initial performance peak.
Before we parted from the weekend, Andrew agreed to take the free“Gambling or Trading?” screen on the marketpsych.com web site. He called
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me a few days after the conference to ask: “Baidu is still trading sideways;do you think it’s going to go up?”
“Did you take the gambling screen on the web site?” I asked.Andrew said he had taken the screen, and he was classiﬁed as “HighRisk for a Gambling Problem.” He acknowledged that his trading was justlike gambling. But he still wanted to know what to do with his large longposition in Baidu.
I tried to give him some perspective. “You just indicated you’ve gota gambling problem, and then you asked me to comment on your bettingstrategy.”
Andrew replied, “But I need to pay my taxes, and I have a hunch about
Baidu.”
“Well, what you just said sounds like trouble. You’re trading to get back
your money. You must know that never works,” I said.
“I don’t know what to do,” he replied.“I can’t tell you what to do. Everything you’ve told me indicates you’re
gambling, and you need to cut your losses.”
“I know, but I have a hunch about Baidu.”The conversation went along like this for a few minutes.Baidu never rallied enough to put his calls in the money. I suspect helost everything on that position. I wish I could relate a happy ending, howhe paid off his home loan and packed his kids away to college with conﬁ-dence, but I haven’t heard from him since.
The story of Andrew illustrates one of the ugly sides of trading. Whilesome traders achieve tremendous success, others take excessive and un-sustainable risk. The thought traps that gamblers fall into are exaggeratedversions of the cognitive biases that afﬂict many investors.
KNOWING WHEN TO FOLD ‘EM
Gambling in the markets is more dangerous than casino gambling due tothe high leverage available. The widespread use of futures and options andthe anonymity and sense of personal control allowed by online trading ac-counts incite investors’ risk-seeking urges. Some traders take excessiverisk because they are unable to weigh probabilities of gain and loss accu-rately. That is, they do not understand sustainable risk management. Thatwas certainly the case with Andrew, whose story I told at the beginning ofthis chapter.
Researchers have found that most individual investors buy stocks with“lottery” characteristics (high volatility, good stories, low probability oflarge gains). Similar to lottery ticket sales, the demand for lottery-type
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stocks increases during bad economic times. Even more, there is a cor-relation between states that have legalized gambling and the tendency ofinvestors in those states to purchase lottery-type stocks.2
Some investors turn into gamblers during bull markets. They start mak-ing money easily. They increase their position sizes. They do well andfeel invincible. Money comes to them effortlessly. They don’t realize howmuch risk exposure they have taken on. Then one day they ﬁnd themselvesrapidly losing, and they don’t understand what is happening. Because their“illusion of control” (see Chapter 8) has been reinforced by early gains,they continue with the same old strategy, and they lose more and more,until they’ve lost not only their paper proﬁts, but also their principal.
Not all high-stakes risk taking is problematic. In some areas of busi-ness, such as in start-up companies, the margin between spectacular suc-cess and dismal failure can be very narrow. Successful entrepreneurshave often taken risks that others deemed unwise. If those entrepreneurshad failed, they may have been pathologized as “gamblers” or “roguetraders.” Furthermore, many investors trade risky or speculative stocksfor recreation, and they rationally understand and accept the risk of to-tal loss. In the markets, when does investment risk taking become outrightgambling?
There are a few key differences between people who invest recreation-ally and those who have a gambling problem. Most recreational investorstrade with money that they can afford to lose. They don’t lie about ormisrepresent their wins and losses when describing them to others. Theirstatistical “risk of ruin” is very low. The “risk of ruin” represents themathematical odds that all one’s assets could be lost in the markets, giventhe average size of one’s positions and their price volatility.
It’s possible to diagnose gambling characteristics in one’s trading byasking a series of tough personal questions. The following questions aremodiﬁed versions of the DSM-IV criteria for diagnosing pathological gam-bling. If you answer “yes” to two or more of the questions in Table 11.1,then you are at risk of having a gambling problem in your trading.
