Coaching Hedge Fund Portfolio Managers: Bursting the Myths of Trading Psychology

In my recent post, I passed along four things that I have learned from serving as a trading coach for hedge fund portfolio managers. This post takes a different perspective, identifying several trading psychology "truths" that I have had to unlearn as a result of working with experienced professionals. Here are a few myths I've had to dump along the way:

1) Success is Largely a Function of Psychology - Simply not true. The portfolio manager generally has a core strategy that is implemented in different markets and/or across different instruments. This means juggling large amounts of information over time and viewing markets multidimensionally for opportunity, extracting themes from the relative movements of national markets and asset classes. Success is a function of information, creative thinking with that information, a deep understanding of what moves markets, and experience with different market conditions. Only when those are present does psychology matter.

2) A Good Trader Is One Who Makes Large Returns - Those who make large returns with large risks are tomorrow's casualties. In the hedge fund world, you lose investors if you cannot rein in risk. It's the ability to generate consistent, significant risk-adjusted returns--not just large absolute returns--that matters in the long run. Successful portfolio managers don't just look at daily profitability. They actively evaluate the correlations among their positions, their levels of risk, and their shifting horizons of risk/reward.

3) Execution Is a Huge Part of Success - When you have hundreds of millions of dollars or more to invest, you don't just click a mouse and enter a full-sized position. You scale into positions over time so as to not disrupt markets and so as to obtain good prices. Similarly, you can't just exit many positions all at once when you have large portfolios, particularly when some of your positions are in markets that have limited liquidity. This is where the management part of portfolio management becomes crucial.

4) Opportunity is Limited - There are plenty of markets to invest in if you have 15 million dollars. It is more challenging to find opportunities for 15 billion dollars. Firms are in a constant race to find new markets, new spheres of opportunity. This lies behind the development of the latest quantitative trading models and the development of frontier investment opportunities. For a daytrader, markets are always moving and there's always a trade around the corner. Not so in the larger world of money management. Much of the long-term success of large hedge funds hinges on their ability to push the opportunity envelope and cultivate new sources of edge.

I sometimes receive mail from traders asking me how they can break into the hedge fund world. Success at portfolio management is not simply a larger version of success at trading individual markets directionally. It's a different game, with a different thought process. Not many traders get that and, sadly, neither do many would-be coaches.

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