Wednesday, September 24, 2014

Interview With Ted Hayes, Ph.D., Part Two: A Surprising Finding About the Development of Trading Performance

The first segment of the interview with Dr. Ted Hayes identified two drivers of performance:  cognitive ability and personality.  In this next segment, Ted draws upon his extensive research and identifies specific personality traits associated with peak performance:

Brett:  What does research tell us about personality traits and performance success?

Ted:  The current best model of personality is known as the “big five” factors of personality. This is an approach in which five personality aspects based on adjectives can predict what you’ll do. The five aspects go by the acronym OCEAN: Openness to new experience, Conscientiousness, Extraversion, Agreeableness, and Neuroticism (or its opposite, emotional stability). You can find these adjectives in all languages and culture groups.

Conscientiousness predicts work performance in all jobs, thus one should be curious about what it is. Conscientiousness includes planfulness, rule abidance, goal-setting, achievement orientation, and focus on details. In short, it’s self-control. And that is important for many aspects of life where orderliness, hard work, and avoiding distractions is valued. So in trading, especially at the entry levels, we need conscientiousness to help establish and follow routines, attend to details, etc. Traders who aren’t careful to chart assets, make journal entries, etc. are ineffective. Traders who get out of their routines (e.g., after the birth of a child, after illness, after a divorce) need to re-establish them before they can become productive again.

Emotional stability plays out through the more apt term resilience. You will lose money in trading at some point; you will, we hope, have some huge winning positions; there will be days when nothing happens, and there will be days where everything happens seemingly all at once. These events will test you. The capacity to modulate one’s one emotional state, maintain perspective, pull back after surging ahead and pull up when in a spiral — all are aspects of resilience.

A great example of someone with both extraordinary conscientiousness and emotional stability is Charlie Munger, Vice-Chairman of Berkshire Hathaway. Even his boss, Warren Buffet, has expressed his awe at Mr. Munger’s ‘hyper-rationalism.’

Brett:  That is very interesting, Ted.  It calls to mind the Angela Duckworth research at the University of Pennsylvania.  She and her team found that "grit"--resilience in the face of setbacks--and self-control were the two most powerful predictors of success. 

Ted:  Related to resilience, particularly in trading, is one’s comfort with taking risks (I refer to this as ‘risk tolerance’ though I appreciate that term might be misconstrued). It’s a combination of openness to new experience with emotional stability. In chess, for example, sometimes you sacrifice a knight to take a bishop. In trading you might lose some trades to test out a new market model you’ve developed. Some people prefer the tried and true, and can build a trading approach around that comfort zone. In either case, the extent to which you can come to terms with a balanced approach to risks for the sake of rewards will benefit you and build your own mental Sharpe Ratio.

Extraversion, which refers to being energize by having a broad network of friends and associates, and agreeableness, which refers to the extent to which you seek and create and enjoy harmonious situations, can be important in some careers such as trading in building one’s reputation for trustworthiness and collegiality.

Brett:  What I've found is that extraversion and agreeableness very much influence how traders work.   More introverted market participants often engage markets via research and study.  More extroverted traders are more apt to source ideas via personal contacts, social media, and other interactive means.  Some of the most extroverted and agreeable traders I've met have been quite effective working as part of teams. You've conducted a number of research projects concerning traders in financial markets and what makes them successful.  What findings have been most interesting and surprising to you?

Ted:  The dynamism of trading. You’re competing with and against people world-wide all the time and work in markets beyond your control, and this places extraordinary demands on traders at different points in their psyches.

Trading seems to have multiple levels based on maturity and style. For example, I work with Zolio where we have ‘pre-traders,’ 20- to 28-year olds who are not professionals engaging in trading on a simulated platform. Among them, mechanics and resilience are critical for success, but they’re also on a very steep learning curve. We also see pre-traders overly risk-seeking, with predictable results. Entry-level traders at firms I’ve worked with do better with, again, conscientiousness and resilience. But more senior traders are distinguished by their emotional approach to risk. That’s because these people have survived to that point, but usually they also have a sizable portfolio and it’s about gaining enough returns relative to the leverage and size of one’s positions.

It’s unusual to see different talent models predominate at different points in a career. Again, a very similar dynamic compared to intelligence analysts.

So let's step back for a moment.  Ted is saying something extremely important that, to my knowledge, has not been emphasized in the trading psychology literature.  "Different talent models predominate at different points in a career."  In other words, the traits that make a beginning trader achieve profitability are different from those that make a profitable trader a world-class talent.  It is possible to have the skills and traits needed to learn trading and become competent, yet other abilities and qualities may be needed to turn competence into proficiency.

This very much fits with my experience working with traders.  Early career traders I worked with in Chicago struggled with issues of discipline (conscientiousness) and taking/growing appropriate risk (resilience).  The experienced portfolio managers I've worked with more recently already have developed risk management skills and solid work routines and have demonstrated an ability to take appropriate risk.  Their greatest challenge has been adapting to changing market conditions, which Ted would subsume under Openness to new experience.

Each developmental level seems to call upon different success ingredients.  In the third and final segment of the interview, Ted will identify some of the implications of his research observations for traders and trading firms.

Further Reading:  How Personality Affects Trading Performance