Profile of Trading Greatness
What makes a great trader?
In the 1983 movie "Trading Places," Eddie Murphy (a wily street con-artist) and Dan Akroyd (an ivy-league heir and investor) had their identities reversed by two wagering millionaires. Could Eddie Murphy, with no prior experience, succeed in the trading pits? Could Dan Akroyd pull himself out of forced homelessness with nothing but his own smarts? The comedic pair ultimately outwitted their interlopers and made a killing in "Frozen Organe Juice" futures. Yet the question those two devious millionaires gambled on remains unsolved, is it innate skill or life experience that makes a trader great?
Please take the trader's personality test before you read what follows.
Researchers have begun analyzing the psychological components of outstanding trader performance. It turns out that several emotional and personality characteristics are correlated with superior trading in recent studies.
Psychological traits that relate to successful trading are discussed below. The traits are measured using different techniques that include mailed surveys, personality inventories, and psycho physiological measurements. What follows are simplified explanations of various research findings. Due to the simplified nature of the research interpretations, some of the information may be unintentionally distorted.
1) Low emotional reactivity.
The most important characteristic of outstanding traders appears to be low emotional reactivity during periods of market turbulence: "stability during volatility." (Lo and Repin, 2005). In one study Andrew Lo and Dmitry Repin used psycho physiological equipment to measure heart rate, blood pressure, and skin conductance while traders performed real-time trading. They found that more experienced traders had less physiological reactivity to information surprises (Lo and Repin, 2002). Additionally, Oblechner (2004) found that "emotional stability is considered almost equally crucial [to judgment] for a successful foreign exchange trader."
2) Low illusion of control AND
3) Likely to believe in the occurrence of chance (random) events.
Winning traders do not feel that they have control over market price action, and they have a strong belief in the role of chance events in shaping market prices. Winning traders prepare for their trades with thorough research. Before they enter into positions, contingencies have been thought through, and their plan is in place.
Losing traders feel that they have some control or sway over price movements, and they do not believe in the influence of chance events on their trading performance. Because they attribute control to themselves, losing traders are more emotionally affected by mistakes - "it was my fault" - and therefore have more emotional difficulty recovering from losses. Likewise, losing traders become elated by successful performance, and they are more likely to believe that it was their "brilliance" or "expertise" that led to their latest wins. The attribution of control and chance to oneself leads to greater emotional reactivity to both ups and downs in performance.
Other researchers have found that the illusion of control among experimental trading subjects led to under performance relative to others (Fenton O'Creevy, 1998).
4) Low Overconfidence.
Overconfidence refers to a mis-appraisal of one's foresight, talent, and abilities as being better than they really are. Overconfident traders tend to trade too frequently and tend to ignore danger signs regarding their positions. Biais et al found that overconfidence is correlated with sub-par performance among experimental subjects in a trading environment (2001).
In a now famous study, Terrence Odean and Brad Barber (1998) analyzed 10,000 brokerage accounts at Schwab. They found that overconfident investors tend to sell their winning stocks to early and stay in underperforming stocks too long, leading to 3.5% annual under performance of the market. The actual nature of overconfidence is still debated, and Odean and Barber's definition of overconfidence above may now be more reflective of other phenomena such as the disposition effect.
Academics now generally accept that overconfidence refers to one's belief in the superiority of one's information, superiority in abilities, and superiority in probabilistic forecasting (in contrast to reality). Overconfident business people, including entrepreneurs and brokers in two studies, actually attract more business. Although the overconfident brokers underperform in their investment recommendations, they attract more clients.
5) High Self-discipline.
Self-discipline relates to how we manage our impulses. Self-disciplined people are better able to control and channel their impulses towards goals. Self-discipline is a facet of conscientiousness.
Thomas Oberlechner from Webster University in Vienna mailed a survey form to 600 professional foreign exchange traders in Europe and the UK (2004). 54% of the survey forms were returned. Each survey form asked traders to rank the most important characteristics of successful traders out of a list of 23. Of the individual items, the most highly ranked were (1) quick reaction time, (2) discipline, (3) experience, (4) concentration, and (5) stress resistance. Out of eight "factors" he derived from sub-groupings of the 23 characteristics, "disciplined cooperation" was ranked most highly.
Biais et al (2001) found that subjects who scored high on a measure of impulsivity (the opposite of self-discipline) placed more trades, without improving performance.
