You Have to Be A Horrible Human Being to Be a Good Trader

There was a fascinating article in Institutional Investor last week arguing that money managers actually generate alpha and outperform the market. In other words, just like in other areas of life research and hard work pay off. However, almost all of that alpha is squandered because money managers fall in love with their positions.

“Active managers … can generate alpha of 1.2 percent annually, on average, at the portfolio level. That’s enough to beat their benchmarks after an average fee of 75 basis points (0.75 percent), the consultant found.

After evaluating about 10,000 “episodes” — full cycles of a given position from first entry to last exit — across 43 portfolios over 14 years, Essentia Analytics found that “alpha starts out strong and fades sharply with age.”
According to the report, “Investors often hold on to positions too long (a consequence, we believe, of the endowment effect), diminishing or eliminating whatever excess returns they were able to generate early on.”

The endowment effect is a nice sounding academic term, but I believe it masks what’s really going.

Since we are toddlers we are taught the following things.

Love those around you.
Be loyal to your friends.
Forgive and forget the errors of others.
Always give everyone a chance.

If we are any kind of a decent person these are the values we hold. They are so ingrained in us that we don’t even realize how they permeate our life and affect everything we do.

Trading, on the other hand, requires the exact opposite set of beliefs. It requires you to be a complete jerk.

Don’t marry your position.
Cut your losers.
Press your edge and annihilate those on the opposite side of the trade.

Trading requires a mercenary and transactional mindset that on some deep level is very much the opposite of how we perceive ourselves to be. That’s why “the forget and forgive” pep talk we constantly give ourselves inside our head never works.

Successful trading requires you to be ruthless. And the person you need to be most ruthless to is …YOU.

Until we stop making excuses for lifting stops, taking out-of-setup trades, trading way beyond our risk sizes and chasing trades after the signal has passed we will never master the game.

So here is to being a total asshole in the markets while trying to be a decent person in real life.