Monday, March 12, 2007

The Paradox Of Trading Rules: What Attracts People To Trading Is What Makes Them Fail

I've asked many traders what attracts them to the field and responses of varied. Many cite the challenge of figuring out complex markets, the lure of a large income, and the inherent competitive nature of trading. The most common theme that emerges, however, is that of autonomy. Many traders are attracted to the markets because trading enables them to set their own (reasonable) hours and work for themselves. It is not at all uncommon in my experience for a struggling trader to voice his or her worst fear: not losing money, but losing the autonomy of self-employment. The idea of working a 9-to-5 job for a straight salary rubs many traders the wrong way, despite the seeming lure of security and benefits conferred by such jobs.

In recent posts, I mentioned that autonomy is an important component of personal well-being. For that reason, I included it as a dimension in my brief personality questionnaire for traders. Research suggests that daily fluctuations in our perceived ability to control our outcomes contribute to shifts in our moods and that people in societies that offer greater personal freedom report higher levels of positive mood than those in countries with restricted options.

As Daniel Nettle reports in his book Happiness, people with professional jobs report higher levels of well-being than people in unskilled positions. This is partly a function of income, but also represents a response to the higher autonomy present in most professions. In fact, on a ten-point scale of personal happiness, poor individuals who report a high level of autonomy average a score of 7.85. Wealthy persons who perceive a low level of autonomy average only 5.82. The conclusion? "Being at the top of the social heap only makes you happy in as much as it gives you the opportunity to control your life" (p. 74).

This helps to explain why traders will stick with trading even after it is clear they are not making a solid living from their efforts. Perhaps, paraphrasing Milton, it is psychologically better to rule in financial Hell than serve in heavenly wealth.

But therein lies the rub. What if trading success requires a high level of rule-following and self-restraint? No one would point to Army boot camp as a source of high autonomy for a recruit, but trading arguably requires just as much attention to detail and discipline. Ironically, what most attracts people to trading is what frequently does them in: they subconsciously--and sometimes overtly--view rule-governance as a form of unwanted restraint. Their violation of trading rules and plans represents an assertion of autonomy, not a deeply hidden motivation to court failure.

The key to succeeding with trading rules is to truly make them your own. Frame them your way out of your own experience. Having rules imposed by your trading firm or trying to borrow rules from another trader won't provide the autonomy of self-defined rules that you actively choose. Autonomy doesn't mean living without rules or limits. It means actively selecting the guidelines for your own behavior. If no one followed the rules of the highway, everyone's freedom to travel would be impaired. We willingly accept rules because these sometimes get us where we want to go in life.

If your trading rules are right for you, they should feel natural, like driving on the proper side of the highway. If your rules feel like strait-jackets, you know there will be a battle between the need for autonomy and the need for profits. And, if you're like most people, autonomy will win out.