Personality, Emotion, and Trading Performance
Research in behavioral finance suggests that participants in financial markets are not fully rational actors. Instead, they tend to act upon cognitive biases and emotional reactions that slant their estimates of risk and influence their perceptions of financial data.
In a study that I conducted with Andrew Lo and Dmitry Repin of MIT, we found that emotional reactivity to financial markets was correlated with trading performance. Specifically, “…subjects whose emotional reactions to gains and losses were more intense on the positive and negative side exhibited significantly worse trading performance, implying a negative correlation between successful trading behavior and emotional reactivity” (p. 352).
In that study, we found, no single set of personality traits was significantly correlated with favorable trading outcomes. Rather, it was emotional reactivity overall that seemed to best predict profitability.
These results would seem to support the common perception that success in financial markets requires an elimination of emotion from trading decisions. A corollary of this view is that all good trading must be rationally conceived, planned, and executed: that good traders are those, as the saying goes, that “plan their trades and trade their plans.”
The problem with this perspective is that it does not fit the realities of trading floors at the firms where I work as a psychologist and coach. Traders, even the most successful, are often highly emotional and competitive. Many sustain significant profitability year after year trading actively each day, holding positions for mere minutes. Invariably these very active traders have no time to research their trades, not to mention develop formal trading plans.
Research into implicit learning suggests that people routinely apprehend complex patterns in the world without necessarily being able to verbalize those patterns. For instance, young children can form grammatically correct sentences and yet cannot explain the rules of grammar. Very active traders develop a “feel” for markets that enables them to act on short-term shifts in momentum without being able to formally lay out the rationale underlying their trades.
Antonio Damasio’s research suggests that such implicit learning is cued by “somatic markers“: a felt sense of fit or non-fit when we perceive patterns in the world. Such markers, for instance, may cue us to shift topics in a conversation when we sense that the other party is uncomfortable. We may not be able to verbalize the reasons for the shift at the time–it occurs spontaneously in the flow of interaction–but we know it feels right in the context of discourse.
Very active traders describe a similar feel for what they do. A market will be weak and suddenly the trader will perceive that “we’re having trouble going lower.” Quickly he enters bids into the order book, gets filled, and rides a reversal move higher. Asked what made him think we were putting in a bottom, the trader simply replies, “They just couldn’t break ‘em.”
Damasio’s contention is that the feel that accompanies implicit learning is indeed a kind of feeling: emotion is an integral part of decision making. What makes emotional arousal detrimental to trading is not that emotion necessarily biases decision making, but that it can cover over the more subtle, felt somatic markers that alert us to subtle market patterns. When we are frustrated with our profits and losses, we can no longer fully attend to what feels right when we process complex market relationships. That leaves us out of sync with the market’s conversations.
In Lo and Repin’s study, ten experienced traders were connected to biofeedback equipment while they viewed financial markets. Interestingly, all recorded significant physiological changes during such trading events as breakouts from price ranges. “Contrary to the common belief that emotions have no place in rational financial decision-making processes,” the authors explain, “physiological variables associated with the ANS [autonomic nervous system] exhibit significant changes during market events even for highly experienced professional traders” (p. 332).
The intriguing implication of this work is that those who have immersed themselves in financial markets probably know far more than they know they know. Their performance crucially hinges, not on brushing emotion aside, but in sustaining access to those implicit cues that literally embody expertise.
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September 3rd, 2009 at 3:04 pm
“…subjects whose emotional reactions to gains and losses were more intense on the positive and negative side exhibited significantly worse trading performance, implying a negative correlation between successful trading behavior and emotional reactivity”
I can relate to that. If I play poker (an activity quite similar to trading) while being emotional, I suck to no end. OTOH, if I’m calm and analytical, I rarely have a bad session. I’ll lose at times, of course, but my overall performance will be better, if only for the fact that I played the best I had too under the particular circumstances of a given session. Which is about the best one can do while performing an activity that has built-in uncertainty of outcome.
September 3rd, 2009 at 3:36 pm
Isn’t this the same problem as with “gifted” minds.
They can look an equation and solve it in one step, yet when ask to explain how they solved it. They will make mistakes. Since they get uncomfortable to explain how they solved a problem without knowing how they solved it. So much for math being emotionless.
September 3rd, 2009 at 3:37 pm
This is an excellent post. Thank you for this.
September 3rd, 2009 at 3:45 pm
Great article. It’s true. The best traders sometimes just have an “intuition,” a feel for things. Also, the very best know how to take great gains and losses in stride. Don’t get too excited about gains and don’t get too down after losses.
