Quality begins on the inside... and then works its way out. - Bob Moawad
Investors are often taught to find an investing style which meets their risk tolerance and financial goals. Online tools typically consist of wizards with questions like, "how much are you willing to lose in a single drawdown? 5%, 15%, 25%?" Usually the conclusion of the wizard is to create a Modern Portfolio Theory based portfolio of index-funds, where risk-averse investors allocate more into bonds, and risk-tolerant investors allocate more into stocks.
While these traditional tools are a great starting point from a quantitative perspective, they often miss covering concepts from the psychological angles -- risk assessment, motivation, and money management. I believe understanding these goals from a qualitative, personal perspective is hugely valuable.
The Investor's Journey
Victory is not a question, it is a DECISION
After the 2008 financial collapse, like many investors, I began doing some soul-searching, and asking many core questions about the way the financial world works, and where my place was in it. I decided then and there my mission was going to be to find an investing system that worked well for me, and something I could depend on in the years to come. I began to pour hours into researching every night and figuring out just what exactly did work for the masters, and how I could learn from their methods.
The past few years have been a blast, first with an experimentation phase, trying many different systems and styles, with constant experimenting, and reading many of the classics from the masters like Benjamin Graham and Jesse Livermore.
Many ideas were adopted across the risk spectrum, from day trading leveraged ETFs, to holding index funds. What worked was kept, what did not was thrown out. Sometimes there is more value in finding out what does not work for you than what does. In this ongoing process, knowing what not to do tends to build confidence.
Left: Benjamin Graham, Source: Buying Value
Right: Jesse Livermore, Source: The Scarlet Kings
In life, often times in your journey, you look back and find key moments where things just come together. Clarity follows, key themes emerge, and confidence moves up to the next level. A great mentor can speed up the process by graciously sharing their life's work and experience. Some of my key moments, with those I consider mentors:
- David Van Knapp gave simple advice to treat your investments like a business, defining a clear mission statement
- Mbkelly noting the paradigm shift when investors relearn they are owners in the company
- Chuck Carnevale's masterwork on valuation
- Clay King defined Dividend Growth Investing and GARP, as I-GARP
Insight into Personality Motivations and Investing
To be pleased with one's limits is a wretched state. - Johann Wolfgang von Goethe
Another big moment came when I when I found a personality assessment test for traders run by Dr. Darren Miller on his site Psychtrader.
Already being a huge fan of personality assessments, originally developed by Carl Jung, I was excited to take the test and see how this could benefit my investing. More on that in a minute, but first we need to appreciate the importance of personality, and its importance in the investing decision-making process.
Dr. Carl Jung, Source: Dover Beach
Successful Personalities in Action
The world needs multiple personality types to draw from. Think about some of the most lucrative stories in the history of technology, for example. Microsoft (NASDAQ:MSFT), powered by the quiet mastermind Bill Gates, and the outgoing, no holds barred Steve Ballmer. Apple (NASDAQ:AAPL) was created by the humble wizard-architect Steve Wozniak, and the bold, visionary Steve Jobs.
The personalities in these alliances were often complete opposites, yet legendarily successful, creating some of the most famous success stories in capitalism, and making generations of investors wealthy.
Left: Bill Gates and Steve Ballmer, Source: Instinct
Right: Steve Jobs and Steve Wozniak, Source: Masu
A person often meets his destiny on the road he took to avoid it. - Jean de La Fontaine
The key point here is that life is not about trying to be the perfect personality; it is how to find out what works best for yours. Embrace who you are - make no apologies for it. Do the same with your investments.
So you tried out day trading option spreads on triple-leveraged ETF like (NYSEARCA:SFK), and kept losing money, badly. You loved the excitement but you just could not make it profitable, even though a friend swears they are wildly successful at it.
Your friend may very well be dominating with their method, but you may be a totally different person, with totally different beliefs and motivations, so their style may not a good fit for you, and that is fine. Investing and trading, just like life, has multiple ways to win. The key, again, is to find out what works for you.
The Next Level
Dr. Darren Miller developed the Market Awareness Profile (MAP) after seeing traders spend thousands learning how to trade and failing. He saw a need for the MAP became apparent as these budding traders came to the stark realization that they were trading the wrong market, using the wrong time frame, and were unable to control their emotions.
In addition to the MAP, Darren has developed a unique approach that combines cognitive psychology, psychometrics and brain training. The idea is to help those that have found success in the markets but are looking to increase their performance.
He works with individual traders, proprietary trading firms and hedge funds.
The actual MAP test has dozens of personality factors mentioned and explanations to go with them. I thought these three excerpts from my own results were extremely helpful. Being conscientious, agreeable, and able to control anger well, shows I gravitate towards systems with very specific rules, and can learn from my mistakes.
This was a great epiphany moment for me as it reinforced why I had been gravitating towards systems-based investing rather than discretionary decisions.
This does not mean someone else with different scores cannot manage a systematic style well, it just means they will need to do it in a way that matches their own personality.
In fact, the most common remark of the once naysayer is that they wished they'd traded a system or strategy that matched their personality earlier.
Recently I have been doing some soul searching outside of the investment world, and it rekindled my interest in how our personalities affect our financial decision making. This sparked quite a few questions, and I wanted to see what Dr. Miller thought about them, so I could share them with the rest of the investment community.
Thanks Darren for being gracious enough to take some time out!
DAB: Is there a particular personality type that is best suited for trading or investing?
DDM: Not really. There are personality traits that will lend themselves to trading success, but overall there's no type or style that is best. What's most important is that the trader/investor first understands their personality then matches it with a trading style or system.
