Why do successful traders go bankrupt?
Why do successful traders turn into bankrupt? Is it simply the result of a few unsuccessful trades or is it somehow related to the general problems of intraday trading and is a natural end to the career of any speculator?
Before I try to answer these questions, I want to explain how I got them: for almost nine years now, I have been working as a coach and later as a psychologist with a number of small, but quite stable private financial investment funds.
I'm not a trader. But my work forces me to communicate with traders on an almost daily basis. In my time, I also studied trading on financial and stock markets and listened to the advice of professional traders who have given many years of their lives to this profession. "A trader is someone whose efforts are focused on achieving short-term profits, and this focus is sometimes so strong that in some cases the end justifies the means," they said. Self-interest as a motive for maximizing profits?
I don't think it follows from anywhere that a good trader is simultaneously a good teacher.
It is impossible, figuratively speaking, to unscrew one's own head and put it on the shoulders of one's own student. What you feel and understand yourself, it can be extremely difficult to convey or explain in words to someone else. This is quite true in my personal experience.
The dominant personal ego
For many traders, their sense of self-worth is determined, almost uniquely, by their profit and loss (P&L) ratio. The gains and losses they make for the fund is what determines the size of their bonus or final earnings.
Their profitable trading shows that they are right. And the bigger the profit, the more right they are. However, not everything is linear. Income may indeed be very, very significant, but it is still not the determining factor. The material benefits they bring are not as important and meaningful as the recognition of a trader's status and success.
I have known monstrously "overpaid" traders who were very upset when they suddenly found out that some colleague of theirs, in their opinion less successful and therefore less worthy, was able to earn more than them.
In this sense, the story is very telling Kweku Adoboli.. During the trial he denied in every possible way that he had committed certain actions motivated by the receipt of a bonus, i.e. on the grounds of personal gain, and it seems that the jury at that time believed him. Nevertheless, personal gain was still present in the motivation for his actions, only in a somewhat distorted, non-linear manifestation. He claimed that he felt as if he was under pressure, because the management expected high performance and results from him. He claimed that it was this psychological pressure that triggered a number of losing trades.
This is indirectly evidenced by his "confession letter", which he sent to his risk manager when he realized that it was impossible to hide his losses any further. In this letter, Adaboli claimed that at one point he almost managed to compensate for the drawdown, but the market turned against him. According to this logic, he was a kind of victim of circumstances, he was just unlucky at some point. In his understanding, this explanation was supposed to be an excuse for his irresponsible behavior.
"Gekko syndrome."
So why do investment funds recruit these particular "players" in the first place?
When recruiting candidates for the trading profession, I have very often observed that the main emphasis is on technical competence - the candidate's high cognitive abilities or their IQ. On the second indicator, which, as recent research in this area shows, is even more significant for successful trading, namely emotional intelligence - the EQ (Emotional Quotient), employers prefer not to particularly focus their attention.
Emotional Intelligence (EQ) shows the level of a person's ability not only to recognize and manage their own emotions, but also their ability to build relationships with other people. Emotional intelligence was first discussed by a prominent psychologist Daniel Goleman..
I can tell you from personal experience that a great many traders suffer from "Gekko syndrome" (Gordon Gekko), who postulated that greed is a very good thing. This character and others like him have a complete lack of self-awareness, i.e. the ability to understand their own emotions and how they affect others. They create the image of an aggressive, risk-taking, boundary-pushing, "crazy" trader, and employers are eager to hire just such candidates.
Unfortunately, the recruiters themselves usually have no idea how to manage people. They are often traders and recruit people based on their own idea of what is good and what is bad. They are more focused on the impression the candidate made on them, whether they liked them or not.
In reality, many traders try to actively avoid being promoted to administrative positions. This distracts them from their favorite business - trading - and deprives them of the thrill of victory. And, besides, many of the most successful traders earn much more than their managers, and sometimes even more than the head of their company.
