Here’s a quick, informal personality test.  Among the following pairs of options, which would you prefer?

1.  a)  Eating at a favorite restaurant;  b)  Eating at a new, exotic restaurant.

2)  a)  Relaxing at home after work;  b)  Going to a lively party after work.

3)  a)  Driving a reliable sedan;  b) Driving a sports car.

4)  a)  Avoiding recreational drug use;  b) Trying recreational drugs.

5)  a)  Vacationing in the mountains;  b)  Climbing a mountain with friends.

If you gravitated toward the b) selections, you exhibit a trait that psychologists refer to as “sensation-seeking“.  People who are sensation seekers tend to like novelty and adventure and quickly become bored by routines.

So what does this have to do with financial markets?  It turns out that a large body of psychological research finds that people who are sensation seekers tend to also be risk takers.  Indeed, many hapless traders are attracted to markets precisely because of the stimulation of risk and reward.  At the extreme, this makes trading an addiction, not a disciplined quest to exploit market inefficiencies.

Cognitive neuroscience researchers suggest that much of risk-taking may be hard-wired, controlled by specific brain regions.  Indeed, much of the risk-taking commonly associated with adolescence can be traced to changes in the brain during that developmental period.  Similarly, brain differences have been linked to the impulsive, risk-seeking behaviors of psychopaths.

Could it be that some people are hard-wired from birth to seek sensation and risk?  We see this most clearly among children who exhibit attention deficits and hyperactivity:  most often they also display impulsivity and sensation-seeking from an early age, making them particularly prone to antisocial behavior.  Longitudinal developmental research supports the idea that temperaments–which include the traits of activity and distractibility– appear at a very early stage of development and remain remarkably stable across the lifespan.

It is easy to see how tendencies toward activity, distractibility, sensation-seeking, and risk-taking could undermine market participants and doom them to failure.  A few years ago, I wrote a post noting that markets were rigged against human nature, as short-term returns following strong periods reliably underperformed those following weak periods.  (This mean reversion has been tracked admirably by the MarketSci blog).  If traders, eager for stimulation and risk, impulsively jump aboard directional market moves, they would systematically underperform market averages.

Successful trading requires the ability to take meaningful risk, but also the capacity for controlling that risk.  One can trade for sensation and one can trade for profits, but rarely can one do both.

Category: Psychology

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

38 Responses to “Are Some People Hard-Wired to Fail in Financial Markets?”

  1. cvienne says:

    @Steenbarger

    I’ve enjoyed your posts, but please don’t turn into “Self Magazine” with these quizzes…

  2. karen says:

    No, these quizzes are FUN. However, I fell exactly in the middle.

    1. 50/50, a and b.
    2. a, without a second thot; i don’t like parties. hate see-and-be-seen venues.
    3. b, i drive a 2007 911 Carrera S and consider it the most beautiful piece of machinery/artistry/design.
    4. a, no debate.
    5. b, i can’t vacation without strenuous physical activity.. what would be the fun in that?? !

  3. Mannwich says:

    I’m with you, karen. Generally in the middle, but my preferences can shift daily (even hourly) depending on my mood. What can I say? I’m a Gemini (sign of duality), and a real twin at that.

  4. Wes Schott says:

    50/50

  5. karen says:

    BTW, you don’t need a Ph D to know that “some people are hard-wired from birth to seek sensation and risk.” I have a brother, 3 years younger, that is in prison because he couldn’t channel his thrill seeking into something socially acceptable or rewardable.. with better steerage, he would have been a jet pilot (like his father), a race car driver, a horse jockey (like his great uncle), or sniper… who knows.. but he wouldn’t be in prison as the fall guy.

  6. cvienne says:

    @karen @Manny @wes

    Congratulations! You’re all 50/50… Now you know exactly who you are…

    Is this the new version of “Trekkies”? Should we start a convention?

