Monday, December 22, 2014

Two Hidden Virtues of Successful Traders

One of the most interesting aspects of working as a trading coach is the ability to see, first hand, what contributes to the success of traders.  So often the factors that lead to success are not those emphasized in mainstream articles and books.  Here are two unappreciated virtues I see among successful portfolio managers and traders:

1)  The ability to tolerate uncertainty - Suppose you take any particular configuration of price in a market; say, trading x% above or below a Y period moving average.  Then look at what that market does on average over the next Y period.  The odds are great that for any value of x and Y, the market's directional tendency will be swamped by the variability of price within that next Y period.  What that means is that, on average, the signal to noise ratio for a directional trader is low.  Whatever directional tendency is present is generally not statistically significant and not readily tradeable.  Given such a situation, the modal opinion of any trader should be "I don't know".  Uncertainty is itself a view and, in fact, should be one's base case.  When a trader cannot tolerate uncertainty and needs to manufacture conviction, the result inevitably is overtrading the objective opportunity set.  It is impossible to properly manage risk if you are intolerant of uncertainty.

2)  The productivity of time spent away from trading - I consistently find that successful traders spend more time identifying good trading opportunities than actually putting on and managing trades.  Csikszentmihalyi conducted a fascinating study with artists in which they were shown 27 objects and asked to arrange a small group of them into a composition and generate a sketch.  They had one hour for the task.  The artists fell into two categories.  One group quickly identified the objects for the composition and spent the better part of the hour refining their sketches.  The second group spent most the hour figuring out what to draw.  They selected objects, started sketches, changed the objects, sketched some more, rearranged objects, etc.  By the time they found the composition they liked, they spent only a few minutes on the final sketch.  The drawings of the second group were rated as significantly more creative by a group of art critics than those of the first group and, after a five year period, the second group demonstrated significantly greater success as artists.  The less successful artists spent most their time sketching.  The successful artists spent most their time finding compositions worthy of sketching.  It's a great analogy for trading.

Good things happen when these two strengths come together.  The ability to accept uncertainty frees the mind to maximize time away from trading and creatively generate sound trade ideas.  For the successful trader, uncertainty provides the opportunity to get away from screens and look at markets through new lenses.  Overtrading exists when the need to trade exceeds the need to understand.

Further Reading:  How to Deal With the Uncertainty of Trading