Decision Fatigue

06/29/15 02:14:47 PM

by Stella Osoba, CMT

Yesterday, you made a really bad trade. After you have closed out the position at a loss, you study the chart and ask yourself why you entered the trade in the first place. The more you study the chart, the more confounded you become. Clear as the light of day is evidence that the stock is acting badly. You see price had been making lower lows and lower highs for some time, there was no break of the down trend line to the upside. So you ask yourself why did you take a long trade? All the signals were screaming that this would be a bad long trade. Yet you took it. You can't understand why you made such a poor decision. You feel you should have known better.

Security: BTU
Position: N/A

Decision fatigue might help explain why you are in this situation. It is a little known psychological phenomena coined by Roy F. Baumeister, a social psychologist. The more decisions you make throughout the day, the harder it becomes for your brain to cope. You begin to run out of mental energy and so your brain starts to look for shortcuts. Usually there are two ways your brain will use shortcuts to conserve depleted mental energy. One is to become reckless and act impulsively, hence the bad trade. The other is to do nothing which is the ultimate energy saver. The following is an example of the latter.

Two men go before the Parole Board. Both men serving 30 month prison sentences for fraud. The first case was heard at 8.50am, the second at 4.25pm. Which one do you think got a favorable decision from the Board? If you said the first, you would be right. Researchers found that prisoners who appeared early in the morning received parole about 70% of the time while those appearing later in the day were paroled less than 10% of the time. A research study found the judges on the Parole Board may have been suffering from decision fatigue. By late afternoon, after a whole day of making decisions, with their mental energy now depleted, they chose to deny parole. In preserving the status quo, they effectively did nothing.

When decision fatigue sets in we are not consciously aware of being tired unlike physical fatigue. But as we go through our day making choices, we deplete our mental energy with the result that decision fatigue could eventually set in, causing the quality of subsequent decisions to deteriorate. The significance of the decision is not important. After all, we make so many decisions — choices from what to wear, what to tell the boss, how to talk to an irate customer, how do deal with your child's poor performance on a school test, what to eat, a series of trading decisions, etc. Any series of decisions induces mental fatigue which makes it harder for your brain to cope.

Decision fatigue is like stress; it is an invisible enemy. We cannot measure it, so it is likely that we may not be aware that we are operating under decision fatigue. We must learn to check in with ourselves and our mental states regularly. Apart from suggesting the obvious, which is to make trading decisions early before decision fatigue sets in, a good way of overcoming the depletion of our mental energies in trading is though structure (Figure 1). Having a plan and sticking to the plan means that we will not have to make as many choices, therefore we will slow down the speed at which our mental energies are being depleted.

Figure 1. The Result Of Fatigue. Trading can induce decision fatigue. Structure can help us minimize its effects on our trading.

Graphic provided by: StockCharts.com.

Stella Osoba, CMT

Stella Osoba is a trader and financial writer. She is a frequent contributor to "Technical Analysis of Stocks and Commodities" magazine and "Traders.com Advantage" as well as other financial publications.