I’ve often thought that trading is the world’s most equal opportunity employer. This wonderful fact comes about because the market neither knows nor cares about you. Therefore by extension it doesn’t care about your age, race, religion, sex or education. The fact that you may have an MBA from the Wharton School of Business or a PhD in computational finance is a complete irrelevancy to the market and, by extension, your chances of success. Whilst these academic endeavours are undoubtedly very rigorous, there is no way to convince the market of your academic prowess because the market doesn’t know you exist.
To date my view has merely been based upon my anecdotal observations of people as they embarked upon their trading careers. One observation that struck me quite early on was that there seemed to be no correlation between my perceptions of a person’s intelligence and their ability to trade. More often than not the brighter I perceived a person to be, the more they struggled with the trading process. This opinion has been enhanced by my observations of graduates of my Mentor Program. I have witnessed some very bright people struggle with the mundane nature of trading. Their natural curiosity has driven them to tinker and generally fiddle with various trading systems. Undoubtedly they believe there is a better way. Curiosity and self-reflection are good traits to have as a trader and all trading systems need revision. However, eventually there is a need to settle and begin the production line process of trading, and it is with this settling down that I think people have trouble.
Peter Bossearts from the California Institute of Technology has offered a different and very interesting slant on this problem. In a series of studies he has found that trading success did not seem to correlate with mathematical ability which is often used as an indicator of intelligence. Rather, it seemed to require an ability to understand the intentions of others. This is sometimes called having empathy or theory of mind. It is the capacity to understand that others may have different intentions, beliefs and views to you. My reading of this is that such people have an innate ability to lock into the current predominant group think. As such they may be more natural trend followers as opposed to individuals who are resistant to group think and who will pursue an individual agenda – often to their detriment. These traders would have what I would term a high illusion of control – successful traders have a low illusion of control. That is, they are willing to surrender to the trend rather than cling to a point of view that is opposite to what is actually occurring.
Such a point of view ties in with work done by Terrence Odean who looked at overconfidence as a predictor of trading performance. His work looked at differences in confidence between men and women and then reviewed this data as a function of returns from brokerage accounts. The overconfidence models said that men would be more confident (overconfident) in their ability than women and this would be reflected in differing investment returns. On a risk adjusted basis men traded 45% more but earned 1.4% less.
This is not to suggest that people who struggle with the trading process lack empathy or are dangerously overconfident but rather that they have an inability to conceive of the market as an aggregation of differing beliefs which oscillate from bullish to bearish. Hence they are always clashing with the predominant group because its world view does not tally with their own. This is undoubtedly a disadvantage since trading is simply about having the ability to decide who is in charge, the bulls or the bears, and then following the appropriate strategy that reflects this understanding.
Whilst the reasons why traders struggle with the trading process are no doubt many and varied and cannot be ascribed to a single feature, it is essential that traders realise that they do not act in isolation. What the group or herd think is more important than what the individual thinks.