are sure to be attentive to potentialrisks.
Conscientiousness versus Impulsiveness
Conscientiousness concerns the way in which people control, regulate,and direct their impulses. Conscientiousness describes a tendency to planand organize towards achieving goals, to follow rules while pursuingthose goals, and to control one’s impulses along the way. Conscientious
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people typically agree with the statement: “Know how to get thingsdone.”
Impulsiveness is on the other end of the conscientiousness pole. Im-pulsive people are likely to identify with the statement “Often make last-minute plans.” In times of play rather than work, their spontaneity andimpulsivity can be fun. A problem with impulsive acts is that they may pro-duce immediate rewards but undesirable long-term consequences. Theiraccomplishments may sometimes appear small, scattered, and inconsis-tent.
Openness to New Experiencesversus Traditionalism
Openness to new experiences describes a willingness to experiment withtradition, to seek out new experiences, and to think broadly and abstractly.Open people are intellectually curious, appreciative of art, and sensitive tobeauty, and they are more likely to identify with the phrase “Like to solvecomplex problems.” Open people often think and act in individualistic andnonconforming ways.
Traditionalists prefer the plain, straightforward, and obvious over thecomplex, ambiguous, and subtle. Traditionalists agree with the statement“Am attached to conventional ways.” Compared to traditionalists, openpeople are often more aware of their feelings. Open and traditional stylesof thinking are useful in different environments. An open intellectual stylemay serve one well as a psychologist or professor, but research has shownthat traditional thinking is related to superior job performance in policework, sales, and a number of service occupations.
Agreeableness versus Self-interest
Agreeable people believe others are basically honest, decent, and trustwor-thy. Agreeableness reﬂects concern with cooperation and social harmony.Self-interested people place their own concerns above getting along withothers. They are generally less interested in others’ well-being, and there-fore are unlikely to extend themselves for other people.11 Agreeablenesswas not measured in the marketpsych.com Investor Personality Test, de-scribed below, due to space constraints. Yet it is of interest as one of the“Big Five” traits.
THE GENETICS OF PERSONALITY
One’s unique life experiences have a large role in shaping who theyare. During development, people learn how to respond to adversity and
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TABLE 12.2
The Genes Weakly Associated with Risk Taking and RiskAttitude
Genes
Abnormal Variant
Serotonin transporter 5-HTTDopamine D4 receptor
Anxiety and depression sensitivityNovelty and sensation seeking
opportunity from their caregivers and role models. Beyond such develop-mental conditioning, individuals are all endowed with inborn psychologi-cal differences rooted in genetics and biology. These hardwired differencesare the basis of personality and are seen in infants. Exuberant infants tendto remain emotionally positive, social, and novelty seeking, while nega-tively reactive and inhibited infants are more likely to remain shy through-out their childhood (but not necessarily into adulthood).12
There are two genes that correlate (weakly) with scores on neuroti-
cism and extraversion in individuals (see Table 12.2).
In the past four years, DNA analysis has revealed two personalityﬁndings related to genetics. The serotonin transporter (5-HTT) gene canhave a polymorphism (producing a short version of the 5-HTT protein) thatis present in a signiﬁcant proportion of the population. The 5-HTT proteinis a reuptake channel, similar in structure to that pictured in Figure 4.2 onpage 49. The shortened transporter removes serotonin from the synapticcleft more slowly. When serotonin molecules linger in the synaptic cleft,downregulation of the postsynaptic serotonin receptors occurs, causingserotonin desensitization and an experience of lower serotonin levels atbaseline.13 Neuroticism scores are correlated with the presence of theshort serotonin transporter gene in individuals,14 but the variance is high.It is an interesting ﬁnding, but it is by no means deterministic. The oddsthat one who carries this gene will become neurotic are only slightlygreater than among noncarriers. Overall, the expression of neuroticism ismultifactorial, depending on the interrelationship of multiple genes andlife experiences.
