In general, the conscientiousness (C) factor of personality rates a person’s degree of self-control, perseverance, and striving for achievement. those who have an overall high C score are good rule followers. This is particularly true for those high in facets C2 (order) and C3 (dutifulness). If this is you, you will do well trading mechanical systems. Systems trading is rule-based; the trading system dictates which trades to make and when. System trading decisions are absolute (if the criteria are met, the trade is made no matter what) and do not offer you the opportunity to decline to make a trade based upon your own discretion. For example, if a system trader reviews her charts and finds that her trading system’s requirements for a trade have been met, she will make the trade without any further decision-making process (that is, regardless of whether she liked the price, if she has a “gut feeling,” or whatnot).
As system trading decisions are absolute, system trading is perfectly suitable for fully automated trading. Once a computer program has been developed to recognize when a trading system’s requirements have been met, the program can be designed so that it executes the trade (including the entry, management, and exit) without any (or minimal) involvement of the trader. There are various trading technologies and charting software programs on the market that provide the ability for such automated trading, (VisualStation from TickCom, for example).
The trend that we found in all of our top-notch traders was this: High C, and especially high C2/order, was associated with systems trading (see Chapter 24 on KD Angle). Someone high in C2 feels he has to stick to his formula and a well-defined set of rules. And for him, this works. However (as we will especially see later on, in the chapter about my dad’s personality), traders with lower total C or C2 scores cannot stick to systems, and would probably even feel uncomfortable just reading the chapter on KD!!
Of course no trading system is totally automated. For instance, it is always up to the trader which system she is going to follow, in which market, and so forth. And it would not be surprising if an impulsive (high N5) system-based trader had a tendency to break the rules of the system she is trying to follow. But in general, we can think of high-C people as being well suited for systems trading.
Those who are low in C, especially in C2 or C3, will feel confined by and have trouble following the rules of mechanical trading systems. (Note: If you are low in the C2 or C3 facets and are also low in O, this is even more true.)
If your C scores are low, you are probably going to have more success trading discretionarily. Discretionary trading is decision-based trading: The trader ultimately decides which trades to make and when. The discretionary trader makes the best decision he can, based upon all of the information available at the time. A discretionary trader may still, in some ways, follow a trading system with clearly defined trading rules, but in the end he will use his own discretion (hence the name, discretionary trading) to decide whether or not to actually make each trade. His discretion always can and will trump the trading system. For example, a discretionary trader might review his charts and find that all of the criteria for a trade have been met, but decline to make the trade simply because he believes that the price is too high, the market is too volatile at the moment, or whatnot.
Both discretionary trading and mechanical or system trading have the potential to be equally profitable. There are fabulously successful systems traders, and there are just as many very successful discretionary traders. From our research, the decision about which trading style to adopt should be based upon the personality of the trader.
Some traders are intuitively and in some cases are instantly able to recognize which type of trading is more suitable for them. Perhaps they have especially good insight into their personalities, perhaps one form of trading “just feels right” to them, or perhaps by a stroke of luck they get started with the right style of trading and are never even exposed to the other. Meanwhile, other traders may struggle with deciding whether they should follow systems or discretionary methods, and it is for these traders that NEO-AC testing can be especially helpful. But this revelation is most critical for the poor and unfortunate market trader who has been stuck trying to trade using one form or the other (systems or discretionary) and has lost money time and again, never realizing that his innate personality simply does not match the style of trading he has adopted and persevered with for so long, without trying the other flavor of trading.
Pure discretionary trading is most compatible with traders who want to be in personal control of every trading decision (the entry, every aspect of the management, and the exit). Pure discretionary traders often feel uncomfortable and anxious when they think about giving complete control of their trading to a computer program. And remember from our earlier discussion, excess anxiety usually does not parlay into successful trading; discretionary traders often have personal backgrounds in artistic or visual endeavors, such as painting, writing, and gardening, and hence they will often also score high on facets O1 and O2: fantasy and aesthetics.
