Thursday, October 11, 2007

The Cognitive Development of the Trader

Jean Piaget, the Swiss biologist who left his mark on psychology, is known for his research on cognitive development. His view was that such development progresses through a series of stages, during which our internal maps of the world become increasingly differentiated. Piaget viewed people as scientists, continually testing and refining their hypotheses about the world. We both fit our perceptions to our maps (schema) and adjust those maps to accomodate discrepant perceptions, according to Piaget. This provides cognitive stability, even as it facilitates growth and development.

Howard Gardner has added to the cognitive development literature with his recent text "Five Minds for the Future". He argues that five kinds of thought process are essential to successful functioning in a world of increasing information and complexity:

1) The Disciplinary Mind - Mastery of ways of thinking specific to particular fields of study and work;

2) The Synthesizing Mind - The ability to integrate ideas into a whole and communicate broad understandings;

3) The Creating Mind - The ability to generate novel questions, answers, and understandings and assemble existing information into new, illuminating frameworks;

4) The Respectful Mind - The capacity to appreciate and draw upon diverse forms and sources of knowledge;

5) The Ethical Mind - The understanding and discharging of personal and professional responsibilities.

Gardner's fascinating observation (that places him in the Piagetian camp) is that these forms of mind emerge in a progression. We start with a Respectful Mind and an openness to information and experience. Under tutelage and mentorship, we then acquire the knowledge and ways of thinking associated with a particular line of work or profession, the Disciplinary Mind.

As we accumulate knowledge, we learn to relate pieces of information to one another and develop larger understandings--the Synthesizing Mind. For example, medical students will draw upon their knowledge of biochemistry and anatomy to grasp principles of pathology, and they will synthesize their knowledge of pathology to help them diagnose diseases in patients.

With the ability to synthesize information and perceive larger patterns in nature, the advanced thinker becomes able to perceive new relationships: the Creating Mind. That medical student, for instance, might go beyond textbook definitions of illnesses to perceive an emotional component to a patient's presenting problems, opening the door to a fresh way to tackle a longstanding problem.

Throughout this developmental sequence, the learner acquires from mentorship a sense for the standards of a particular line of work or profession: obligations to self and others. This is the Ethical Mind, and it guides how knowledge is ultimately deployed. One distinguishing element of a profession is its formulation and cultivation of a set of ethical principles.

When I first read Gardner's account, I was struck by how well it fits the developmental process of trading that I experience in the best trading firms.

Developing traders are encouraged to approach their craft with an open mind, consulting multiple sources of information--from media to peers and original research--to generate trading ideas. They also are taught ways of thinking specific to the kinds of trading that they're doing. Market makers in derivatives, for example, think very differently about trading than do portfolio managers mutual funds.

Ultimately, whether the trader is piecing together order flow information at a bank desk or macroeconomic data for a fund, he or she engages in a synthesis of findings which helps transform them into actual trading and investment ideas that capture broader understandings of supply and demand.

The best traders think creatively about their markets, seeing relationships not obvious to the rookie observer. Currency movements are seen as connected to sector performance within equities; the pulling of offers in the order book for stock index futures is linked to a breakout rise in bonds. Traders will sometimes tell me, "This market reminds me of 1987 (or 1997)", and then weave the similarities and implications. That is the creative process at work.

Moreover, traders at the best firms acquire a sense of duty and responsibility that defines their ethical thinking. They have a responsibility for capital, a duty to investors, and certainly obligations to themselves and their families. Integrity is a watchword at firms that handle other people's money; without that, trust is lost--and so are assets.

A child thinks in simple ways with undifferentiated understandings. When my daughter Devon was very young, she watched a tape of herself on TV and her jaw dropped open. She turned to me and exclaimed, "Two Devons!" She did not understand, at her age, that the videorecording was of her. Instead, she assumed that there must be another Devon.

Similarly, traders begin their careers with very simple--and often equally magical--views of markets and market movements. Later, they understand that traders and investors operate at differing timeframes, that markets are interconnected, that themes abound in markets, and that probabilities and departures from value govern trading opportunities. With this development comes a richness of mental maps and the fivefold cultivation of mind noted by Gardner.


Pain and Gain in a Trader's Development