    May you all live long & prosper…

    PS… I’m really not as grumpy as this all sounds (and I know I’m being a smart @ss)… Oh well, I leave you all to your fun… I have my vices as well…:-)

  7. impermanence says:

    “Could it be that some people are hard-wired from birth to seek sensation and risk?”

    Man is incapable of understanding even the simplest of things, so entertaining the notion that comprehending cognition is possible seems a bit of a stretch. I believe we can all agree that there are those who will do EVERYTHING for money, and there are those who could really care less.

  8. karen says:

    cvienne, even if you are mostly or all b’s, I BET you are BETTER at controlling risk than I am.. I am a STUBBORN female, LOL.

  9. karen says:

    a second BTW, loyalty may be over-rated. i think some people are hard wired for that, as well. of course, there are distinctions between allegiance, faithfulness, and devotion.

  10. Mannwich says:

    @karen: And to whom you are loyal. Important distinction.

  11. call me ahab says:

    ok let’s see- my answers are-

    1)Eating at a favorite exotic restaurant.

    2)Relaxing at a lively party at home

    3)Driving a reliable sports car.

    4)Trying to avoid recreational drug use

    5)Vacationing climbing a mountain

    there we have it- i nailed it- what do i win?

    oh yeah- is this Cosmo? then i have to ask-

    is it foreplay when i say “brace yourself”

  12. karen says:

    Jeff, my musing was that loyalty can be a failing.. to direct the discussion from myself, let’s look at the bush administration as an example..

  13. Wes Schott says:

    cv-

    luv ya man, but…

    no idea what you are talkin’ about @9:20

    trekkies, live free, prosper, grumpy, vices – you, vices, come on

  14. Bruce in Tn says:

    Franklin here….if you would just give the stimulus more time, we could all drive a sports car from a party at an exotic restaurant to our mountain climbing vacation….

    g’night…..

  15. Swampfox says:

    Karen, I think loyalty in politics these days is troubling in general:
    http://intellectualtakeout.org/readtheblog/2009/09/04/the-danger-of-factions/

    As for people being born a certain way, I don’t doubt it. I’d also say that the research blows a hole in the rational markets theory. Or does it? Do thrill seekers approach investing perceiving themselves to be rational? Just throwing it out there.

  16. Cool! And to think my psychopathic, anti-social leanings were going to be wasted in the futile serial killer industry. It looks like I’m overwhelmingly a sensation seeking nutcase. (Hmmm, though I must say… I do like dining at my favorite restaurant with someone special). I’m going to give this trading a killer shot… er, stab. If it doesn’t work out, I always have my true calling. Right?

  17. I’m 4 out of 5 routine oriented. I assume that is what is helping me be a good trader. I can show the patience to analyze the opportunity and then WAIT for it to bear fruit. Another thing you need is to plan a trade and then trade the plan when it begins to unfold. BTW, my risk taking is in the sports car but you can buy a sports car that is just as reliable as a sedan so maybe that was a trick question

    Also, because my job is rigorous I tend to need down time in my vacation time. People tend to gravitate towards vacations that are the opposite of what their ‘work’ routine is. If you sit behind a desk all day, your vacations will be vigorous. If you repair or lift things all day you probably spend two weeks sleeping your vacation away and healing your body. You may also relax after work instead of going to parties for the same reason I outlined above so a couple of the questions maybe be ‘cubicle’ biased

    I don’t know about anybody else but the markets can be really boring at times and maybe the risk takers are the ones who will force a trade whereas the routine people will find a way to build a routine around the wait times. I find the most tempting time to over trade is when a trade has gone about 65% to 80% in the direction you want it to go and then just stops. The temptation is to trade that in order to capture the gains. The only problem is that if you do you don’t meet your trade margins. Sure, you make money, but only a little money. Yes, it is frustrating to see that go back down (or up depending on the trade), but trading the plan is the only way to go and I assume that is where the risk takers get stung the most. Then they are put into a position of over trading and maybe getting behind the trade when their position turns again with them left outside of the opportunity.

