Friday, January 19, 2007

The Personality of the Trader: How It Affects Performance

A recent pilot study addresses the interesting topic of how a trader's personality affects his or her trading performance. The researchers focused on six personality traits and their impact upon trading:

* Locus of control - The degree to which a trader believes that the ability to be successful is within his or her control;

* Maximizing tendency - The degree to which individuals seek optimum outcomes from their decisions, not just outcomes that meet or exceed expectations;

* Regret susceptibility - The tendency to look back on outcomes of decisions and focus on negative aspects, creating regret;

* Self-monitoring - People's tendency to track and control their own thoughts, feelings, and behaviors;

* Sensation seeking - The degree to which people seek varied and stimulating experience;

* Type A behavior - The degree to which individuals are driven to achieve.

The researchers set up a simulated trading exercise with real money payouts. Because data from only 32 subjects were collected, results must be considered preliminary.

Examining the personality profiles of the participants, the researchers found that the first two traits--locus of control and maximizing tendency--were not related to trading performance. Among the remaining traits, three clusters or personality types emerged:

1) Relaxed, risk-averse traders who avoid regret, dislike sensation-seeking, and show type-B (non achievement oriented) behavior;

2) Traders who were controlled risk takers: high in both self-monitoring and sensation seeking;

3) Achievement-driven traders who showed high Type-A personality traits.

Of the three groups, number three performed the worst. These highly competitive traders were also the most impatient in their decision making, reducing their effectiveness. The first two groups performed similarly--no significant difference. What this suggests is that a relaxed attitude toward performance may be more helpful than a driven one: the highly achievement-driven trader may create his or her own internal noise, interfering with sound decision-making.

Although this is a small study and needs to be followed up with more extensive work, the findings are consistent with other research related to personality and trading performance. In my own study with Andrew Lo and Dmitry Repin of M.I.T., we found that highly emotional reactions to trading outcomes--positive *and* negative--are associated with worse trading performance. The highly driven trader may generate more positive and negative emotional experiences in his or her approach to trading, interfering with clear, calm decisions under conditions of risk and uncertainty. This would fit with research mentioned in my Psychology of Trading book (p. 276), which links stimulation-seeking to high states of emotional arousal. (One of the rationales for the Philip Glass techniques mentioned in that book is the creation of internal states in which stimulation--and hence arousal--are reduced).

The conundrum is that successful traders do tend to be an aggressive, achievement-oriented lot. Up to a certain point, that Type-A tendency works for them, especially if they are able to combine self-monitoring and self-control (the personality trait of conscientiousness) with the desire to take risks. At very high levels of aggressiveness and need-for-achievement, however, the frustrations inherent in working in a setting of high uncertainty may prove overwhelming. I would expect that highly achievement-oriented traders who also have a strong tendency toward negative emotional experience (guilt, anger, depression, anxiety) might experience the worst trading outcomes of all.

The interesting finding of the pilot research summarized above is that group one--the relaxed, risk-averse traders--performed as well as the conscientious risk takers. It may well be the case that clarity of mind--not personality per se--is the most important psychological determinant of good decision making and trading profitability.