Self-awareness is an enhanced consciousness of one's own physical and emotional state. Additionally, self-aware individuals often have logical reasoning behind their choices and behavior. Self-awareness is one of the key traits of individuals who have high "emotional intelligence." Emotional intelligence (EQ) is associated with long-term success in most vocations, and it is more predictive of vocational success than IQ. Biais et al (2001) found that highly "self-monitoring" participants in an experimental financial market place more profitable orders than others.
Oberlechner (2004) reports that a "tackling attitude" is necessary for trader success. Kahn and Cooper (1996) report that decisiveness is essential for traders, regardless of the stressors they are facing on or off the trading floors.
Assessing trading emotions
Personality scales, such as the NEO personality inventory used in our "Investing Personality Test," measure one's propensity to experience particular emotions and utilize certain coping mechanisms in daily life. The NEO test examines a moderate range of personality traits such as conscientiousness, neuroticism, openness, extraversion, and agreeableness.
In general, by the age of 18 our personalities are somewhat fixed and will not change much over our lifetimes. While personality traits are difficult to change, there are maladaptive habits and coping strategies associated with personality styles that can be managed for greater success.
Many authors have concluded, without studying large samples of traders, that personality traits are themselves not important for trading (Lo et al, 2005 in a study of 36 traders).
Most of us assume, as Jack Schwager concludes in his book "Stock Market Wizards", that traders do best if they adjust their trading style to match their personality. And this is true as a good first guess, however there are some tantalizing findings of personality traits that predispose traders to success.
Fenton-O'Creevy, who studied 118 professional traders for European investment banks, found that successful traders tend to be emotionally stable introverts who are open to new experiences (2004).
Trading coach Brett Steenbarger reports that a study of 64 traders at one of Linda Bradford Raschke's LBR seminars demonstrated that high conscientiousness was the most reliable predictor of trading success. Conversely, Steenbarger found that high openness and high neuroticism are correlated with trading problems (2003). He summates these findings as "one important lesson: Success in trading is related to the ability to stay consistent and plan-driven."
On the Marketpsych.com website, we also have two psychopathology measurement scales that are used to assess the presence of clinical disorders such as inattention and impulsivity, gambling, anxiety, depression, obsessiveness, or substance abuse.
Techniques such as psycho physiological measurement can be used to assess emotional reactivity. Reactivity can be measured via changes in skin conductance during periods of surprise or stress. Additionally, it appears that fMRI brain imaging can be used to assess emotional reactivity in the brain's limbic system.
Biais B., D. Hilton, K. Mazurier, and S. Pouget. (2000). "Psychological Traits and Trading Strategies" unpublished manuscript.
Biais B., D. Hilton, K. Mazurier, and S. Pouget. (2002). "Psychological Disposition and Trading Behavior" unpublished manuscript. Fenton O'Creevy, M.N. Nicholson, E. Soane, and P. Willman. (1998). "Individual and contextual influences on the market behavior of finance professionals" unpublished manuscript.
Fenton O'Creevy, M.N. Nicholson, E. Soane, and P. Willman. (2004). "Traders: Risks, Decisions, and Management in Financial Markets." Oxford, UK: Oxford University Press.
Lo, A. & D. Repin. (2002). "The Psychophysiology of Real-Time Financial Risk Processing", Journal of Cognitive Neuroscience, 14, 323-339.
Lo A. & Repin D. (2005). "Fear and Greed in Financial Markets: A clinical study of day-traders." Presentation to the Annual conference of the American Economics Association.
Locke, P & Mann, S. (2000). "Do Professional Traders Exhibit Loss Realization Aversion?" working paper.
Kahn H. & Cooper C.L. (1996). "How Foreign Exchange Dealers in the City of London Cope with Occupational Stress." International Journal of Stress Management, 3, 137-145.
Oberlechner T. (2004). "Perceptions of Successful Traders by Foreign Exchange Professionals." Journal of Behavioral Finance, v5, n1, 23-31).
Odean, T & Barber, B. (1998). "Are Investors Reluctant to Realize Their Losses?", Journal of Finance, Vol. LIII, No. 5, (October), 1775-1798.
Schwager, Jack. (2003). "Stock Market Wizards: Interviews with America's Top Traders." Harper Business: New York, NY.
Steenbarger, B. (2003). "The Psychology of Trading." John Wiley and Sons: New York, NY.
The consultants at Market Psychology Consulting, LLC perform coaching and implement training programs for investors and traders, portfolio managers, brokers, and financial analysts. We work to reduce the damaging effects of decision biases and to improve profitability. We also offer seminars on the development of psychology-based investment and trading strategies.