    BTW, my ‘routine’ is either to go away and do something else or put my mind into research and study like Barry’s blog. That is one way blogs like this help. They serve as a good distraction to overtrading

  18. Common Man, what makes you so common? I don’t overtrade because it takes me so long to put my make up on. Even in heaven you have to look good. I tell ya, it doesn’t get any easier up here…trust me.

  19. aitrader says:

    @ahab – chuckle :-)

    Trading biases are well known. There’s a whole Wikipedia page about them in fact – http://en.wikipedia.org/wiki/Cognitive_bias.

    My method is to let a machine breed trading strategies, backtest them thoroughly (also automated), and let it do the trading. Works quite well. No human biases allowed.

    I do bias some strategies in advance by adding forward looking figures in certain cases. Oil trading, for example, seems to benefit from including unemployment and production data. Gold strategies seem to evolve better when consumer sentiment data is included. So adding a human bias data point itself seems to help a machine in its strategy development.

  20. cvienne says:

    @karen

    This is for you (because I know that you ladies tend to like these Cosmo quizzes)…

    FWIW – Here are cviennes answers:

    1. c) opening my own restaurant
    2. c) staying AT work
    3. c) driving a tractor
    4. c) legalizing & taxing recreational drug use
    5. c) living in the mountains & otherwise contemplating them spiritually

    How that makes (or doesn’t make) me hard wired to fail financial markets, I have no friggin’ clue…

  21. dead hobo says:

    Steenbarger wondered:
    ———————————-

    1. a) Eating at a favorite restaurant; b) Eating at a new, exotic restaurant.

    Either, just as long as someone else pays the bill and tip

    2) a) Relaxing at home after work; b) Going to a lively party after work.

    Relaxing at a resort on an expense account

    3) a) Driving a reliable sedan; b) Driving a sports car.

    Something expensive as long as the bonus comes through

    4) a) Avoiding recreational drug use; b) Trying recreational drugs.

    An expensive single malt scotch will do if I’m paying for it with bonus money. If you are paying I’ll order something good

    5) a) Vacationing in the mountains; b) Climbing a mountain with friends.

    Owning the mountain is better. God I love capitalism and wall street.

  22. flipspiceland says:

    I hate bugs, critters, and depise even the thought let alone the embedment of a deer tick in my flesh, but I am ga-ga 0ver big, wild animals-So I would go to the mountains for a vacation IF in those mountains there was no chance of running into a fly, mosquito, midges in zillions, and anything that makes me itch.

    Driven a 911 for over 27 years; put most of my mileage on a toyota pickup truck, which to me is indispensable–no option for that above so Ican’t make this forced choice.

    Parties and relaxing about equally

    ‘Recreational’ drugs is a misnomer. Don’t like losing control that came with prior experiments in ‘shrooms (the inside of my brain felt like it was crawling with unmentionable bugs), Coke (felt
    awful afterwards), but some very fine strains of ganja were transcendant. Most left a depression afterwards. Amyl nitrate was a 15 second rush, hardly worth the trouble. Wouldn’t likely do any but a Very promising reefer.

    Only would like to eat in a restaurant that serves soccer ball sized Pecan Balls with 22% butterfat ice cream made from the milk of the unborn virgin calf, doused with the finest dark chocolate fudge sauce. They can give the rest of the food to the homeless for all I care.

    Reading back over this, I now understand why 1) I missed the 50% run-up since March, 2) didn’t cash out my Brazilian Real and $Aus at 100% profit in two weeks, and finally, 3) when I got on-line with my laptop in a hotel in Paris, May, 2007, looked at the portfolios of several people’s money I was managing, with everything in the green, for over 5 years, had a sudden chill up my spine, and an angel thunderously screaming in my ear– SELL SELL SELL!!!! everything!!!

