There’s a conundrum in trading that I’ve struggled to make sense of for years. In today’s day and age, we are taught that the best trading is emotionless. It’s cold, calculated, and quantitative. The best traders are systematic, executing using well-tested models. Good traders should be mechanical, with all of their emotional faculties in check, ignoring their gut and relying on mathematics & probabilities…right? Then why are so many of the most legendary traders incredibly emotional individuals? Jesse Livermore, George Soros, Paul Tudor Jones, Bill Lipschutz, etc.…all of these market masters notoriously relied on their gut AND their data to make (and sometimes lose) historic amounts of money in the markets. If you ask me, I think we’ve unnecessarily demonized “gut feelings” in trading when, in fact, they are an integral part of successful trading. To me, there's a big difference between controlling your emotions while trading and listening to your gut. In this article, I’m going to explore the science and reason behind trusting your gut while navigating financial markets.
In the 1850s, scientists such as Meissner, Billroth, and Auerbach, gave us the first clear descriptions of ganglionated plexuses within the walls of our digestive tracts, opening the eyes of the scientific community to an astonishing amount of neural tissue located in the human gastrointestinal tract.(1) Eventually, researchers would refer to this perplexing home for neural tissue as the enteric nervous system (ENS), commonly referred to as “the second brain.” Believe it or not, there’s more neurons (over 100 million) in your digestive system than your spinal cord. Over the years, scientists discovered that there’s actually some validity to the slang term “second brain,” as our guts produce over 30 different neurotransmitters, such as serotonin, the neurotransmitter that makes us “feel good” when we’re trading well. Your vagus nerve connects your brain to your gut, allowing for powerful bidirectional communication. “Bidirectional” is technically a bit of a stretch because roughly 90% of the neurons in the vagus nerve are actually conveying information from the gut to the brain.(2) So if we do so much “thinking” with our guts, why are we taught to ignore gut feelings during trading?
Since the information relayed from our guts to our brains is not expressed in typical conscious thought, what we’re really talking about is the concept of intuition.
What is intuition? The textbook definition of intuition is “the ability to understand something immediately, without the need for conscious reasoning.” [emphasis added]
So what’s really happening within the process of intuition?
Our brains are wired for prediction. Whether consciously or unconsciously, our brains seek to find meaning in data in order to make a prediction that best protects its host, our bodies. When I mention data or predicting, it’s natural to think about statistics and other complex mathematics; however, we see evidence of this natural brain phenomenon every day in the most basic forms. I was doing some yardwork recently and came across a small hole in the ground. I could hear a faint buzzing noise and I saw a ground bee enter the hole. It doesn’t take the brain of a genius to quickly synthesize this information into a prediction that if I stick my finger into that hole I’m probably going to get stung. I don’t actually need to physically test this hypothesis to trust my intuition, my brain had enough data to determine the wisest course of action. This analogy is predicated on the fact that I’ve seen a ground bee before and I’ve been stung by several—our brains rely on past experiences to help formulate predictions. In psychology, this is known as the Predictive Processing Framework. It’s worth noting that the Predictive Processing Framework is not a stagnant process, our brains are constantly updating our “models” as new information arrives that differs from our past experiences. This last point is absolutely critical for answering the main question of this article:
Is there room for intuition in good trading? Yes…but only if you have vast past experiences for the predictive power of your brain to draw from. In other words, I don’t think relying on gut feeling or intuition is a good idea for new traders.
What’s the best way to gain the experience needed to incorporate intuition into your trading? Time and careful observation. Don’t get me wrong, time has nothing to do with “paying your dues,” but rather, it has everything to do with how the brain stores information in order to accurately recall that information in the future. When we are learning something new, either through kinesthetic or visual learning, our brains need time to “reset” between repetitions in order to ingrain the learning. It’s far better to practice the guitar 1 hour per day than to binge practice for 12 hours straight. If you’re cramming for an exam, it’s advantageous to take short breaks between each reading of your lecture notes. In my experience, a lot of newer traders feel like they are “missing out” if they are not in a trade. Quite the contrary. When you are flat with no position on, you are able to observe the market’s behavior without a bias (also critical for learning), becoming more intimately familiar with how your trading vehicle of choice moves, how wide the spreads are, how it behaves during different levels of volatility, etc. Most of the time when you’re in a position, your Reticular Activating System (which acts as a gatekeeper to your brain) is ignoring these micro details and instead your brain is focused on “I hope this trade keeps moving in my favor” or “Should I take some profit or move my stoplosses?” In other words, when you’re in a position you’re likely focused on everything except the intricacies of how that market moves.
Being flat shouldn’t be “boring” to you, it should be a time to learn; a time to study in order to develop the foundation of experiential learning that your brain will need in the future to effectively utilize intuition. As for the experienced traders reading this…are you using intuition? If you specialize in a specific trading instrument, I’d advocate that you should be…and you should not be ashamed of that. While you're actively trading, you're brain is soaking in vast amounts of data while your eyes scan the charts, attempting to quickly synthesize this information into a thesis; it's entirely possible to feel your brain's prediction in your stomach before your conscious mind is aware of the conclusion in the form of thought. Your brain is going to do this whether you like it or not, so in the case of experienced traders the question is "Well why not listen to it?" While I have no definitive quantitative proof, I wouldn’t be surprised if gut feeling has contributed immensely to the success of some of the greatest traders that ever lived.
I made a trade today on the S&P500 that puzzled some people in our Discord:
I received several messages about the trade, most of which went something like this: “The market was selling off intensely, and we were well below the 30min Opening Range, why were you going long? And why did you think we’d reverse course and retrace the selloff?” I had a really hard time answering those questions because this was a perfect example of intuition based on thousands and thousands of hours watching every tick of the S&P500. Something about the selloff just felt…off. The delta by price seemed funny, the large order activity was peculiar…the whole move down after the opening bell was screaming reversal to me, but for the life of me I couldn’t find the words to clearly articulate why. Those of you that are a part of our Traderade community know that’s unusual for me—I almost always have a clearly explainable thesis for my trades. But every once and a while your gut screams at you that something isn’t normal and it’s time to make a move, even if it’s against the trend. For clarity, I am by no means advocating experienced traders should ONLY rely on their gut; I’m simply stating that you shouldn’t ignore it. The example above from today is about a profitable trade; however, the vast majority of the time I utilize intuition in trading it is not for trade entries but rather for trade exits. I think our guts are better at saving us money than making us money. The concept of incorporating intuition is predicated on the concept of specialization. Having a gut feeling like “I think the market is going to go up this week” is not at all the same as a gut feeling like “I’ve spent thousands of hours watching ES_F tick for tick and something isn’t normal here.” Those two things are vastly different, likely because one of them involves bias and one doesn’t. Do not confuse your bias with intuition. Of course your gut thinks the market is going to go up, you’re bagholding a fistful of weekly Call Options, Nostradamus. Intuition is only applicable if you know a market like the back of your hand. Our guts are truly powerful “second brains” that should not be ignored once we’ve developed a framework of differing outcomes that our brains (both of them) can use to formulate predictions.
Amidst a backdrop of cold, calculating algorithms dominating modern markets, I think there’s a place for intuition and experienced traders should embrace it rather than scorn its use…and for the newer traders: Specialize in something so you can develop more trustworthy gut feelings.
Furness, John Barton. (2006). The Enteric Nervous System. University of Melbourne, Victoria, Australia. Blackwell Publishing.
Gerrie, Heather. (2022). Our Second Brain: More than a gut feeling. https://neuroscience.ubc.ca/our-second-brain-more-than-a-gut-feeling/. Para 3.