Monday, September 29, 2014

Improving Trading Performance by Building Fluid Intelligence

An important distinction emphasized by cognitive psychologists is crystallized vs. fluid intelligence.  Crystallized intelligence represents what we know, our storehouse of knowledge.  Fluid intelligence represents our "how to" ability:  our capacity for reasoning and dealing with new and unfamiliar problems.  Interestingly, what improves crystallized intelligence does not necessarily improve fluid intelligence and may even interfere with our fluid capacities.  Our ability to solve problems in unique and unfamiliar areas is not advanced by having accumulated more information, but creative activities--such as performance in the arts--may build our ability to handle new situations creatively.  Physical activity also appears to be linked to improvements in aspects of fluid intelligence

There is provocative evidence that video games can improve brain connectivity and hence fluid intelligenceRecent research has shown that this translates into better school performance for children, as well as multitasking skills.  This is important, because it shows that quick, adaptive reasoning in one situation can build the capacity for similar capacities in other domains.

Discretionary trading is a great example of an activity that requires fluid intelligence.  We can read and memorize information about markets until we have an encyclopedic database, but that does not cultivate the skill to reason and function in uncertain and rapidly changing markets.  Pattern recognition is an important aspect of fluid intelligence:  the ability to understand new situations based upon patterns experienced in similar situations.  

We commonly hear that the best traders are not necessarily the ones with the highest IQs or the most college degrees.  That is true to a point.  Crystallized intelligence of the type tapped by standardized tests may be poor predictors of performance in fluid situations.  When I taught full time in a medical school, a research finding that interested me was that medical school admission test scores predicted grades in medical school courses, but did not predict performance in clinical education, which focused on patient care.  

That doesn't mean that intelligence is irrelevant to trading.  It may well be that great traders are fluidly intelligent:  they may not have the largest databases of information, but they are good at knowing what to do with the information they have.  If this is the case, then more fundamental analysis and more technical analysis and more statistical analysis will not make someone a better trader.  What will boost their trading performance is cultivating their fluid intelligence.  This has important implications for the education and training of traders and portfolio managers.

Further Reading:  A Fresh Vision of Trader Mentorship