Your Money: Using your emotions to gauge your trades

If you have just had an argument with your spouse, that is a bad time to rebalance your retirement portfolio. Your emotions influence the way you trade, says a new book by a professional Wall Street trader and trading coach.

Market Mind Games: A Radical Psychology of Investing, Trading and Risk (McGraw-Hill), due out this January, says that when it comes to making judgment calls on your portfolio, don't suppress your emotions. Instead, harness them and understand how they are influencing your decisions.

Rather than ignore your emotions, trade better by acknowledging them, explains Denise Shull, the book's author and former head trader at a NYSE member firm. She now consults with traders on psychological aspects of trading.

"There are simple things you can do to put yourself in a position for better perception of the situation," Shull said in an interview. "Get enough rest, and don't make decisions when you've had an argument. Always know what feeling or emotional context is dominant. Don't set them aside, just be aware of them. That is valuable data."

Shull offers an example: "I have a trader whom I coach who has gotten good at emotional awareness. We call it psychological leverage. He got into this trade and got stubborn. He could have made money and broke even. But he lost a little. He knew the whole time he was breaking all the rules. Instead, he wanted to be right."

She asked him afterward if he had been in an argument with someone: "He told me he'd been in an argument with his property renter, who took all the furniture and left the previous weekend. As a result, he wanted so badly to be right that he got stubborn" - and took it out on his portfolio.

Shull also advises big hedge fund traders about the recent swings in the market, both up and down. "These 300- and 400-point swings create a lot of fast moves, but really that's meaningless," she said. "It's only scary because it's new. And it doesn't have anything to do with the long-term price, for instance, of Apple stock."

Therefore, while it is rational to have higher anxiety because of the crisis in Europe or recession in the United States, "being cautious is reasonable," Shull said. "It doesn't mean stay out of the market completely."

"If you know you're being cautious; then you make a judgment by using emotion as a data point in a regular way," Shull said. "So you can evaluate what it's about, then you make a choice: Is it about what just happened [to you], or is it about what's going on in the market?"

As December approaches, it is time to review year-to-date realized short-term and long-term capital gains in your portfolio. We checked in with Jenkintown-based wealth-planning and accounting firm Eisner Amper, which issued "Maximizing Portfolio Return on an After-Tax Basis" in a November note to clients.

If you have large gains in your portfolio but don't have what is known as a "loss carry forward," or losses that you can use to offset the gains, your next step should be to review what you can sell to harvest any unrealized losses.

Beware the "wash sale" rule: the Internal Revenue Service will not allow your loss to be used to offset capital gains if you buy the same security or one the agency deems "substantially identical" within 30 days before or after the sale.

A common technique to avoid violating the rule and maintain market exposure is the use of an exchange-traded fund as a substitute for an individual stock. For example, take a loss on a large-cap value stock by selling the position, with the proceeds invested into the Russell 1000 Large Cap Value ETF. The index fund must be held for 31 days before you can sell it and repurchase the stock - assuming you still want to buy that stock.

Make sure to check your individual state tax regulations. New Jersey, for example, does not allow capital loss carry forwards, according to Eisner Amper.

If you were lucky or smart enough to buy Apple stock at the end of December 2008 when the stock market was in turmoil, you probably paid about $85 a share. If you still held the same lot of Apple on July 26, 2011, the market price was about $400 a share. If you purchased 500 shares, your cost basis totals $42,500 with a current market value of $200,000.

The unrealized capital gain equals $157,500. With the extension of the President George W. Bush-era tax cuts, the 15 percent long-term capital gain tax would be more than $23,600 for federal tax purposes, if the Apple shares were sold on July 26, 2011.