However, for big trades, or “prop trading,” you can’t emphasize enough that “plan your trade, trade your plan” theme. The very best prop trader I ever met said that he spent 95% of his time thinking through his trade and only 5% executing/managing it….
September 3rd, 2009 at 4:29 pm
@AndyT 3:45 PM – Excellent point. There is an important cognitive difference between market making/very short-term trading and longer term trading/portfolio management. As the holding period of positions increases and the frequency of trading decreases, there is more time to research and plan trades. When trades last all of a minute and catch dislocations in the order book, quick perception and reflexes take over. Matching the cognitive strength/styles of market participants to trading styles and holding periods might be particularly important to long-term success.
Brett
September 3rd, 2009 at 5:14 pm
The less emotional I am (and I’m not), the better I usually trade.
Walling off parts of the portfolio to limit losses helps keep the mood on an even keel, as well as separating the book into shorter-term trades/long-term investments. I’ve done a lot better of late in terms of having a couple of exit strategies planned before entering a trade, and in terms of scaling into positions. It all comes with experience, and listening to some sound advice from my TBP buddies.
September 3rd, 2009 at 5:29 pm
I believe Nassim Taleb had an anecdote about this sort of stuff and how it is innate in us humans. This may be a terrible job paraphrasing but here goes. He says acting on emotion is what got us humans here today. The human brain is not made for precise and complex computations when making a decision. He uses an example of the prehistoric man running into a lion. The men who stopped to think and calculate the probabilities of the sighting being an actual lion would wind up dead. However, those that acted on emotion and impulse at the first hint of a lion would wind up surviving.
Anyways as I said before (though somehow it must have gotten moderated out) great post Brett. Thanks.
September 3rd, 2009 at 6:37 pm
Thanks Brett for a great article. Your comment to Andy, “Matching the cognitive strength/styles of market participants to trading styles and holding periods might be particularly important to long-term success” is really interesting. In sports, you can see that someone fits their sport better than others — whethers it’s body type, or speed, or ball-handling ability, etc. But in markets, pretty much everything is psychological, so you/others can’t *see* your/their strengths & weaknesses (except in the P&L over very long periods of time or with extensive experience). It’s just another way how humans are woefully inept towards markets — it’s a psychological arena that we aren’t evolved for.
Side note … it’s always funny & interesting to see a suberb trading/investing psychology article not get many comments, but if the post was on a particular person, company, or political issue, you would get tons of comments. The many dimensions of pyschology are 80% of the market battle … yet very few seem to really spend much effort on it.
September 3rd, 2009 at 7:47 pm
Wow… another kick ass Steenbarger post… I gotta start checking your blog, bro.
When I saw this pop up earlier, I immediately decided to wait until I was at home chillin to get deep into it. I agree with everything up there. There certainly is a distinction in psychology between the type of market maker, what I would call “ultra short term trading,” and what I do… but at the root of all of it, its your ass really. You make decisions and deal with the consequences. Money seems inherently emotional tho, doesnt it?
I’ve always had a very personal connection to my trading (and the money that enables it, ie: my “stake” as it were) because I’ve never had much dough begin with. That has made my experiences with trading inherently emotional. Fear of loss, failure, etc. There is a reason that many pros will tell you dont bother trading with money you cant afford to lose… I feel fortunate as hell to not be out of the game already after just a couple years. Trading has been extremely emotionally developmental for me. At a certain point I realized that trading was more about me psychologically than what I “knew” about this or that stock or market. That was a turning point to begin looking inward to the center.
It cannot be said enough how important it is to remain decidedly unemotional when relating to an open position, more importantly, its profits and losses. Nothing has screwed me more than taking profits too early because I was afraid of losing them… Besides thinking I’m smarter than the tape and that a loss will soon be a win, despite obvious signs of the opposite being true… which brings a whole different aspect of emotion and psychology into this.
One thing is for sure, I feel a hell of alot less emotional about a position that is winning than one that is losing… so the logical step is to stay out of losing postions.
To do that, I must avoid “out-thinking” the tape and trading against it.
Deep, the stream that is emotion in trading.
Good comments rolling here, lets keep it up. Love to hear BR, karen, uno, Hoffer, CV, B22, et al chime in on this one. Irie vibe- I-Man
September 3rd, 2009 at 8:06 pm
A great position trader is very much like a great poker player. They both need to consciously and sub-consciously absorb information/tells and then repeatedly calculate probabilities, certainties, uncertainties, and then make calculated moves. The ability to “see” what others can’t has everything to do how one absorbs and calculates ones moves. It is not a coincidence that the best poker players routinely make it to the final table or that the best traders lead the pack. The key is that markets, like poker, have a very human aspect to it outside of the data and information. That is one of the reasons why being book smart is only half the equation to being a good trader. Just because one reads Brunson’s super system, doesn’t make them as good as Doyle. The reason is that he, like others, cannot explain how they know what to do in any situation, like the article states.