I'd be more on the lookout for personality traits that are associated negatively with success such as excitement-seeking which is a facet of extraversion. The concern would be that the traders are in the market for the thrill and tend to be overconfident in their approach. If they happen to have low conscientiousness as well then the red flag gets raised a bit higher.
DAB: Is it a fair statement that most introverts are risk-averse, while extroverts are more willing to take bigger risks?
DDM: In a sense, yes. However, there is so much more that can be learned about a person's risk tolerance through other traits. As an example, traders who score high on certain facets of an openness scale of a personality test have a higher propensity for risk.
Having a propensity for risk isn't a bad thing as long as the risk is defined and the trader is comfortable with the risk. Problems arise when someone who is risk averse tries to scalp futures simply because they have a friend who is successful at it and they believe they can do it as well.
DDM: It's more complicated than that. Once again I'd look deeper than just introversion/extroversion for clues as to what system or strategy would best fit with a trader's personality. Looking at openness, again, we can see that there are certain facets which suggest the motivation behind trading a leveraged instrument or high beta names versus something like JNJ.
It's possible that the desire to trade a leveraged product is based more on a challenge of self-mastery versus seeking high reward from such risk. Understanding our motives can yield both good and bad data about why we do what we do. Just knowing the why can help stifle less than favorable personality traits from interfering with trading success.
DAB: What would you say to skeptical readers that don't think this kind of "psych mumbo-jumbo" can benefit them?
DDM: There are plenty of them out there, which is fine. There are also just as many that see the value of understanding themselves to improve their participation in the market. I've worked with traders who were once in the disbelief camp and after losing significantly have decided that perhaps trading isn't as easy as they thought. In fact, the most common remark of the once naysayer is that they wished they'd traded a system or strategy that matched their personality earlier.
DAB: Is there any danger of boxing oneself in philosophically by personality tests, foregoing critical thinking, by accepting their conclusions as absolute? For example, telling yourself, "that's just how it is," based on a test score?
DDM: I think the danger is that type of thinking is very small-minded. It's important to get a professional's feedback/input on any personality assessment. As an example, I provide a phone call and as much follow-up email as needed with everyone that takes my assessment. I want to first make sure that they understand their results while also letting them know that it's one piece of data. You wouldn't place a trade based on one piece of data would you?
DAB: Susan Cain, in her book, "Quiet," argues that, in the 2008 bubble, the financial community had favored the swashbuckling, risk-taking personality types. (*)
Image Source: City Paper
As they kept bringing in more and more money, confirmation bias kicked in, where more and more deals were given to those who were able to present their case the most effectively -- style over substance, reward over safety -- which magnified the systematic risk throughout the system.
Is that a fair assessment?
DDM: Absolutely. In addition, on more of a retail trader perspective, overconfidence can occur in markets where even poor execution and a lack of risk management are rewarded. This builds a false sense of confidence which is quickly removed once the bubble pops. These types of blinders make it difficult to be objective, especially in situations like the financial crisis in '08.
DAB: In 2010, a study found that college students were 40% less empathetic than their peers 10 years ago.
Have you seen any personality shifts over the years for your clients as a group? Has this altered the trading landscape at all?
DDM: Not really. Maybe I've noticed more overconfidence in those that have taken the reigns of their financial situation post the financial crisis. They haven't seen a bear market or even a market in which the dip isn't eventually bought. A whole new experience awaits those traders as they'll have to adapt their strategies as they fail to work in the new market environment. The difficulties arise from poor habits that were formed during a forgiving bull market.
DAB: What was the most dramatic example of when you helped a client improve their trading through understanding their personality?
DDM: I'm reminded of one client that loved to be outside and traveling. They were day trading/scalping for a proprietary trading firm and doing great but the hours and stress were killing them inside. After they saw a seminar of mine they decided to take my Market Awareness Profile (MAP) to see if there was something of value there.
Over the next 6 months this trader studied, tweaked and made his own system that uses the CAN SLIM methodology as its core. He's not making as much as he was as a day trader but he's also not staring at a screen all day. The tradeoff was a lifestyle that was more desirable while still being able to meet his financial obligations to his family.
DAB: What is the one thing, psychologically, a trader can do today to become more successful?
DDM: I believe that anyone can be a successful trader/investor if they match a strategy/system with their personality. The catch is that some will have to work harder at being successful than others. As an example, someone that scores high in neuroticism is more likely to let small losses overwhelm them to the point that it saps all their cognitive capital.
However, if that trader uses a mechanical system that has defined risk in which they are comfortable with (and they know that losses will occur) then they can be successful.
The real test of success in the markets should be measured more by longevity and less by equity curves. Success, to me, would be a trader that adheres to their defined risk parameters (requires discipline) with a system/strategy that matches their personality and they're able to trade profitably for many years in many different types of markets.
DAB: This is great Darren, huge thanks for your time and knowledge with investors and traders, this is very valuable information, and an area I think we can all benefit from both personally and financially.
Investors and traders can benefit tremendously from understanding their personality through its strengths, weakness, and its motivations. I found Darren Miller's Market Awareness Profile tool a tremendous resource for building confidence and fine tuning my own strategies.
I wish investors well on their investing journey and continued development.
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- I-GARP Income Investment Strategy
- Put selling by Teddi Knight
- 7-Twelve Asset Allocation
- Money Management through Trend Following
- Fundamental Analysis 101 by Cramer
(*) Cain, Susan (2012-01-24). Quiet: The Power of Introverts in a World That Can't Stop Talking (p. 155). Crown Publishing Group. Kindle Edition.
Disclosure: I am long MSFT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.