Last Updated on November 17, 2020 by Oddmund Groette
Most traders focus on finding an edge in the market by developing good and robust trading strategies. But many neglect one other very important factor for good returns: understanding your personality type. As a trader, you can gain an additional edge in the market by knowing yourself well. Not only are you better prepared, but you get a better understanding of what kind of strategies you can execute equally well in both good and bad times. In general terms, we at Quantified Strategies believe introverts have a better chance of surviving the learning curve and later prosper.
Most novice traders entering the financial markets expect to make good profits as long as they have solid and robust trading strategies. Little do they know about the behavioral mistakes they are guaranteed to do frequently. Even with the best trading strategies, it’s not given you will profit from the strategies. It all depends on your ability to execute the strategy. It all looks easy on paper and in backtests, but the reality is that you will do many mistakes along the way which reduce the trading profits.
Trading is difficult. To succeed takes both conviction and commitment. Many fail because of their inability to understand themselves. Juel Anderson writes in Poker, Sex and Dying that the only asset you have is yourself. In trading, you make your own rules, but make sure they fit your personality. Understanding your personality is paramount to become a successful trader. Emotional and psychological strength are the most important factor in trading success. This article explains how you can go about getting to understand yourself.
What are behavioral biases?
Behavioral biases is another label for cognitive biases. This is systematic patterns or deviations from rational decision making. For example, many tests have shown that almost all people are risk-averse by maximizing losses and minimizing gains.
Another bias is anchoring. Traders tend to anchor stock prices and make decisions on where the price was yesterday. A somewhat similar bias is the recency bias which makes us focus on what has happened recently and neglect important events further back in time.
And who doesn’t seek confirmation bias? We look for sources and people that confirm our ideas and philosophy instead of looking for more valuable sources that might contradict our beliefs. Twitter is a perfect example of confirmation bias. We follow people we agree with and block people we disagree with. This is not a good way of learning and adapting.
The number of biases is almost endless. Daniel Kahneman and Amos Tversky have become world-famous for their work on biases. In order to get a better understanding of both yourself and the markets, we recommend reading Kahneman’s Thinking, Fast And Slow, and Rolf Dobelli’s The Art of Thinking Clearly.
Kahneman believes we can divide our thinking into two buckets. The first is intuitive and automatic (system one). The second is rational, logical, and slow thinking (system 2). Traders must use system two to develop trading systems and strategies, while system one can help us taking ad-hoc and intuitive decisions on the spot.
Rolf Dobelli’s book is an easier read than Kahneman’s and explains in an entertaining style 100 different biases.
Why it’s important to understand your personality type
How do you handle stress? How do you deal with uncertainties? Can you cope with losses? Are you humble? Do you get euphoric after substantial gains? Can you detach from money? Are you patient? Do you prefer decisions based on analysis or gut feelings? Are you flexible and willing to change? Can you admit defeat or being wrong?
If you’re confident that you will succeed in the long-run, you might not buck under for inevitable losses. As a professional, you need to make objective decisions regardless of the situation. The problem is that fear, greed and adrenaline interfere almost on a daily basis. You need to understand your emotions and what drives your decision-making to offset the risk of falling into all these mental traps.
What is an introvert?
Merriam-Webster defines an introvert as someone who is characterized by introversion, someone who is reserved, shy, and like spending time alone. Typically, an introvert doesn’t seek attention and feels often exhausted after social engagements. They like to keep in the background. When they get things wrong, they tend to blame themselves and they generally want to make sure it will not happen again. Because of this, introverts often have a personality style that finds it hard to execute trading signals, despite being analytical, disciplined, meticulous, focused on details, and like doing research. When it comes to risk-taking they tend to be risk-averse.
What is an extrovert?
Extrovert means “turned outward”, according to Merriam-Webster, and this means extroverts are talkative, optimistic, social, and like having people around them. Extroverts get bored easily and they need stimulation. They are mentally “aggressive”/competitive, like going to parties, and are more willing to take risks than introverts (precisely because risks keep them stimulated).
Typically, extroverts are more prone to take risks than introverts, they like to use their gut-feeling, they crave action and stimulus, and are usually impulsive.
Are you introverted or extroverted?
Obviously, a good trader would have the best assets of both these personality types. It would be perfect to have the introvert’s respect for details and the extrovert’s taste for risk!
However, no one is neither a total extrovert nor an introvert. We score somewhere along the continuum and have some traits from both sides, and unfortunately, we can’t cherry-pick our own personality traits.
If you know which category is your dominant force, it can help you in your daily trading: You can easily know in advance if you are able to execute and trade certain types of strategies, and you’ll have a better understanding of how you handle inevitable drawdowns and losses. In short, you should have a better understanding of your risk tolerance. This serves as a guide to what kind of trading strategies/systems you can trade and what kind of leverage to use.
Establish your strengths and weaknesses
More important than who you are, is to know why you are as you are and why you do what you do. In order to understand that, we recommend writing down your strengths and weaknesses. Look at yourself from a distance and try to be as objective and neutral as possible. By putting your traits down on paper, you force yourself to express your thoughts clearly.
However, many personality tests show that our own introspection is limited. Pretty often we think of ourselves as completely different than who we really are. You can test this yourself by asking someone who knows you well. Tell them to write down your strengths and weaknesses, and see how it fits with your own observations. Most people are surprised by the difference in opinions! You can equally well take online personality tests, the one most famous is Myers-Briggs.
You might ask what all this has to do with trading. Our experience, after full-time trading for two decades, is that it’s crucial to have an understanding of your personality traits, and your strength and weaknesses. All your dominant personality traits will sooner or later influence your trading and thus your profits (or losses).
What is required as a trader? There are of course many types of traders, but we believe there are certain assets that are instrumental for having some sort of success in trading stocks, futures, options, or other financial instruments:
- You must like working alone.
- An analytical mindset.
- Like to crunch numbers.
- Trust yourself and your own thinking.
- Like to keep detailed trading records.
- Possess self-control.
- Keep detachment to money. Your bankroll is merely a means of keeping score.
- Last but not least: have a real passion for trading.
The reality of trading:
Any form of trading and investing means responsibility for your own decisions and results. You need to analyze and work on your own. Trading can at times be very boring and feel like a grinding routine. If you’re an extrovert, can you handle boredom? Sometimes trading is just a waiting game.
The best trades are often the ones you do not trade. David Cohen illustrates this very well in his book called Fear, Greed and Panic – The Psychology of The Market. Cohen makes an interesting analogy to experiments with rats. As long as the rats sometimes get a reward, for example sugar, they will go on pressing levers thousands of times. A rat might get only two or three rewards in a hundred presses but this intermittent reward schedule would keep them pressuring for days until they are exhausted. Intermittently rewarded rats were endlessly persistent and trading creates just such a pattern of reinforcement.
What’s the relevance? If you consider yourself an extrovert, trading may lead you into overtrading.
We believe that those who are more introverted than extroverted stand a better chance of survival in the marketplace. Introverts have more and better traits that fit into what we consider the main factors for success. Of course, nothing is written in stone and there is always an exception to the “rule”. But do yourself a favor, and think hard and long about your personality. Build your trading around your strengths, not your weaknesses.