Another gene-personality link involves the dopamine 4 (D4) receptor.The D4 receptor regulates sensation seeking (an aspect of personality sim-ilar to “novelty seeking”). Sensation seeking is one facet of extraversion.People who have the D4 polymorphism have more difﬁculty staying inmonogamous relationships, and they report signiﬁcantly more extramar-ital affairs in one study.
A high score on the personality trait of “sensation seeking” is indicativeof risk-taking propensities in many domains (ﬁnancial, recreational, social,and health). Sensation seeking is a highly consistent predictor of variouskinds of risk taking, including compulsive gambling and participation in
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high risk activities.15,16 In fact, a Finnish study found that the sensation-seeking personality trait is correlated with overtrading stocks.17
Substantial heritability of sensation seeking may be inferred from evi-dence linking individual D4 concentrations and venturesome personality.18A recent study indicates that a combination of the D4 polymorphism witha polymorphism of the catechol-O-methyltransferase (COMT) gene predis-poses individuals toward hypomania and extraversion.19 Further researchis needed to substantiate these links.
As seen from the evidence above, the gene-personality link is sig-niﬁcant, but tenuous. Many genes are not expressed (turned on) un-less a particular environmental event triggers them. Furthermore, sin-gle genes do not determine one’s personality, rather it is a multifactorial(many gene) construct. For now, these ﬁndings indicate that we have onlyslightly greater odds than chance of knowing who will become neuroticor sensation-seeking. Simple pencil-and-paper tests, such as that describedbelow, still do a better job of classifying people’s personality styles thangenetic studies.
INVESTING PERSONALITY
“Success in investing doesn’t correlate with I.Q.once you’re above the level of 25. Once you have or-dinary intelligence, what you need is the tempera-ment to control the urges that get other people intotrouble in investing.”
—Warren Buffett20
Do investors’ scores on the “Big Five” correlate with performance? Toinvestigate the performance/personality link, I set up a 70-item online per-sonality test. The test uses 60 of the most signiﬁcant personality phrasescreated by Goldberg and Johnson, and it has 10 research questions at theend. In designing this test I was looking for correlations between personal-ity traits and ﬁnancial decision making. The test measures four of the “BigFive” personality traits: neuroticism, extraversion, openness, and consci-entiousness. First I’ll explain the methodology underlying the study, andthen the results follow.
By the time of this writing, 1,000 people had taken the test on mar-ketpsych.com. Each test taker registered as a “businessperson,” “trader,”or “investor.” In order to ensure data quality, I deleted all test reports thathad clear response patterns (all “Strongly agree” answers, for example). Ialso deleted responses from people aged under 25 or over 80, from those
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originating in nondeveloped countries, and from people who had less than5 years’ experience. The personality items were numbers 1 through 60.
The experimental questions, listed below, followed the personalityquestions. The experimental questions were prefaced by a statement re-questing honest self-report. Experimental Questions 62 and 63 asked aboutcaffeine and alcohol use, and did not yield signiﬁcant results. The providedresponses used the “Strongly disagree” to “Strongly agree” format or, inQuestions 69 and 70, used ﬁve numeric ranges from low to high values.The experimental questions follow:
61. (Dream) I think or dream about the markets or my positions while I
am in bed, trying to sleep.
64. (Exit plans in place) I have exit plans in place, considering all the pos-sible contingencies, before I enter my trading or investment positions.65. (Hold losers too long) I hold my losing positions too long (often longer
than I had planned).
66. (Cut winners short) Sometimes after my positions go up a lot, I take
my proﬁts even though I had not originally planned to.
67. (Double-or-nothing) Sometimes after taking losses, I ﬁnd myself taking
more risk in order to make the money back (to get back what I lost).
68. (Win left open) Often after I’ve had a big paper win in trading or invest-
ing, I leave my position(s) open, and my proﬁts disappear.
69. (Total returns) The total returns of my trading or investing from Jan-
uary 2000 through December 2004 was approximately:
70. (Largest loss) The largest loss I have ever personally taken from a sin-gle trade or investment position, between 2000 and 2004, as a percent-age of my total asset value, was approximately. . .