If you were to build a robot that could calculate every possible probability/odds, that robot would still not make it to the final table, because the game is inherently human and requires human intuition about emotion. Since markets are also inherently human, building a robot to replicate a successful trader would not yield great results (unless all trades were done by robots, stay tuned). Why? Because a programmer/trader themselves do not know how they know. They, like the poker player, do not know how to explain their absorption and calculation of information that builds intuition. How does one know if a player is giving you a tell or a head fake? How does a trader know if the market is giving them a head fake? They know because they see it, and they see it because it is in their mind, which is very much personal. So, what happens when the market is full of bots one day? The game shifts to understanding the mass behaviour of bots, their programmers, and the effect of human/bot interaction. No wonder why behavioural finance is becoming much more useful (on top of interesting).
September 3rd, 2009 at 8:33 pm
Steenberger-
any acquaintance w/ Alexander Elder, MD (Psychiatrist) – author of ‘Trading for a Living” and “Come Into My Trading Room”
I have read “Come Into My Trading Room” and many of his observations remind me of your observations
September 3rd, 2009 at 9:16 pm
@I-Man
I’ll 2nd the I-Man… Steenbarger did it again…
My 2 cents is as follows ( because it ‘feels’ that the tone of the article bids each individual to respond to its vibe by relating either personal experiences, or personal relationship with the subject matter)…
I could bore everyone with my own stories… But sometimes it’s more fun to express something in analogous terms… (that is, what THING did reading the article make me think of – a song? a painting? a poem?)…
Oddly, the thing that popped into my crazy head was a scene from the movie “The Replacements” (a funny and very underrated movie from about a decade ago)… I was going to waste a lot of electrons trying to describe the SCENE I was thinking of, but fortunately, I found a clip from it on YOU TUBE…
The whole clip is worth watching (because there are some funny parts)… But the part I’m interested in conveying starts at about the 2:05 minute mark…
http://www.youtube.com/watch?v=H9DIzcBTWYg
It’s the thing that most aptly describes my gut baptism into the TRADING arena…
September 3rd, 2009 at 10:13 pm
to IIIrd I-Man, Steenbarger makes w/ another fine post..
easier Said, than Done, the Key, to me, comes in this reversal of a familiar set piece: “Don’t just do Something, Sit there.”
It is too easy to become wrapped up in Flows that, from a better perspective, have nothing to do with one’s Self.
The Grand challenge, I find, is to remain in Observation, to be able to keep one’s Self in Tune, able to filter the Noise of the scene(screen).
I think it was AT relaying a vignette about the greatest Trader he knew–spending 95% of his Time preparing the Trade, 5% Executing/Managing it. If that sounds extreme, We should wonder..
To me, I know that it hews to my experience, when I’m most effective/efficient..
In a different Fashion, We should be good Landlords of Our meta-Space, our mindsphere, and, with that, know, for certain, whom is Renting space therein..
September 3rd, 2009 at 10:41 pm
@MEH
The WORDSMITH of this, yet young, century…
“Don’t just do Something, Sit there.”
That is logic that, unfortunately escapes the seemingly “fertile” minds of the likes of Obama or Bernanke…
I hereby nominate you POTUS!… or, as the case may be:
- CZAR
- Chief Official in charge of disbanding the Federal Reserve Bank of the United States
September 3rd, 2009 at 10:41 pm
… or Buddah!
September 4th, 2009 at 12:03 am
Damasio, Lakoff, etc, pretty well do in the idea that reason rules. Oh, and don’t forget the testosterone. (And probably a few lines of cocaine, too, at least for some.) Turns out that the “rational actor” is magical thinking.
September 4th, 2009 at 3:34 am
What I find interesting is how people obtain their intuition in the first place. The physical experience of trading is one way and, generally speaking, intuition is embodied by the individual’s interaction with others and the flow of information they receive. I think this means that there are many sources of intuition.
Traders, when they were in pits, would process information and signals not only from their own orders but also from other traders around them. With electronic terminals and internet trading, charts and news chatter are the main medium through which we sensitise ourselves to the market. This is at least one degree removed from the more personal/direct interactions and hence, knowledge, that bankers and fund managers have. (Which I presume give the latter a distinct advantage.) And now with blogs like this and zero hedge, there is a counter-current of information and social interaction online that goes against mainstream CNBC propaganda.