Match your trading style to your personality. The more conscientious you are, the more you will want to employ a style that is based on rules and is detail-oriented. For those lower in conscientiousness, trying to trade in such a highly structured manner will only lead to frustration and likely failure. Such a trader will likely do far better with “big picture trades”—trades that do not follow detailed rules, formulas or analysis, but rather require interpretation and creativity
If your C score (and especially facets C2 and C3) is neither high nor low, but average, then what? This is when blending trading styles might be most fruitful. For example, it is certainly possible to be a discretionary trader who uses some system trading. It is far more difficult to be a true system trader who uses discretionary trading. For example, a discretionary trader may follow a trading system for his entries and take every trade that the system identifies, but then manage and exit trades using personal discretion. A purist system trader does not have this option, because he must follow his trading system exactly. Once a system trader deviates from the hard and fast rules of his trading system, by definition he has become a discretionary trader.
Interestingly, Lo, Repin, and Steenbarger’s research1 on personality and successful trading found that high C resulted in more profits in trading. Keep in mind that this research was different from ours. They studied the personalities of both successful and unsuccessful traders, while we only studied the personalities of the very most successful traders. When interviewing the subjects in his study, Steenbarger found that half of the successful traders reported using mechanical systems. The other half all reported that, although they did not use systems per se, they did base their trades on specific patterns that they had carefully investigated. Meanwhile, of the less profitable traders in Steenbarger’s study, none were mechanical traders, and none were grounded in pattern research.
Does this evidence imply that all traders should either follow systems or use careful pattern recognition? At the very least, it would seem to suggest that this is a good starting point for many, especially those high in C. But this thinking is actually contradicted by our own research, which shows that there are very successful traders who are average or even a bit low in C, and who do not follow specific systems. In fact, this subset of traders recognizes that they fair worse when trying to stick to systems.
The facet C1 (competence) also deserves extra attention in our critique of conscientiousness. The term competence somewhat distorts what C1 is all about. Scoring high in C1 does not mean you are a more competent trader. Think of C1 more in terms of confidence. Confidence, clearly, is a good thing. But we all know that having either too much or too little confidence can be a big problem when it comes to trading—or to life in general.
traders who score very high in C1, on the other hand, need to be aware that they are prone to believing too much in themselves, their skill, their knowledge, or the system they created. Excess confidence that is not grounded in reality can be disastrous. It typically leads to inadequate money management and the outright ignoring of very real potential risks. Simply put, overconfident traders tend to deceive themselves into thinking that they are smarter and more in control of things than they really are.
They start to think they are immune to rookie mistakes. They think they have stumbled onto a trading pattern or system that is “flawless” and outperforms anyone else’s. They may misinterpret the accuracy and importance of their data or a particular tool that they are using. They overestimate their skill in analyzing information. The most grandiose traders at times will even think that they are impervious to making any mistakes at all. Thoughts like these, even if they are fleeting, can result in Titanic-like disasters. Overconfidence tends to lead traders to underestimate the risks involved with trading, and that is what sets them up for failure.
Meanwhile, during my interviews with successful market traders, time and again I heard the words, “respect the market,” and, “only the market knows.” Successful traders are not overly confident, and in fact, quite surprisingly, they are very humble in recognizing their own limitations as traders. (Note how this is different from being low in vulnerability, represented by the N6 facet.)
One of the classic scenarios of over-confidence is that of “beginner’s luck.” As a novice trader, one does not yet have a full appreciation for how difficult and how risky trading really is. A beginner has not yet been burned big time. In this circumstance a relative newbie who—by luck and luck alone—has a string of several winning trades in a row is bound to develop a sense of overconfidence. “This isn’t all that hard. I can do this!” The higher in C1 the trader is, the more likely he is to fall prey to this trap. He is more apt to attribute his early success to some special talent or insight and fail to realize the components of luck, timing, chance, and serendipity.
You can probably already guess the next step. Being overconfident in his early good fortune, such a trader quickly becomes more aggressive and takes on larger positions in subsequent trades—only to be entirely wiped out and forced to stop trading once he hits rock bottom. This same predictable pattern plays out more times than you can imagine. Even if you no longer consider yourself a rookie at this point in your trading career, there is still a lesson to be learned from this classic rookie blunder, as overconfidence will pop up even in the best and most seasoned of traders.