One major weakness of asking people to describe their behavior iscalled self-report bias. For example, people answer according to their in-nate biases. Those who are neurotic may be more likely to agree withnegative self-descriptions. Extraverted people might be overconﬁdent andexcessively optimistic about their investment performance. Fortunately,other studies have looked at individual’s actual investing behavior andcompared it to their personality traits, so these ﬁndings can be comparedto others’.
First, I’ll report the results of my online study in technical terms andthen layman’s language. Comments about other NEO-based investor per-sonality studies follow this section. Below are the results of correlationsbetween each of the four measured personality traits and the responseson the experimental questions. The following correlations were performed
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TABLE 12.3
Linear Correlations between Personality Trait Scores and ResearchQuestions (up arrows indicate a positive correlation and downarrows an inverse one). Please read on for further explanation
Personality TestResults
Q61. DreamQ64. Exit plans in
place
Q65. Hold losers too
long
Q66. Cut winners
short
Q67. Double-or-
nothing
Q68. Win left openQ69. Total returns
Extraversion Neuroticism Conscientiousness Openness
—↑
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↑
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↓
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↓
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—
↑↑
↓
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—
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using linear regression and are reported if they meet a 95 percent conﬁ-dence interval. In fact, all correlations but one met a 99 percent conﬁdencecriteria (p < 0.01). The full results are shown in Table 12.3. There were nosigniﬁcant correlations for Question 70 (largest loss), as if no single person-ality trait predisposed investors to poor risk management. Because the ta-ble is a bit dense, the results are explained verbally in the following pages.Up arrows indicate a positive linear correlation between a personalitytrait and the bias noted in the left-hand column. For example, referring toTable 12.3, if someone scored highly on the personality trait extraversion,they were signiﬁcantly more likely to have agreed with Question 64, “I haveexit plans in place. . .” Down arrows are inverse correlations; that is, theopposite pole of the personality trait is positively correlated. For example,people who scored highly on neuroticism were signiﬁcantly less likely tohave agreed with Question 64.
And if that’s not confusing enough, consider the opposite pole of eachpersonality trait. Because “emotional stability” is the opposite pole of neu-roticism, high emotional stability scorers were signiﬁcantly more likely tohave agreed with the statement in Question 64. Also consider that extraver-sion is correlated with higher investment returns (Question 69), while itsinverse (introversion) has a negative relationship with returns.
Neurotic Investors
In terms of investment biases, neuroticism appears to be the single mostdangerous trait for investors. Interestingly, neuroticism does not lead tolower investment returns (Question 69). Neurotic people are typically more
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hypervigilant to danger and self-critical. As such, they may be able to usethese tendencies to their advantage. They are more aware that they havebiases, and they use this personal insight to prevent mistakes.
In general, neurotic people report dreaming about positions at night(Question 61), holding losing positions too long (Question 65), taking morerisk to earn back losses (doubling down) (Question 67), and leaving posi-tions open and losing paper proﬁts (Question 68). Neuroticism is inverselycorrelated with Question 64; neurotic investors are less likely to have exitplans in place than emotionally stable investors.
In psychology studies, the trait of neuroticism was found to correlatewith episodes of clinical depression and anxiety disorders, both of whichcan impair sleeping patterns (as in Question 61) and lead to indecisionwhen under stress (as in Questions 64 and 65).
The inverse of neuroticism is “emotional stability,” which is thereforeone of the traits least correlated with investment biases. However, emo-tionally stable people don’t have higher returns than neurotics, and thereason for this may be in their lack of critical self-awareness. They maysuffer from biases without realizing it.
Test takers who described themselves as “traders” were signiﬁcantlyless neurotic than “investors” or “businesspeople.” This makes sense. Peo-ple dealing with short-term ﬂuctuations in market prices can’t be overlynervous or stress sensitive; if so, they would quickly burn out.
