You have been a trader, what lead you to carry out this investigation on the psychology of traders?

Before anything, chance! Trading is such a fascinating activity that it is difficult to find the time to write a book on the subject. For a long time I hesitated before starting to write this book because I knew it would be long and painful. However, after many long hours I was thrilled to arrive at the end of this adventure. For me it is so satisfying to receive letters from people of all ages and from all backgrounds (professionals, private individuals, students, etc). This work has benefited me because the research that has been carried out has allowed me to see what level my skills were at and to perfect them.

Why psychology? I believe that this aspect which is crucial to the success in trading is often overlooked in any books on the subject. For this reason I deemed it necessary to dedicate a book to the subject which would answer the many questions that both professional and novice traders have. When it comes to financial markets and traders having the same skills, it is the use of psychology that makes the difference..

You have followed the path of a dozen traders or exceptional managers, namely Ed Seykota, Steven Cohen and Paul Tudor Jones. Which stand out the most for you and why?

Traders who followed an atypic path are probably the ones that stood out the most. I myself have a path less than orthodox and I don?t like following the beaten track. The big traders are often skeptics with strong personalities. Without doubt, what attracts me most in trading is the freedom that it provides. It?s one of the only lucrative activities in which the individual is judged first for his performance and not for his political skills and even less for his integration into such a system. Without sound skills, you can not fool people for very long in the markets!

Among the traders I studied, the one who impressed me most was Martin Schwartz. For ten years this trader was a financial analyst and during this period he did nothing but lose on the markets. Despite these setbacks, he did not give up. Let us not forget, he started with $ 100 000 which he borrowed from members of his family. After a few years, his annual return exceeded 10 million dollars as a sole operator. Many others would have given up but Schwartz continued to believe in himself and and his chances of success. He therefore developed a detailed trading plan and a trading method that suited his personality - scalping the S&P 500 futures.

The trader who taught me the most is unquestionably Paul Tudor Jones. Here is a trader who succeeded in everything that he undertook, whose performances were regularly superior to 100% during several consecutive years and who explains that the most important thing in trading is defense and not attack. When you compare the following quote from this legend trader “Don?t be a hero on the markets” , with that of the notorious Imad Lahous [1], « You must find the trade that will make you famous», you can understand why Paul Tudor Jones, who began in the 1980?s, is still among the best managers in the world. Imad Lahoud speaks about a trade that will make you famous while a good trader does not seek fame but instead perfectly applies his trading plan. He is completely focused on the process.

Finally, the trader who most inspired me to follow this career is undeniably Jesse Livermore. I read “Memory of a Speculator” a book written by Edwin Lefevre. It is a which is a fictional biography of the famous speculator and I applied several principles from this book to my trading activities. This classic, published in 1923, is definitely the work that taught me the most about trading and I strongly recommend it to all novice traders. It describes mob psychology in a remarkable way and (almost) nothing had changed since...

According to you, “channelled emotions are the key to success!” However, the current trend in hedge funds is the development of the black box, based on increasingly sophisticated mathematical trading formulas. Do you not foresee an eventual end to the emotional and the psychological aspect of trading?

The black box is not a recent phenomenon and I still remember the hype of the proponents of this revolutionary system towards the end of the 1990?s promising to be a magical system that would do everything for us. In these somewhat comical advertisements, stressed traders operating in a classic way are compared with those who have adopted this miraculous system and as a result are able to leave the floor to play golf or go fishing while the machine does the work for him. As surreal as this seems, people love to dream, as demonstrated by the ongoing success of the lottery...

This may come as a surprise but I consider the current success of the black box as the irrefutable proof that emotions are always present. The quest for the Holy Grail has stimulated traders since the beginning of time and recent technological developments have only fuel this desire and lead us to believe that it is possible to find the infallible system. The alchemist myth still exists and will do for many years. In some ways, black box resembles the Holy Grail. It seduces many players (even in the more serious financial institutions) because it allows traders to operate in an automatic way and prevents emotions from interfering during the decision process. The trader develops a system which tells him when to buy, sell, get out of a situation, etc. Certain sophisticated systems even take the decision making away from the trader. Orders are sent automatically as soon as a signal is generated. Yet, one assumes that the originator of the system would analyse the information at his disposal without the interference of emotion and at the same time would develop the system while taking into account all the limitations. Is this really the case? We are all subject to psychological prejudice. We are going to be interested in a share because we know it, because it has proved itself in the past, etc. Cognitive biases will directly influence the development of the black box.

