipate the worst-case scenario before it happened? Did you manage risk, and make sure that a few losing trades would not hurt your account balance very much? A defensive stance can do wonders in the trading realm where setbacks are commonplace. But there may be a price for too much pessimism.

Research studies have shown that defensive pessimists tend to feel greater stress and anxiety than rosy glow optimists. Pessimism, under the right circumstances, doesn't have an adverse influence on performance, but it does cause emotional pain. It's hard not to feel fearful and anxious as you question your trading plans and try to account for a variety of possible worst-case scenarios. But for many traders, the protection that pessimism offers may be worth the negative feelings. How many traders have you heard about who were wiped out by not taking enough precautions to protect their capital? Again, the key is to find the right balance between positive, uplifting enthusiasm and realistic, defensive pessimism. If you can find the right balance, you'll be prepared for the chaos that is commonplace in trading, and in the long run, be one of the few who stays profitable.