As we’ll see later in this chapter, successful investors must match theirpersonality to their trading style. In the case of neurotic people, most ap-pear to avoid short-term trading and compensate for their biases. Thus,they have equivalent returns to emotionally stable investors.
Extraverted, Open, and Conscientious Investors
Extraverts report that they tend to have exit plans in place for all mar-ket contingencies, they sell when their positions appreciate a lot, and theyreported higher total returns than introverts. Extraversion was inverselycorrelated with the results of Questions 65 (hold too long) and 68 (leaveopen). Keep in mind that this means introversion was positively correlatedwith those biases.
Extraverts deny that they hold their losing positions too long, and theydeny leaving winning positions open and losing their paper proﬁts. Overall,extraverts report greater returns than introverts. This could be due to con-ﬁrmation bias, where extraverts are representing their skills and returnsaccording to what they think the researchers want to see. However, theydo acknowledge cutting their winners short as their one weaknesses, sothey are not painting a perfectly rosy picture of themselves.
Openness yields results identical to extraversion, with one added cor-relation. Openness is positively correlated with Question 61 (dreaming):
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Open people report more thinking about their investment positions atnight. Overall, openness and extraversion are the personality traits mostcorrelated with overall investment returns.
Jim Rogers is probably the most famous open and extraverted investor.He actively seeks out new experiences and is in the Guinness Book ofWorld Records for his long motorcycle and automobile journeys crisscross-ing the continents. He has written two books: Adventure Capitalist and In-vestment Biker. He created a commodity index in the late 1990s, when fewinvestors were paying attention to that sector, and he has recommendedinvesting in markets as diverse as Botswana, Nicaragua, and Bolivia. Morerecently, he announced that he and his family are relocating from New YorkCity to a Chinese-speaking hub in Asia so he can be closer to the businessepicenters of the new millennium. Rogers was an early partner of GeorgeSoros in the Quantum Fund. Rogers’s openness and extraversion haveserved him well both in the markets and in creating a rich quality of life.
The personality trait of conscientiousness correlated with responsesto Question 64 (exit plans). Conscientious investors are more likely tohave exit plans in place. Inverse correlations appeared with Questions 61(dream), 65 (holding too long), 67 (doubling down), and 68 (leaving posi-tions open). That is, as compared to more impulsive individuals, consci-entious people report more discipline in their trading decisions: cuttinglosses sooner, not taking more risk when down, and taking proﬁts off thetable before they disappear. They deny that investing thoughts intrude ontheir sleep. Given the number of good decisions conscientious people re-port making, one might expect higher returns from them, but that’s notevident in the data.
In occupational research, conscientiousness is correlated with careersuccess in most types of work. One might then expect conscientious in-vestors to perform better in the markets, but they don’t report higher re-turns. The discrepancy between occupational and market performance ispuzzling. However, investing is not like a regular 9-to-5 job with knownrules and regulations. The markets are complex and dynamic. Perhapsa rigid, rule-based approach to market analysis sabotages an investor’sadaptability.
OTHER PERSONALITY RESEARCH
Using the NEO, other researchers have found signiﬁcant performance cor-relations with personality traits. When consolidated, the results of the fol-lowing studies suggest that investors and traders may beneﬁt from differ-ent personality traits. Partial support for my personality ﬁndings comesfrom a small study in Australia. Durand, Mewby, and Sanghani tracked the
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brokerage account performance of 18 Australian investors. The authorsmailed surveys to gather psychological, personality, and ﬁnancial perfor-mance data. After one year, they found that extraverts held more stocks,traded less, and made more money than introverts.
The authors also found that investors who scored higher on opennessand neuroticism took greater portfolio risk. Neurotics traded more fre-quently than the emotionally stable. Conscientious investors took on lessrisk than the impulsive. Agreeable people took on more risk.21 Perhapstheir ﬁnding that conscientious investors take on less risk explains whythey do not have greater returns than impulsive investors.
The paragraphs that follow describe psychological test results fromshort-term traders. Trading requires a different skill-set than longer-terminvesting or portfolio management. Therefore, some of these researchers’ﬁndings contradict my results. However, keep in mind that my results cov-ered a mixed group of 1000 traders, investors, and businesspeople, withtraders less than 25 percent of the overall sample.