PATHOLOGICAL GAMBLING
“The gamester seeks the gambling-house, and won-ders, his body all aﬁre, ‘Will I be lucky?’ ”
—The Rig Veda, Hymn 10.34
Studies of gambling have focused on two measurable aspects of thegambling experience. Psychological surveys often gather information on
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TABLE 11.1
The “Trading or Gambling?” Screen (also available at www.marketpsych.com)
If you are a trader who suspects you may have a gamblingproblem, please answer the following questions.
Yes or NoResponse
Are you preoccupied with trading (e.g., preoccupied with reliving
past trading experiences, planning the next venture, or thinkingof ways to get money with which to trade)?
Do you need to trade with increasing amounts of money or
leverage in order to achieve the desired excitement?
Have you had repeated unsuccessful eﬀorts to control, cut back, or
stop trading?
Are you restless or irritable when attempting to cut down or stop
trading?
Do you sometimes trade as a way of escaping from problems or ofrelieving a negative mood (e.g., feelings of helplessness, guilt,anxiety, or depression)?
After losing money on a trade, do you often return to the markets
to get even (“chasing” your losses)?
Do you ever lie to family members, colleagues, or others to conceal
or minimize the extent of your involvement with trading?
Have you committed illegal acts such as forgery, fraud, theft, or
embezzlement to ﬁnance your trading?
Have you jeopardized or lost a signiﬁcant relationship, job, or
educational or career opportunity because of trading?
Have you relied on others to provide money to relieve a desperate
ﬁnancial situation caused by trading?
Note: These questions were adapted from the Diagnostic and Statistical Manual ofMental Disorders, 4th edition (DSM-IV) diagnostic criteria for pathologicalgambling.
the cues (triggers) and cognitions (thoughts) that accompany or activategambling behavior. Neuroscience studies attempt to understand how thebrains of pathological gamblers operate differently than normal brains.
Pathological gambling is the oldest documented ﬁnancial disorder,having been described in both ancient Greek texts and in the Rig Veda ofthe Upanishads. Problem gambling, which is less severe than pathological,afﬂicts 3.6 percent of women and 6.9 percent of men in the United States.While the current incidence of pathological gambling is between 0.5 and 1.0percent of the population, the lifetime prevalence of compulsive or patho-logical gambling disorder in the United States is between 3.5 percent and6.3 percent.3
Pathological gambling is psychiatrically classiﬁed as an impulse-control disorder, and it is characterized by a psychological insensitivity to
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risk, increased impulsivity, a lack of self-control, a loss of appropriate so-cial value priorities, and the pursuit of pleasure through risk taking. Patho-logical gamblers have higher rates of emotional afﬂictions such as depres-sion, anxiety, and substance abuse (particularly alcohol) than others.
Some speciﬁc emotions and cognitions fuel pathological gambling.Studies have shown that gamblers are triggered to bet by feelings of dis-tress and irrational hopes. Other triggers include being alone in the eveningand thinking about one’s ﬁnances.
When asked to describe their gambling, those who use positive, hope-ful terms, rather than realistic concerns, are more likely to continue gam-bling. Gamblers who mentally compartmentalize losses versus gains areunable to recognize that their net return from gambling is negative, andthey tend to persist in gambling even after large losses.