It might be useful to match these different sources of intuition with the different trading strategies and to see how profitable each has been in different kinds of market environments.
September 4th, 2009 at 9:09 am
IMHO, most come to the game with minimal training, those that have mentor or teacher they trust do well. Some intution works great. Over a long period of time imho it is how well you can teach yourself. There are a thousand ways to trade, finding what works for yourself and why is almost never ending, patience when it comes too money is a tough gig, it is also the one desire that is common too all. The tough part right now is the break between fantasy and reality, a former believe that pps was based on something, now imho, alot of it is based on desire, it is very difficult to embrace desire when logic is non-existent………..for me it seems FEAR, aka, the quicksand is always around the corner. One bad decision always leads too two others is what I say, will the next one be right or wrong???? Only the shadow knows.
September 4th, 2009 at 9:45 am
Sorry, but this post is a croc.
A study of….80 freaking day traders….[And several dropped out of the study because the stock market declined during the period of the study...so we're not even talking about 80...which in itself is paltry.] Are you kidding me?! Do you really think that your “sample”…of 69 daytraders who are foolish enough to sign up for one of these online trading courses from as you state, “a well known futures trader” is healthy and representative?
And the study wasn’t even on strictly Live Trades! It mixes in paper trading results to arrive at its conclusions….
All this study does is make a link between emotion and “trading behavior”…and when looked at more closely, all one needs to do is remove “trading” and what are we left with? There is a link between emotion and behavior. Earth shattering stuff.
Do you suggest Paxil or Zoloft in moderating one’s “emotional reactivity”?
How many people commenting on this post actually spent a few moments looking at the underlying study?
Check out this conclusion…straight from the study:
“The results of our study underscore the importance of emotional state for real-time trading
decisions, extending previous findings in several significant ways.” [We needed a study to tell us this?]
You write: “In that study, we found, no single set of personality traits was significantly correlated with favorable trading outcomes. Rather, it was emotional reactivity overall that seemed to best predict profitability….The intriguing implication of this work is that those who have immersed themselves in financial markets probably know far more than they know they know. Their performance crucially hinges, not on brushing emotion aside, but in sustaining access to those implicit cues that literally embody expertise.”
There is no intriguing implication. You were studying 69 daytraders who were desperate enough up for one of those ridiculous Trading Courses! And many of these were Paper Trading!! C’mon.
What exactly are you telling the readers? That if they “could just sustain access to those implicit cues that literally embody expertise” that they will be better traders?
This is total bullshit. “Implicit cues…” And I’m not being harsh. It’s garbage like this, that perpetuates the notion that these pathetic DayTraders who sign up for bullshit Daytrading Courses from “a well known Futures Trader” {Again, I love that quote from your study!}…could do better if only…they could harness that which they already know from their intuition… and “sustain access to these all-important implicit cues.”
What a joke.
September 4th, 2009 at 11:53 am
One of my favorite books on the topic:
The Disciplined Trader, by Mark Douglas
http://www.amazon.com/Disciplined-Trader-Developing-Winning-Attitudes/dp/0132157578
September 4th, 2009 at 1:01 pm
Success is the ability to go from one failure to another with no loss of enthusiasm – SIR WINSTON CHURCHILL
Here is a Mark Douglas quote from “The Disciplined Trader”:
Most people like to think of themselves as risk takers, but what they really want is a guaranteed outcome with a little bit of suspense.
http://viewpointsofacommoditytrader.com/667/mindset-terrible-to-waste/
September 4th, 2009 at 1:52 pm
Thanks for linking that, Charles. Looks like I have yet another blog to begin digging through in addition to Steenbargers.
The combination left/right brain unity is a big concept. To be simple.
September 4th, 2009 at 4:22 pm
Very interesting. I do not presume to think the study was not analyzed well, however it seems the interpretted results are nonunique. Humans are very good at detecting patterns. So good in fact, that we have great difficulty recognizing non-patterns of purely random variation. Even if the traders recognize patterns, it does not follow that those patterns are real(remember randomness will innevitably appear ordered some of the time), or that the pattern was conceptualized vaguely in the investors mind before he noticed it.
I leave it to the academics in this field to study and report, but it seems there is much wiggle room remaining in the interpretation of observations here.
Intrigueing post
September 4th, 2009 at 8:47 pm
Thanks for the insightful comments on the article. I’ve just posted another piece to TBP re: risk-taking and personality. The analogy between trading and poker playing is particularly apt, as it’s not just playing the odds of the hand, but reading the tells of the other players that leads to success. What I find most interesting about the implicit learning research is that it illustrates how structured exposure to noisy patterns can generate intuitive learning.
Brett