In line with my ﬁnding that traders are generally not neurotic, but go-ing against some of my other ﬁndings, Fenton-O’Creevy and colleaguesconcluded from a study of 118 professional traders at investment banksthat successful traders tend to be emotionally stable (low on neuroti-cism scale), introverted (low on extraversion scale), and open to newexperiences.22 While openness correlates with success in both our studies,the researchers’ ﬁnding that introversion is correlated with success may bespeciﬁc to their short-term trader clientele and not applicable to businessowners and investors (who were the primary sample in my experiment).
Trading coach Brett Steenbarger performed personality tests on 64traders at one of Linda Bradford Raschke’s LBR trading seminars. Hefound that high conscientiousness scores were the most reliable predic-tor of trading success—again, a ﬁnding I did not get with a mixed audienceof investors and businesspeople. Conversely, Steenbarger found that highopenness and high neuroticism are correlated with trading problems.23Steenbarger’s ﬁnding relating to high openness and poor trading results aredifﬁcult to explain, except perhaps that short-term traders must remain fo-cused and undistracted. He summates these ﬁndings as, “One importantlesson: success in trading is related to the ability to stay consistent andplan-driven.”
Trading coach Doug Hirschhorn performed a NEO personality studyof traders for his psychology PhD dissertation. Having played division onebaseball himself, Hirschhorn suspected that playing athletics at a high levelteaches one a mental discipline that is beneﬁcial for short-term trading. In-terestingly, Hirschhorn found that having a sports background did not con-tribute to trading success in his sample. The only NEO trait that he foundcorrelated with trading success was low scores on openness.24 Short-termtraders may need to be focused and conservative in their trading analyses,
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and that may be why both Steenbarger and Hirschhorn found a correlationwith low openness. Long-term investors may beneﬁt from awareness of di-verse economic trends and abstract ﬁnancial concepts, which may explainwhy both Durand and I found that high openness scores were correlatedwith investor performance.
Lo, Repin, and Steenbarger examined the trading patterns, personalitycharacteristics, and daily emotional reactions of 80 traders over 25 tradingdays. In part due to a market decline of 20 percent during the study period,only 33 traders of the original 80 completed the study. While this samplewas probably too small to ﬁnd statistically signiﬁcant correlations, Lo andhis co-authors concluded that personality traits are themselves not relatedto trading success.25
Thomas Oberlechner from Webster University in Vienna mailed a sur-vey form to 600 professional foreign exchange traders in Europe and theUnited Kingdom.26 Fifty-four percent of the survey forms were returned.Each survey form asked traders to rank the most important characteris-tics of successful traders out of a list of 23. Of the individual items, themost highly ranked were (1) quick reaction time, (2) discipline, (3) expe-rience, (4) concentration, and (5) stress resistance. Out of eight “factors”he derived from subgroupings of the 23 characteristics, “disciplined coop-eration” was ranked most highly. Subjects who scored high on a measureof impulsivity (the opposite of self-discipline) placed more trades, withoutimproving performance.27
In summary, it appears that for investors, extraversion and opennessare correlated with higher risk taking and higher overall returns. Fortraders, emotional stability (low neuroticism) and conscientiousness sup-port higher trading returns. Conscientiousness drives plan-driven trading,which is especially important for short-term traders who need the patienceto wait for high risk-reward opportunities.
It is not only measurable personality traits that inﬂuence decision mak-ing. Many other investor characteristics are important as well. Such fac-tors cannot always be measured directly; rather, they are often revealedthrough observation of patterns of decision making, critical thinking, prob-lem solving, and behavior. Some of the important cognitive and emotionaltraits of excellent investors are discussed below.
