Fear and Greed in Financial Markets: A Clinical Study of Day-Traders

Abstract

We investigate several possible links between psychological factors and trading performance in a sample of 80 anonymous day-traders. Using daily emotional-state surveys over a fiveweek period as well as personality inventory surveys, we construct measures of personality traits and emotional states for each subject and correlate these measures with daily normalized profits-and-losses records. We find that subjects whose emotional reaction to monetary gains and losses was more intense on both the positive and negative side exhibited significantly worse trading performance. Psychological traits derived from a standardized personality inventory survey do not reveal any specific "trader personality profile", raising the possibility that trading skills may not necessarily be innate, and that different personality types may be able to perform trading functions equally well after proper instruction and practice.

Emotion regulation and trader expertise: Heart rate variability on the trading floor.

“…The novel contribution of this study is to offer evidence, first, that traders find it more difficult to regulate their emotions in volatile market conditions and second psychophysiological evidence that emotion regulation may be an important element of trader expertise. Not only are emotions implicated in traders moment by moment financial decision-making (Lo et al, 2005;Lo, 2004;Lo & Repin, 2002), but, this study suggests, effective emotion regulation in the context of financial decision-making may be an important part of what traders learn over the course of a career.…”

“…Previous work has offered physiological evidence of traders' emotional responses to market events (Lo et al, 2005;Lo & Repin, 2002) and qualitative evidence of the role of emotion regulation in traders decision-making . The novel contribution of this study is to offer evidence, first, that traders find it more difficult to regulate their emotions in volatile market conditions and second psychophysiological evidence that emotion regulation may be an important element of trader expertise.…”

“…There is evidence specific to investment and trading decisions. For example, Lo, Repin and Steenbarger (2005) found some clear associations between day-traders' emotions (as measured by an emotional-state survey), their decision making, and performance (N=80). Investors who experienced more intense emotional reactions to gain and loss were poorer performers than those with more attenuated emotional responses.…”

Anxiety, Overconfidence, and Excessive Risk Taking

“…Our framework also applies to environment where the agent's job involves risk-taking without risk to bodily harm. For example, the finance profession should be particularly likely to feature overconfident agents, as documented by Ben-David et al (2013), see also Lo and Repin (2002); Lo et al (2005).…”

Executive compensation and investor clientele

“…See, for example, Benartzi and Thaler (2001), Lo, Repin, and Steenbarger (2005), or Hong, Stein, and Yu (2007) for evidence regarding investor naïveté about financial markets. More generally, for evidence that agents often have naïve notions about complex issues (such as scientific inquiry or the intricacies of scientific subjects such as physics), see Reif (1995).…”