Reblog: Do You Have What It Takes To Successfully Trade Financial Markets?
Over the course of 15 years working as a performance coach with traders and investors, from day trading shops to hedge funds and investment banks, I’ve enjoyed an unusual front row on the factors that contribute to success and failure in financial markets. During that time, I’ve conducted numerous interviews, directly observed hundreds of traders and administered countless personality tests. That experience has convinced me that much of what we think we know about trading success is just plain wrong. In this article, I tackle three myths of trading success and offer alternate perspectives.
Myth #1: Markets Are Efficient And No One Can Sustain Success As A Trader
Myth #2: Markets Are Inefficient And Anyone Can Achieve Success As A Trader
If we were to look at the academic finance literature, we could easily come away with the impression that markets are highly efficient and that beating markets over an extended period is not possible. When we look at the popular literature on trading, however, we readily get the impression that success is possible to anyone who works hard enough at market mastery. What are we to believe?
My first observation is that, at just about every firm where I have worked, there have been traders who have achieved envious track records of success. These are not traders who merely happened to catch one large market move, but rather ones who have sustained high risk-adjusted and absolute returns over extended periods. Some are hedge fund managers with decades of consistently positive returns; others are day traders who place many trades per day and sustain meaningful profitability year after year even after transaction expenses.
My second observation is that these highly successful traders are a small proportion of the total professional trading pool. That is sobering, given that the professional trading universe is a small proportion of the total number of people who try their hand at trading financial markets. When Brad Barber and team investigated returns from daytraders in Taiwan, they found that more than 8 out of 10 participants lost money in a typical six month period, but a small proportion of participants sustained success over multiple time periods. Their subsequent study confirmed that the great majority of active traders are not able to make money. Barber and Odean found that individual investors as a group also underperform standard market benchmarks. One 30 year study found that individual investors earned only a third of the returns of the overall market averages.
This suggests that trading is no different from other performance activities in its dynamics of success. Many are called, few are chosen. This is true with respect to professional athletes, Broadway stars, and chess grandmasters. The proportion of participants able to sustain a living from their performance activities is small relative to the pool of total participants. Elite levels of success do exist, but few people achieve such stature. That, of course, is what makes performance success elite.
Myth #3: Becoming A Successful Trader Is A Function Of Finding The Right “Style” For Your Personality
The unusually successful traders I have worked with indeed have found ways of engaging financial markets that draw upon their distinctive personality strengths. One such money manager is quite introverted and analytical and has created work routines to make the most of those characteristics. At the same office, another very successful manager is extremely gregarious and uses social interactions to successfully gauge market sentiment and positioning. As Jack Schwager has noted in his Market Wizard books, what elite money managers do is intimately connected with who they are.
Unfortunately, many rookie traders have seized upon Jack’s seminal findings to advance a far different view: that anyone can succeed in financial markets if they just find a style that fits their predilections. No doubt, we find a congruence of personality and playing styles among chess grandmasters. Does that mean that anyone can be a grandmaster if they simply find a style that feels right to them? What makes elite performers special is that they find ways of expressing inborn talents and traits through their work, which ignite what psychologist Ellen Winner has called a “rage to master”. As Daniel Coyle observes in The Talent Code, this ignition results in deep practice an unusually rapid and prolonged learning curve. It is not mere passionate interest in a field that distinguishes the best performers, but the ability of this passion to ignite sustained deliberate practice and learning.
Over the years, my consistent observation has been that cognitive strengths are more important to trading success than personality traits. In an intriguing recent book, Annie Duke, the poker champion, describes success in many performance domains as “thinking in bets”. In day to day life, we fall prey to “resulting”: the tendency to judge decisions by their outcomes. Champion poker players make decisions based upon odds–probabilities. This is what we find among highly successful market participants as well. They are skilled at identifying situations in which there is a favourably skewed reward relative to risk.
Duke points to the work of Daniel Kahneman, who observed two information processing systems within the brain. One is fast and broad and detects patterns in real time; the other is slow and deep and examines relationships among variables. The ice hockey star who is able to skate to where the puck is likely to end up utilizes the fast processing system. The scout for the ice hockey team, searching for new talent, engages in a slower, deliberative process. When we think effectively in bets, we often utilize both information processing systems. The poker star can read the mannerisms of other players in real time and infer whether they are likely to be holding strong or weak hands. That star also knows the odds of success holding any particular hand. Both sources of information go into a betting decision.
Elite traders in financial markets are extraordinarily gifted in one or the other of these information processing modes–and often both. Some are phenomenal pattern recognizers with unusually fast perception and response times (common among shorter-term participants). Others are unusually skilled data analysts, able to uncover meaningful relationships among variables that predict market outcomes (common among longer-term participants). When we look at how these talented individuals actually conduct their work, we often see both fast and slow information processing modes operating in harmony, as with the poker champion. For example, the rapid daytrader will notice an economic data release and will realize the implications for particular industries. This analytical insight will then fuel short-term trades that take advantage of the fact that others have not yet digested the data. Similarly, the longer-term portfolio manager will have a well-researched view, but can detect when other market participants, who have been leaning the wrong way, are now taking the other side. That creates an unusual opportunity to size up the position.
In both cases, the elite traders succeed because they see things that others miss, and that is a function of how they process information, not just their personality traits.
What Does This Mean For Trading Success?
Given the ability of computers to process information faster than ordinary humans, but also process more relationships than individuals can, it’s no surprise that the best financial returns in recent years have been achieved by quantitative firms employing large data sets. Mere perceptual or analytical competence is not enough to yield elite outcomes, especially as machines think both fast and deeply.
That being said, I continue to see outperformance among a select group of discretionary traders and investors who are skilled at thinking in bets. They, like Annie Duke, approach each market in a probabilistic way, with an uncanny ability to update odds in real time and adjust exposures accordingly. One unusual example is Peter L. Brandt, who publicly shares his trade recommendations and calculates his returns in real time. His portfolio is up healthily this year and indeed has produced meaningful positive returns over an 18 year horizon. What makes Brandt unusual is his reliance on charting, a technical analysis method often denigrated as subjective and without value.
Close observation of Brandt’s work finds that he uses charts in highly non-traditional ways. The chart pattern is used to dynamically frame hypotheses, not establish conclusions. Consider a few quotes from Brandt’s Twitter feed:
If you think you know what a given market is going to do, you are only fooling yourself.
Keeping your pile of chips intact is the only thing that really matters at the end of the day.
I know changing one’s mind is antithetical to many, but as a Bayesian I must continually modify short-term opinion as price action unfolds.
Many of my best trades in the past 43 years came about when a chart failed to perform as expected.
Charts are constantly morphing, being redefining and resetting reward-to-risk profiles.
Notice that Brandt has taken a cognitive strength–the ability to process information visually–and used it to assess and reassess market probabilities in real time. That is a clear blending of fast thinking and slower, analytical reasoning. Indeed, he finds opportunity when shorter-term pictures line up with longer-term ones. Most important of all, he thinks in bets and prioritizes money management. This appears to be central to trading success.
Do you have what it takes to be a successful participant in financial markets? The answer to that question hinges on your personality strengths, cognitive talents, and your ability to channel these in fast and slow ways to perceive what others miss. Great traders generate better ideas, and they have a greater velocity to their idea generation. When talent fuels the rage to master, that creativity and productivity appear relatively early in a learning curve, providing the best possible indication of one’s money management potential.
The original article is penned by Brett Steenbarger, appears on forbes.com and is available here.