TRADING PSYCHOLOGY
The use of psychological and emotional tools to improve executive and in-vestor performance has been increasing rapidly.28 An excellent exampleof this trend is one of the world’s most successful hedge fund managers,
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billionaire investor Steve A. Cohen. According to Jack Schwager, author ofStock Market Wizards, Steve Cohen is “unquestionably one of the world’sgreatest traders.”29 Cohen is the principal of SAC Capital, where a formerOlympic psychiatrist, Ari Kiev, MD, is “a permanent ﬁxture.” Cohen’s em-ployment of a performance psychiatrist suggests that psychological man-agement has a beneﬁcial effect for ﬁnancial risk takers, including thosealready functioning in the top tier.
While observing Cohen trade, Schwager is “struck by his casualness.”Schwager notes: “He also seemed to maintain a constant sense of humorwhile trading.” Cohen’s sense of humor and ease demonstrate that he isn’ttaking his trading gains and losses “to heart.” He is not affected emotion-ally (at least not outwardly). How can the average ﬁnancial decision makermaintain emotional balance and a healthy perspective on his or her tradingoutcomes?
It is crucial for investors to cultivate opinions without value judgment,to detach ego, and to maintain ﬂexible expectations. In particular, practi-tioners should not focus on the outcome of their decisions, but rather ondeveloping an excellent decision-making process. Investors who pressurethemselves to achieve speciﬁc outcomes are at risk of “choking” if pressureis too high (see Chapter 10). Furthermore, it is crucial to remain “present”with what is happening in the markets. Rumination or deliberation aboutpast events is self-defeating. Recalibrate yourself to each day, so that everyposition appears fresh, as if it was just opened.
George Soros, one of history’s greatest traders and philanthropists,provides an excellent example of nonattachment with his well-publicized“Belief in Fallibility.” “To others, being wrong is a source of shame. Tome, recognizing my mistakes is a source of pride. Once we realize thatimperfect understanding is the human condition, there’s no shame in be-ing wrong, only in failing to correct our mistakes.”30 Soros’s belief struc-ture prevents a crisis of conﬁdence during downturns. While others mightbe wracked by fear and self-doubt, thus worsening their judgment, Sorosmaintains emotional equanimity and intellectual curiosity.
Mental ﬂexibility is a key to success in the markets. A trader, Jean-Manuel Rozan, “once spent an entire afternoon arguing about the stockmarket with [George] Soros. Soros was vehemently bearish, and he had anelaborate theory to explain why, which turned out to be entirely wrong.The stock market boomed. Two years later, Rozan ran into Soros at a ten-nis tournament. ‘Do you remember our conversation?’ Rozan asked. ‘I re-call it very well,’ Soros replied. ‘I changed my mind, and made an absolutefortune.’ He changed his mind!”31
For most people, the possibility of being wrong is threatening. It givesrise to anxiety, especially if one has internal or external performance pres-sures or benchmarks that will not be met. “The difference between Soros
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and most other traders is that he accepts fallibility, so he starts out byassuming his hypothesis is wrong, rather than right like almost everyoneelse.”32 By maintaining a belief in fallibility, Soros remains open-mindedabout his positions. His emotional reactions, such as denial, disappoint-ment, and anger, are minimal when his decisions do not go in his favor.In fact, his emotional reactions may seem somewhat paradoxical. Soroswrote of his logical process, “I derived actual pleasure from discovering amistake.”33 Soros’s mental ﬂexibility and personal courage are contributorsto his success.
In the next section of this book, the primarily cognitive decision biasesare outlined. The fundamental components of analytic decision making,such as an understanding of probabilities and trust, are explained. Furtherchapters examine systematic cognitive and self-control distortions.
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Thinkingabout Money
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C H A P T E R 13
MakingDecisionsThe Effects of Probability,Ambiguity, and Trust
“Take the probability of loss times the amount ofpossible loss from the probability of gain times theamount of possible gain. That is what we’re tryingto do. It’s imperfect, but that’s what it’s all about.”—Warren Buffett, speech given at the BerkshireHathaway Annual Meeting in 19891
I n 2000, during the run-up to the June Mexican presidential elections,
an outsider was poised to overturn