THE GAMBLER’S BRAIN
Risk and potential return have a powerful allure for gamblers. Accordingto Hans Breiter, MD, co-director of the Motivation and Emotion Neuro-science Centre at the Massachusetts General Hospital, “Monetary rewardin a gambling-like experiment produces brain activation very similar to thatobserved in a cocaine addict receiving an infusion of cocaine.”4
Each of the primary motivational systems, the reward-pursuit and loss-avoidance systems, has a distinctive character in pathological gamblers. Onthe one hand, gamblers appear to be less reward responsive. They have de-creased concentrations of dopamine receptors, making them less sensitiveto everyday novelties and interests. This ﬁnding is borne out in studies ofgambler physiology during gambling experiments. Gamblers showed both(1) less anticipatory heart rate increase when facing likely losses and (2)less heart rate increase following wins. Gamblers are not as afraid of loss,and they are less excited after winning, than nongamblers.5
In further support for the contention that gamblers are underaroused,neuroimaging research shows that gamblers have decreased activity intheir neural reward systems on functional magnetic resonance imaging(fMRI) scans. In fact, the severity of their gambling illness correlates withthe lack of activity in the reward system.6
Desensitized dopamine systems drive gamblers to self-stimulate withgames of chance, temporarily increasing their dopamine levels whenrewards are anticipated and received. Paradoxically, Parkinson’s diseasepatients, who have chronically low dopamine levels in their brains, canbecome pathological gamblers (up to 40 percent) when given a dopaminereceptor activating medication (pramipexole) in their treatment course.7
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As explained previously, the prefrontal cortex is essential for planning,reasoning, and impulse control. Gamblers have decreased performanceon tasks requiring prefrontal skills such as inhibition, time estimation,cognitive ﬂexibility, and planning.8 During gambling experiments, the bestperformers (those who learn to avoid high-risk/low-reward options) havethe highest prefrontal cortex activity on fMRI scans.9 However, gamblershave neural activations associated with poor impulse control duringdecision-making experiments.10 The origins of problem gambling lie inpoor impulse-control and hypoactivity of all three major brain systems:prefrontal cortex, reward system, and loss system during risky decisionmaking.
OUGHT TO KNOW BETTER
Many celebrities enjoy casino gambling. Among some celebrities and politi-cians, a common justiﬁcation for excessive gambling is, “I can afford it, sowhat’s the problem?”
The former United States drug czar (under President George H. W.Bush) Bill Bennett had made dozens of trips to casinos in Atlantic City andLas Vegas in the 1990s and early 2000s. He was a “preferred customer” atseveral casinos, and sources put his total losses at more than $8 million.11When Washington Monthly and Newsweek reporters interviewed Bennettabout his gambling habit, he responded: “I play fairly high stakes. I adhereto the law. I don’t play the ‘milk money.’ I don’t put my family at risk, and Idon’t owe anyone anything.”12 Bennett himself claimed to have been nearlybreakeven in his gains and losses: “Over 10 years, I’d say I’ve come outpretty close to even.”
Bennett is also the author of the best-selling Book of Virtues, whichintends to instruct children and adults in living a principled life. In the bookhe writes, “There is much unhappiness and personal distress in the worldbecause of failures to control tempers, appetites, passions and impulses.”13Bennett may not have a gambling problem in a strict sense. He is awealthy man, and he has no debt or family disruption due to his gambling.However, his preference for high-stakes slot machines,late at night(midnight to 6 A.M.), mirrors the behavior of many problem gamblers. Heis likely suffering from a gambler’s cognitive distortions when he assertsthat he is nearly break-even. Most likely, he is unable to accurately assessthe magnitude of his actual losses; otherwise, he would probably quit (ashe stated an intention to do after the Washington Monthly article waspublished).
Celebrities who report large gambling losses include basketball legendCharles Barkley (having lost at least $10 million) and professional golfer
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John Daly (who claims to have lost $50 to $60 million). Basketball greatMichael Jordan enjoys gambling, and there are published accounts of hislarge ﬁnancial swings in casinos. Some experts speculate that people witha competitive nature, such as athletes, are susceptible to developing gam-bling problems. They want to win against the gods, even though the godsof the odds play by different (mathematical) rules.
REDUCING GAMBLING
Medications, psychotherapy, and educational interventions have all beenstudied as treatments for pathological gambling. Medication treatmentsuse one of three neural strategies: (1) improving impulse control in the pre-frontal cortex, (2) increasing fear of loss in the amygdala, or (3) decreasinggambling cravings by bolstering the reward system. Psychological treat-ments, such as psychotherapy, target cognitive distortions that minimizelosses and the social costs of gambling.
Education about mathematical probabilities did not change gamblingbehavior in one study, indicating that the decision to gamble tends to be anemotional, not an intellectual, process.14 Warnings that describe irrationalgambling beliefs do decrease gambling behavior,15 which implies that ir-rational beliefs and expectations can be changed when they are directlycontradicted (as can happen in psychotherapy).