  23. dead hobo says:

    Steenbarger proffered:
    —————————————-

    Successful trading requires the ability to take meaningful risk, but also the capacity for controlling that risk. One can trade for sensation and one can trade for profits, but rarely can one do both.

    reply:
    ————
    Shouldn’t your piece be titled “how to win a zero sum game”? If someone buys then someone sells. In order for the system to balance, the wins must equal the losses. The only ones who win consistently are the ones who own the house or get commissions from the house for roping in the rubes. The rest is hype just like the big mega pick 5 winners who get their pictures in the paper from time to time when their investments pay off.

    Given the incompetent regulation and the multitude of interesting games currently in favor on wall street, this is not investing in any sense. Trading is like card playing. A few here are naive and still think that technical analysis or secret skills are the key to riches. And they regularly report that their good ideas didn’t work, but will certainly pay off next time.

    Just as conservative Republicans want us to go back to a time that never was and to a place that never existed, the stock market is now also in that fabled location. It’s a rigged game. The only way you might make anything is by mimicking the house’s bets since it’s their game and it’s crooked.

  24. Common Man, what makes you so common?

    I started out poor and worked my way up

  25. Cunning Linguist says:

    Correlation does not equal causality, but a family member became an equities trader — and a heroin addict. Fortunately recovering from both.

  26. I understand the Fed wants to hire this guy to paint a picture of the economy that fools the public into thinking we’re not headed for a brick wall

    The astonishing 3D murals painted on the sides of buildings by a trompe l’oeil artist

  27. call me ahab says:

    cool link common man

  28. Check this one out. The clouds rolling through really add to it

    The Crevasse – Making of 3D Street Art

    /thread hijack

  29. call me ahab says:

    pretty wild stuff common man- surprised no-one fell in the chasm- seeing is believing :-)

  30. Just don’t let Bernanke know :mrgreen:

  31. ToNYC says:

    I prefer a+b in all cases and moderation as in all things. I have a long-cycle view and since I own neither crop nor mine nor stock company, I want nothing to “go up” but my knowledge of human ADD.

  32. Pat G. says:

    I’m definitely the “a” type. With a few wrinkles.

  33. MA Trader says:

    I hope dead hobo also recognizes that liberal Democrats are always trying to get to a place that never WILL exist, which can only happen at a time that never WILL BE. I guess that’s why they’re never happy. (Studies have shown that, on balance, conservatives are happier than liberals….)

    Anyway, I scored 5 A’s — just like back in school :) — so I should be a great trader, right? Except I find I’m rather risk averse. I wonder if there’s an opposite end to that sensation scale for people who not only are not sensation seekers but are actually sensation avoiders! (I guess I’d call myself calm and sedate, which translates to predictable and reliable. But I have no doubt others would call me boring….)

    What do you do if you love the market but hate the rush?

  34. franklin420d says:

    1) The town I am from you can choose between Dairy Queen or a Taco Truck – So dinner at home.
    2) Have had at least 3 drive byes in last year alone – Relax at home? What ever….
    3) Dive something nice it will get stolen or vandalized, I will stick with my beat up S-10, unlocked and drity.
    4) Good greif – just pour me a beer or two.
    5) Both I very much enjoy camping, but have also climbed to the top of Mt.Adams and gone up Mt.St Helens (Not all the way though) and would like to climb Mt. Hood and Mt. Rainer.

  35. VennData says:

    Become an Asset Allocator…

    http://www.bogleheads.org/forum/index.php

    …never worry about this nonsense again.

    Or… keep worrying, feeling… failing.

  36. [...] some interesting reading:     Are Some People Hard-Wired to Fail in Financial Markets?     Stack the Odds for Daytrading [...]

  37. rajnah says:

    guess i am not good for anything:

    a. neither
    b. neither
    c. neither
    d. does that include coffee?
    e. neither

    … or else i am no longer in grade two….

  38. [...] “Successful trading requires the ability to take meaningful risk, but also the capacity for controlling that risk.  One can trade for sensation and one can trade for profits, but rarely can one do both.”  (Big Picture) [...]