How big a problem is overconfidence in trading? UC Berkeley School of business professor Terrance Odean has conducted numerous research studies on trading. In fact, he is often credited with having done more research on the behaviors and habits of individual traders than anyone else. Odean says, “Our central message is that trading is hazardous to your wealth. Specifically, a large fraction of day traders, more than eight out of ten, lose money, though a small fraction of day traders earn large and persistent profits.”2
How to become one of the small fraction and not end up in the 80 percent bracket of losers? Odean’s research suggests that overconfidence plays an important role in enticing new traders to enter into the investment arena, an arena where less than 20 percent are profitable (after costs). Some of Odean’s other studies in behavioral finance find that around 74 percent of all fund managers self-rate their own trading prowess as “above average” in comparison to other fund managers. Of course that is not mathematically possible, as obviously only half of traders can statistically be better than the other half. So we can see from Odean’s data that there is both a lot of overconfidence and a lot of failure going on in trading.
Overconfidence can easily lead to overtrading, although often the trait of impulsivity reinforces overtrading behaviors (as we talked about earlier, in the neuroticism chapter). A trader who believes her abilities are better than average will trade more frequently. But frequent trading also means more trading commissions (which reduces profits in the long run, usually) and an increased likelihood of an emotional blunder that triggers a panic or series of subsequent bad decisions in other trades.
Basically it comes down to degree of self-control. Those market traders who are excessively high in the C facets, and in particular C1, feel a huge need for order in and control over their lives. The most overconfident of traders, thinking that they have some sort of magical ability to control the markets and see into them better than other traders, often attempt to strategically time nearly every single market move, as opposed to picking and choosing only the most prime entry points. Studies by Odeon have shown that the most active traders (top quintile) actually have 7 percent lower annual returns in comparison to the least active of traders (bottom quintile).
Another intriguing study3 regarding trader overconfidence has something to teach us. Market traders were shown sets of fictitious, randomly generated price patterns and asked to figure out the market’s next direction and indicate their confidence in their predictions. Traders with the highest confidence in their predictions, not only traded the most frequently, but also incurred the greatest losses! Not only did they have more losing trades, but the mounting cost of trading commissions was also a major problem for the overconfident trader.
The point we are trying to make is not that you should strip away all your self-esteem and confidence in your trading abilities. Of course not. In fact, our own findings actually show that great market traders are, by and large, slightly more confident (slightly higher in C1) than the mean of the general population, based on NEO-AC findings. But they have a different kind of confidence. And it’s how they apply their confidence that really matters.
The great traders we interviewed consistently talked about their confidence in being able to manage whatever comes up, whatever crisis that arises, or whatever corner they paint themselves into. Yes, they are certain in their trading abilities, but they are also confident that they can be flexible, ready to adapt and improvise when needed. That’s reflected in their low N6 vulnerability scores. In a nutshell, they have confidence that they will know how to get themselves out of a jam when it occurs, and they know that that those jams are going to occur! Great traders learn to balance their high confidence with reality-based prudence and wisdom.
What can be learned from this knowledge of great traders? Those of us who are high in C1 will benefit from practicing humility while trading. If you are high in C1 and have a winning trade on, be glad, but don’t get too cocky. Always keep in mind that the markets are bigger than you and at any moment may make a move you are not anticipating. No matter how many winning trades you have had this month, the markets are always capable of swallowing up your profits all at once. So be on guard. Act not in an arrogant or entitled way; show respect for the markets. Appreciate your own limitations and be psychologically nimble and ready to alter your approach to the markets when you get into a jam.
Those high in C1 should especially pay attention when you are on a roll—when you have had several winning trades in a row. That’s when your overconfidence can translate into careless sloppiness. This is when you let your guard down, leave a position open longer than you meant to, and then take a big hit.
A great NFL football coach knows and appreciates the talents of his players. Internally he can be very confident in them. However, before every Sunday game he will repeatedly tell the media and his players, and even tell himself, how good the upcoming opponent is. He will purposefully minimize the talent of his own team and focus instead on how big a challenge the opposing team is. Every week he makes it sound as if this is going to be the most difficult game of the season. He will name all the players on the other team when he is especially wary of and knows will pose the biggest threats. This is what any wise coach, football or otherwise, does.
In particular if you have a combination of high C1 and high N5 (impulsivity), you really need to be sure you think before you leap. You are a trader who is especially prone to rash decisions based on overconfidence. This combination of tending to be impulsive and overconfident can spell extra big trouble. So be extra deliberate in all your ways. In fact, make a point of taking a brief pause or cooling off period before you plunge your money into that trade that feels like “a sure thing.”