The most widely used medication treatment for pathological gamblingis naltrexone.16 Both naltrexone and nalmefene are medicines that blockmu opiate receptors, and they have both been found useful in reducinggambling among gambling addicts.17 In the reward system, mu opiatereceptors stimulate dopamine release.18 Blocking opiate receptors withnaltrexone decreases dopamine release in the nucleus accumbens, whichresults in decreased subjective feelings of pleasure.19 Gamblers takingopiate blockers are not compelled to seek reward-system stimulationthrough further gambling, possibly because they feel reduced pleasurefrom the ﬁnancial ups and downs.
The medication bupropion (which is popularly known as Wellbutrin orZyban) modulates dopamine pathways in the reward system. This medica-tion also appears to reduce gambling behavior somewhat, with fewer sideeffects than the opiate receptor blockers.20
SUMMARY
Pathological gambling is not a lifelong illness. It often waxes and wanesover one’s lifetime. It can arise unexpectedly in previously disciplined
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investors, or it can suddenly disappear after years of struggle. Manycelebrities have experienced problem gambling. Among traders withannual incentives, excessive risk taking can be rational (from a self-interest perspective) but lead to pathological losses for their clients. Forinvestors who ﬁnd themselves succumbing to excessive, and dangerous,risk taking in the markets, a gambling screen for traders is available at themarketpsych.com web site to help them assess their vulnerability.
Gambling feels good to people who have desensitized reward circuits.The rush of dopamine release that accompanies wins is a deeply satisfying,and addictive, pleasure. Problem gamblers see losses as less threateningthan nongamblers. Furthermore, they have less impulse-control originatingfrom the prefrontal cortex. As a result, pathological gamblers use wins tofeel good, experience little pain due to losses, and have trouble controllingtheir urges to engage in gambling.
Treatment for pathological gambling involves psychotherapy to cor-rect cognitive distortions, behavioral therapy to reinforce impulse control,and medication treatment to block the rush of excitement gamblers feelfrom dopamine release in the reward system. Pathological gambling canbe successfully treated, but it requires motivation on the part of the af-ﬂicted to make it work, and that is often the primary obstacle to successfultreatment.
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C H A P T E R 12
PersonalityFactorsWhat Are Great Investors Like?
“Investment philosophy is really about tempera-ment, not raw intelligence. In fact, a proper tem-perament will beat high IQ all day.”
—Michael Mauboussin1
I n the 1983 movie Trading Places, Eddie Murphy (a wily street con
artist) and Dan Aykroyd (an Ivy League heir and investor) had theiridentities reversed by two wagering millionaires. Could Eddie Murphy,with no prior experience, succeed in the trading pits? Could Dan Aykroydpull himself out of poverty and homelessness with nothing but his ownsmarts? The comedic pair ultimately outwitted their interlopers and madea killing in “frozen orange juice” futures, bankrupting the millionaires inthe process. Yet the question those two devious gentlemen gambled onremains unsolved: is it innate skill or life experience that makes a tradergreat?
The truth is—as with most psychological issues—there is no easy an-swer. The ﬁrst stage of successful investing is having an edge. The secondstep involves conditioning one’s mind for peak performance. This chapteris about the personality roots of personal excellence in the markets—thosecharacteristics and traits that differentiate the great mind from thegood.
Some characteristics of great investors are popularly known. For ex-ample, Warren Buffett has a keen intuitive sense of probabilities.2 GeorgeSoros enjoys examining his investment thinking process for ﬂaws, tak-ing pleasure when he ﬁnds one. Most great investors are extremely
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conﬁdent in their ability to succeed.3 Yet these characteristics are not com-mon to all great investors. Some investors have strength in one or anotherof these traits. One of the keys to investing success is to heavily exploitone’s strengths while strictly avoiding areas of weakness.
