Thursday, September 25, 2008

Financial Risk Taking and Personality Traits

In my recent post, I reviewed five basic personality traits and their different facets. While there is far more to trading success than having "the right" personality--and there is plenty of reason for believing that different styles of trading call upon different personality traits--it does seem to be the case that personality can contribute to trading success. For example, the propensity to take risk has been found to have personality correlates, with different traits contributing to different risk-related arenas. For example, the trait facet of assertiveness is related to social risk taking, but not to the taking of financial risks. The trait facet of fantasy is related to risk taking in career situations, but not to financial ones.

A careful examination of this research from Nicholson, Fenton-O'Creevy, Soane, and Willman finds that the following trait facets positively contribute to the propensity to take risk:

* Sensation-Seeking - The desire for new experiences;
* Ideas - An interest in new and different ideas;

The following trait facets are inversely correlated with risk-taking:

* Deliberation - The tendency to reflect before acting;
* Straightforwardness - The tendency to address matters directly with people;
* Depression - Feelings of negative self worth and hopelessness;
* Self-Discipline - The tendency to stick to one's responsibilities;
* Impulsiveness - The tendency to make decisions on the spur of the moment
* Aesthetics - An interest in art and beauty.

Across all areas of risk taking--social, career, health, recreation, finance, safety, and social, the trait facets most related to risk-taking in a positive way were sensation seeking and ideas. The facets most negatively related to overall risk-taking were deliberation and compliance (going along with others).

Notice, of course, that the tendency to assume risk is not necessarily an indication of trading and investment success; some of the biggest blowups on Wall St. have been high risk takers. Nonetheless, the ability to take risk is necessary if one is to earn sizable returns. This research suggests two interesting conclusions:

1) There is a tension between financial risk-taking and deliberation/discipline;

2) Financial risk-taking is aided by the ability to generate novel ideas.

My next post in this series will explore each of conclusions and their implications.


The Stock Speculator said...

This is one of best sites on the net. Great,well thought out posts on subjects important to traders.

Again, many thanks.

Adam said...

"Financial risk-taking is aided by the ability to generate novel ideas."


I would add to this that novel ideas are worth as much as one's willingness to test them and being unafraid to follow the resulting data wherever it might lead ~ even to the extent of discarding the idea if required.

Trashing what turns out to be a bad idea ought not fill one with disappointment but a shiver of pleasure from having gained new knowledge and enthusiasm to move on to the next.

My theory is that folks who grow too attached to their precious ideas make bad traders. All of us could show each other some losses highly correlated with our love of bad ideas. Some people still "believe" in TRIN.

Stock Speculator is right. Not only is this the single best trading-related site on the net, its depth and breadth makes it a singular public service to the trading community.

Thank you, Brett.


Bill Luby said...

Excellent work once again, Brett.

I find it interesting that impulsiveness and self-discipline are on the same end of the risk spectrum.

The one that still has me scratching my head, however, is aesthetics. Any theories of how/why this fits into the risk aversion brain?



Firebird said...

Dr. Steenbarger,

Excellent post, as usual. I agree with the readers who said this is one the best sites on the net, I also find it particularly distinctive, as opposed to other worthwhile and useful sites but who in my view tend to look alike a bit too much.

On a previous post, you said "My leaning is to question the premise [personality traits as a key factor in trading]; success in trading is probably far more related to talents, skills, and effort than personality features." I do agree, and if you notice some traits overlap each other and/or are contradictory. For example, you mention both deliberation and impulsiveness as inversely correlated with risk taking, which does not make much sense - unless of course, people answering questionnaires have different ideas of what deliberation and impulsiveness is (see also your post on psychology and nursing students). My view is that you need to deliberate beforehand what you're going to do when x happens and act without further thinking if and when x happens. To put it in chessic terms: don't move until you see it, with the catch that in trading, once you see it you have to act at once or risk missing the move.

As for aesthetics, again I would say that it depends on how you interpret the term. Avant-garde artists are surely risk takers and creators of new ideas, but many people claiming interest in art/beauty may actually be interested in fashion (i.e. compliance).

Best trading,


Dr Bruce Hong said...

I know that you know the psychological literature better than I. But, after reading the article, I found one serious flaw as it relates to trading. Namely, that there was no measure of THE EFFECTIVENESS of the traders. Whether they were risk-takers or not, and whether they were risk-takers in different domains, has no relevance to me. I want to know whether those risk-takers were more successful than the others.

Another flaw is that there was no discussion of trading or investment styles. Someone who is trading stocks and options with a 4 - 12 week horizon, will and can be more disciplined and deliberative than someone who is trading index funds or FOREX with a five-minute time frame.

One final note. The measure of "discipline" as a personality trait, in and of itself, is not very illuminating. Impulsivity and Depression, yes, I can agree with. But I submit that discipline is ESSENTIAL to a successful trader. Just look at Warren Buffet!

Brett Steenbarger, Ph.D. said...

Thanks for the kind comments on the site; they're much appreciated!


Brett Steenbarger, Ph.D. said...

Hi Bill,

Yes, the aesthetics finding was interesting to me as well. It may be the case that financial risk takers are also hard headed, practical thinkers--


Brett Steenbarger, Ph.D. said...

Hi Jorge,

That *is* an interesting juxtaposition--the relationships among deliberation, impulsivity, and risk taking--and I'll try to address it in the next post in the series--


Brett Steenbarger, Ph.D. said...

Hi Bruce,

Good point; propensity for risk taking is very important for professional trading firms in their hiring of traders/portfolio managers, but it does not imply trading success. Necessary, but not sufficient...