For example, if while staring at the charts on your computer monitor, you feel a sudden impulse to act on a “sure-thing” trade because you feel invincible and on top of the world, step back. Walk to the kitchen for a few minutes and drink a tall glass of cold ice water. Remind yourself that there will always be plenty of future opportunities that will be as good as (if not better than) this one. Tell yourself it is better to be safe than sorry. Coach yourself. Ask yourself if you have really taken the time needed to examine the trade from a logical perspective and not just an emotional one. Have you really assessed and sized up just how dangerous a trade it is and what the potential threats in the market are? Have you really stepped back to analyze whether you are being over-confident? Are you ready and able to be flexible enough to change your plans if the market suddenly turns against you? And (this is crucial, so pay attention here) if your emotional mind tries to convince your logical mind that there isn’t enough time to do all of that right now, that you are going to miss the boat if you don’t act now and place the trade, then clearly something is amiss. Do not make the trade.
A very helpful task in any decision-making process is to take a piece of blank paper and draw a line down the middle. Write the pros and the cons for making the decision on each side of the line, and then compare them side by side to see which side of the line has more evidence.
Either mentally or on real paper you can go through this exercise when trying to decide about placing trades, too. On the left side make a list of the actual evidence you have for making the trade. On the right side make a list of the evidence that argues against making the trade. It’s OK to put both logical reasons (“I’m heading out of town tomorrow and realistically I don’t think I will have time to closely follow this trade if I am in it”) and emotional reasons (“this is the best trading signal I have seen all month, and regretting missing it would make me feel worse than if it turns out to be a bust”) on your two lists, but be sure to recognize and designate which ones are which. By actually taking the time to make a quick list like this, you are analyzing the situation and removing two of the biggest threats to your success—overconfidence and impulsivity. Bottom line, if the left side of the paper does not strongly and clearly outweigh the right side, do not execute the trade!
This technique of making pro and con lists is another one of the cornerstones of CBT. The more your practice it, the more adept you will become at recognizing pitfalls you may not have otherwise noticed. Many of us already make such lists in our heads when trying to make decisions. However, the research shows that putting the pros and cons into tangible lists, that is, writing them down on a piece of paper in front of you, where you can actually compare them side by side and decide which list holds more weight, is far more effective than making mental lists.
Finally, aside from these lists, look yourself in the eye and ask yourself bluntly if you are really showing enough respect for the markets, or if you are just feeling cocky, and possibly even deceiving yourself. Examine your motives in the moment. Assess how honest you are being with yourself. At all times practice awareness. That is, be aware of all the possible trading risks. If there is any doubt, do not enter the trade. Tell yourself again: There will be plenty more good trades to come down the pike.
If you come to a point where you catch yourself repeatedly acting in an arrogant manner, take an extended time out. Exit all of your trades and cease all further trading until you develop a newfound respect for the markets.
Now, on the other hand if you are actually low in the C1 facet, be aware that you have a propensity to doubt yourself and be underconfident. You are the trader who, despite having a plethora of data telling you to take a position in the market, still finds it hard to “pull the trigger.” You may question your ability to analyze the data appropriately and come to the right conclusion. You may wonder whether you are still missing or overlooking something, despite the fact you have done all your homework. To combat this trait, you need to spend time reminding yourself that you are prepared, capable, and competent (assuming that you actually are).
If you are low in C1, using the CBT methods described earlier in the book, repeat this mantra over and over: There are no sure things in trading the markets, and nobody has access to an ultimate truth that will unlock the secret to the markets, but I have been thorough and careful in my work. I am capable. I am competent.
For you low C1 traders out there, even when a trade turns out to be a lemon, take courage in the fact that at least you were well prepared for battle and that, whatever the cause of your defeat, you will learn from it and apply it to the next battle (and make lemonade). Just as a great football coach is able to instill new confidence in his discouraged team coming off a big loss, so too do you have a mental need to give yourself pep talks to remind yourself that you actually can succeed in trading the markets. This is especially true after a losing trade, as this is when you may be prone to doubting your abilities to study the markets and identify a winner to get you back on track. You must not allow this self-doubt trait to prevent you from taking the next good trade.
Another possible tactic for the underconfident trader is to join a trading group, take on a mentor, or even enlist the services of a friend, spouse, or other loved one who can provide you with some positive feedback and remind you that you actually do have desirable trading skills. Put yourself in a position where you can demonstrate to others (people whom you admire) that you have sharp trading skills. As they report this back to you, this will only build up your confidence.
Mental Edge Tips