While many success factors are intrinsic, some are learned throughexperience. Success is derived from strength in four psychological realms:(1) personality style (reviewed in this chapter), (2) cognitive faculties(mental acuity, critical thinking, speed, and intelligence), (3) emotionalintelligence (motivation and passion, courage, emotional coping skills,and self-awareness), and (4) conditioning (training that improves personalweaknesses and enhances strengths). First, one should have a personality(internal disposition) that supports one’s chosen investing style. Second,one should have excellent critical thinking skills including the abilityto formulate prospects in terms of probabilities and expected values.Third, emotional intelligence and psychological traits such as conﬁdence,decisiveness, and resilience after losses (which signiﬁcantly overlap withpersonality traits) are important. Fourth, one should engage in training,develop resilience skills, and gain experience successfully navigatingvarious crises and contingencies in markets.
A terriﬁc challenge lies in studying diverse investor characteristicswithin a systematic framework. Anecdotes abound about what makes in-vestors successful, but without systematic scientiﬁc study, it is impossibleto develop a reliable sense of the ideal investor “proﬁle.” Another problempresents itself in the diversity of markets and personal characteristics nec-essary for investing success. Different people succeed in different marketsat different times. Are there any broad traits that all great investors share?Personality research provides the best scientiﬁc technique for answeringsuch a question.
This chapter is devoted to exciting developments in personality re-search. Personality is a collective pattern of character, behavioral, tem-peramental, emotional, and mental traits.4 Recent academic researchhas shown that personality can be broken down into ﬁve general char-acteristics. These ﬁve traits (the “Big Five”) are related to how peo-ple describe themselves using language. The “Big Five” traits are by nomeans complete. Among researchers there continues to be controversyover how many traits should be included in a taxonomy of personal-ity (16 traits is another possibility5), but ﬁve is the best estimate so far.Remarkably, personality traits remain generally stable, within individu-als, over the adult life span (exceptions are noted where applicable).6This chapter is primarily devoted to “Big Five” personality traits, whileother psychological traits of great investors are mentioned toward theconclusion.
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155
In 1936, two American psychologists, Gordon Allport and H. S. Odbert, hy-pothesized that: “Those individual differences that are most salient and so-cially relevant in people’s lives will eventually become encoded into theirlanguage; the more important such a difference, the more likely is it to be-come expressed as a single word.”7
In the 1970s, Lewis Goldberg, a professor of psychology at the Uni-versity of Oregon, adopted a list of 1,250 phrases describing personalitycharacteristics. He and his students went door to door, asking 750 home-owners in Eugene and Springﬁeld, Oregon, to rate how well each of the1,250 phrases described them. The phrases were statements such as “Likeparties,” “Follow rules,” or “Fear for the worst.” Subjects rated how wellthat phrase described themselves on a 1-to-5 scale. They circled either:“Strongly disagree,” “Disagree,” “Neither agree nor disagree,” “Agree,” or“Strongly agree.”
Responses from 300 of the original 1,250 phrases statistically groupedinto ﬁve different clusters. For example, people who agreed with “Likeparties” also tended to agree with the statement “Radiate joy,” imply-ing that social and optimistic people have one type of personality trait(subsequently called “extraversion”). The ﬁve phrase clusters were namedthe “Big Five” personality traits: (1) neuroticism, (2) extraversion, (3)openness, (4) agreeableness, and (5) conscientiousness8 (see Table 12.1).Many of the trait descriptions and item examples below are adapted from
TABLE 12.1 The “Big Five” Personality Traits
Personality
High Scores
Low Scores
Neuroticism
Openness
Scattered, indecisive, orpessimistic. Nervous.Open to experimentingwith new ideas andexperiences.
Extraversion
Gregarious, optimistic and
Conscientiousness
Self-disciplined, delays
social.
Agreeableness
gratiﬁcation, organized,rule-following, punctual.
Values cooperation andgetting along withothers, generous.
Emotionally stable. Relaxed
and mellow.Traditional and
conventional. Preferscontinuity over change.Introverted. Often enjoys
being alone.
Impulsive and disorganized.Diﬃculty following setmethods or rules.
Self-interested and oftenmildly suspicious ofothers’ intentions.
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Professor John Johnson’s free online NEO personality inventory whichgrew out of his work with Goldberg.