Aggressiveness
Of course, not all traders are alike, and I try hard to emphasize that I have also met many speculators with very high ethical standards. My personal experience is that traders, very roughly but still, can be divided into three main categories, and this division largely depends on the markets in which they operate.
- As a rule, the most aggressive ones are "flow" traders - people who work intraday, in the most competitive, liquid and dynamic markets, such as currencies or equities.
- The next category is. algorithmic traders or "quants". These are those who use pre-designed and predetermined complex algorithms in their trading, and also actively use trading robots. They have to intuitively master complex mathematical calculations, but if they make mistakes in their calculations, losses are inevitable.
- And finally, "elephant hunters". These characters can spend months working on and preparing one big deal, earning millions of dollars in profit. They are also deep thinkers, like the algo traders, but their thoughts are more on negotiation tactics, drafting and analyzing complex legal documents, and working through the accounting issues in preparation for a deal. They are also generally very calm people, and tend to be mature family men.
Almost all traders who have lost large sums of money that I know of are more often of the first type, less often of the second type, and almost never of the third type.
The situations that led to losses were mostly related to assets that were not too complex (by investment banking standards) and were traded on large volumes. But at the same time, the instruments they worked with were complex enough to create risks that were poorly understood either directly by the trader himself or by the people who were supposed to supervise him (risk managers).
And by the way, I use the pronoun "he" in this case for a reason. The vast majority of traders are men, the ratio of men to women is approximately 10:1. The reason for this behavior of men is related to their physiology.
- 4 dangerous states of a trader. Obsessive-compulsive trading
- 9 proven tips for the trader to trade without emotion. Part 2
Testosterone
According to a study that was conducted back in 2007, traders are more successful when the content of hormones in their blood (adrenaline, cortisol and testosterone) is at maximum values. The hormonal "explosion" prepares them for battle, making them more resilient, more resistant to pain (including psychological pain), and more inclined to take risks.
Success in trading leads to an almost skyrocketing level of hormones in the blood, consequently provoking even more risky behavior. This situation is a feedback loop and is referred to as a "the winner-take-all effect“.
The same effect is evident in the wild. Animals that win the battle for alpha male status experience a release of testosterone, which makes them even more aggressive, willing to fight and advance to new victories. The same is true in sports. Victories create a thirst for more victories.
The flip side of the coin is that it makes a person not just prone to risk, but provokes behavior on the verge of stupid recklessness. This is what happens when traders on the wave of a winning streak "drain" their deposit. And it seems that this is what happened with Adoboli mentioned above. After successfully hiding an unpleasant but generally acceptable loss of $400,000 in 2008, Adoboli continued to take bigger and bigger risks, which eventually led to a loss of 5000 times the previous one. Outside the bank, he traded on his own account alongside his day job, leading the investigating committee to suggest that he suffered from a gambling addiction.
Doubling
The last piece of the psychological puzzle is a mental trap, into which traders fall, whose deposit is steadily moving towards the maximum allowable amount of losses. Conventionally, this strategy, which has already become a textbook, can be called "come or go“.
The trader is faced with a choice: if the market goes against him, he can either take another loss or double the size of the position in the hope that the price will come back before the loss is revealed.
The problem for an investment fund is that, working in it, a trader is limited to the maximum amount of money he can lose. After a certain amount of losses, at best he will be fired, and at worst the situation may turn into criminal prosecution.
And at the option of doubling, the trader, though hypothetically, still has a chance. He is either guaranteed to lose 100%, or the probability becomes 50/50. Agree, it looks much more preferable, and traders often make this decision. But further the situation can develop quite badly. If this option does not work, the trader can really go "into the wild", because now he simply has nothing to lose.
In this state, the trader will repeat the above algorithm with doubling time after time until he either destroys his deposit or recovers his losses. I have never met the second option before. In Adoboli's case, he "reversed" his position twice, and both times the market changed its direction and went against him. His example is just another reason to think how easy it is to trade on the stock exchange and whether it is worthwhile to start doing it at all....