Statistically, test takers’ responses distribute in a normal curve, with40 percent of people scoring in the “average” range. Each test taker scoreson a range from “very low” to “very high” on each trait. One who scores lowon the extraversion scale is called an introvert, and one who scores highis called an extravert. “High” and “low” scores are more than one standarddeviation from the average. Each personality trait has a primary pole andan opposite pole (which describes those who score low on the primarymeasure). Thus, a low scorer on extraversion is, by deﬁnition, high on in-troversion.
Taken together, all ﬁve personality traits balance each other in one’spersonality style. Some people have multiple strong personality traits. Peo-ple who score highly on both conscientiousness and neuroticism are “per-fectionists.” An example of a celebrity high in multiple traits is the ﬁlmdirector Woody Allen. Allen often makes light of his strong tendency toneuroticism. He is also quite extraverted, gregarious, and open, as appar-ent in his public persona. Being both extraverted and neurotic, he enjoysputting his nervousness on display, to humorous effect, in his movies. One’spersonality style is not determined by one predominant trait, but rather byhow one copes with one’s unique strengths and vulnerabilities and how allthe traits work together.
Having some traits but not others does not make one a better or worseperson. Each trait represents a way of seeing the world that is useful insome, but not all, situations. As we’ll see later in the chapter, some traitsdo correlate with ﬁnancial success, but the usefulness of traits depends oncontext. The same traits that facilitate success in a venture capitalist mayimpede the performance of a short-term trader.
Personality traits are somewhat heritable, which indicates that theyhave a genetic basis (although it is multifactored and complex). Personal-ity traits are mild variants on a spectrum of experience and behavior thatincludes clinical psychiatric disorders at its extremes.
When reading the descriptions below, remember that these personaliytraits represent extremes of people’s responses on several similar ques-tions on the NEO test. Forty percent of respondents are “average” on eachcluster. That means they share a balanced mix of each pole of the trait.
Extraversion versus Introversion
On the extraversion scale, high scorers are called “extraverts” and lowscorers are called “introverts.” Extraverts enjoy being with people, are fullof energy, and often experience positive emotions. Extraversion is char-acterized by a desire to socialize, gregariousness, and a tendency towardoptimism. Extraverts are more likely to strongly agree with phrases such as
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“Love life.” They tend to be enthusiastic and action oriented and engage inopportunities for excitement. In groups they like to talk, be assertive, anddraw attention to themselves. Interestingly, functional magnetic resonanceimaging (fMRI) studies show that extraverts have more reward-system ac-tivation to ﬁnancial gains than do introverts.9 That is, extraverts are moreexcited and motivated by opportunities for ﬁnancial gain.
Introverts are typically quiet, low-key, deliberate, and less engagedwith the social world. Introverts are comfortable without much social in-volvement, and this is neither due to shyness nor depression; they simplyneed less stimulation than an extravert and are more likely to prefer be-ing alone. Introverts agree with statements such as “Avoid crowds.” Intro-verts are motivated from an internal drive rather than from outside stim-ulation. That is, they generate motivation and excitement internally ratherthan seeking for external triggers.
Neuroticism versus Emotional Stability
Neuroticism is on the opposite pole from emotional stability. Those whoscore high on neuroticism experience more negative feelings such as anx-iety, anger, or depression and are more emotionally reactive than others.They are more likely to identify with the phrase “Panic easily.” Their dif-ﬁculty in emotion regulation when under stress can impair their ability tothink clearly, make decisions, and cope. In one fMRI experiment, the de-gree of participants’ insula activation when threatened was correlated withtheir level of neuroticism.10 This ﬁnding implies that neurotic people aremore sensitive and reactive to signs of danger than emotionally stable peo-ple. This hypervigilance to threat can be exhausting, but it also ensures thatthey are prepared when real calamity strikes.
Low neuroticism scorers are “emotionally stable” and tend to be calmand free from persistent negative feelings. They are more likely to ﬁnd thephrase “Remain calm under pressure” descriptive of themselves. Freedomfrom negative feelings does not necessarily mean they experience morepositive feelings. In general, they are secure, hardy, and relaxed even understressful conditions. The super-relaxed attitude of the emotionally stablecan be a problem when real dangers loom. Neurotic people may sound thefalse alarm more often, but they also