So to answer your question, one first has to consider the following question :
Who would succeed in a game of chess, man or machine? An automated system will undeniably limit the impact of emotions during decision making but it will never succeed in eliminating them completely. I think that these latest technological advances do not at all mean that the psychological dimension in trading has disappeared for three reasons:

 It is impossible to completely eliminate all emotion during development of a black box
 The superiority of the machine over man remains to be proven
 The development of the black box will inevitably reduce the profits that they generate.

 a. It is impossible to completely eliminate all emotion during development of a black box

For a trader resorting to an automated system, we can suggest that the psychological dimension intervenes at three distinct moments:

• First of all, during the conception of the trading system. The trader will probably come up against a number of difficulties and will go through phases of doubt that he will have to overcome. He will have to constantly be motivated to see the research process through to the end and to develop a strong system. Nevertheless, the psychological dimension will always be present as the trader can be influenced by his emotions but equally by his skills and beliefs during the development of his system (psychological aspect brought to the fore by behavioural finance.) ;
• Next, there is an action phase . An automated system completely eliminates the impact of emotions and therefore the psychology in trading ;
• Finally, the trader will have to constantly improve his system (process of permanent improvement, well known in management). In fact, trading excellence means going beyond your own limits and for this, the trader must constantly question and try to improve his performance.

It is clear that psychology is present even if the negative effect of emotions during decision making can be reduced by the development of an automated trading system. Yet, does machine offer man an advantage when compared to traditional decision making?

 b. The superiority of the machine over man remains to be proven

I named my second book “The Art of Trading” because I consider trading as an art and not as a science. It is possible to identify recurrences in the market but the probability will never be 100%. The great shortcoming of the black box is the belief that a machine can take into account all the possible market configurations. In other respects, we consider that a machine is more capable than man. It is true that automated systems eliminate all emotion in the markets but can they really be better than human intuition?

This recurring question takes on particular importance with technological developments in the past few years. An experiment in this field was been conducted : Deeper Blue, a computer capable of calculating 300 million moves a second, was conceived with the help of several chess masters whose objective was to prove that machine was superior to man. Yet Deeper Blue?s small victory was not convincing and has even been challenged (a victory for Kasparov, two for the machine and three draws). Kasparov was tired after nine days of the competition and gave up.

If we apply the same theory to the markets, we can say that man definitely has an advantage over machine. There are many more applications in a classic game of chess and markets are not static because stock prices continuously change and are directly influenced by random events. The complexity of the markets gives the lead to men and the trader who has learnt to control his emotions can certainly outperform the black box.

In other respects, machines do not possess this precious quality which is intuition. A trader who observes the markets during a number of years develops “a market sense” which gives him the ability to anticipate future movements in the markets. Certain traders specialise in the interpretation of order books, others in reading graphs. Practice and repetition gives them expertise. Despite scientific advances, this intuition is a concept not yet understood by machines.

Is it necessary to eliminate all emotion? Neurologist Damasio emphasises the importance of emotions in decision making. But apart from this effect of emotions, they do provide some information. A euphoric yet seasoned trader will be capable of identifying his euphoria and will make a decision against the dominant consensus. Yet, the best opportunities often arise when most individuals are orientated in the same way. This means that they are in a fragile position and that the slightest news will provoke panic.

 c. The development of the black box will inevitably reduce the profits that they generate.

To be successful in trading, you have to develop an original strategy. If all players develop similar models, it will be difficult to outperform their competitors and to generate P&L. Suppose that at the birth of this system, one is perfectly rational and takes all the parameters into account. He therefore develops an efficient system, expected to capitalise on existing inefficiencies in the market and to take advantage of them. Yet if all the players develop similar systems it will be difficult for a black box to outperform the market and even to generate a positive performance (after deduction of all costs). This result is supported by the market efficiency theory which highlights that the possibilities of arbitrage on the market are extremely limited in a situation where competition is strong. A good trader must have a head start on other players and this brings us back to the fact that the difference will depend upon the individual and not on the machine. Humans have extremely strong analytic and calculating skills. If man can control his emotions and train himself to seize opportunities existing in the markets, I am convinced that man can beat the machine.

The summer crises of 2007 was in this regard extremely interesting. We have a series of hedge funds including some of the most famous in the world whose strategies are based on black boxes and whose performances suffered heavily at the time of these recent events. This is especially surprising as a simple analysis of the situation would have anticipated this failure. Most of these funds have explained that these events were unusual and this justified their poor performance. I think it is a recurring phenomenon in the history of financial markets : when an agreement is shared by all players and when the world orientates itself at the same moment, it only takes some news that is slightly negative to cause panic. Human nature is such that despite major well-known technological evolutions these past few years, certain phenomena repeat themselves and will do so probably in the future...

The markets are not static - they are constantly changing. Certain configurations that functioned perfectly in the 1990?s only generate false signals today. The trading system must therefore constantly adapt to the evolution of markets. Research on the performance of CTA in the United States lead by Kidd and Brorsen is extremely informative. In effect, a lot of research shows that a large part of the CTA uses an analysis technique in decision making. Yet widespread use of this technical analysis (development of the internet, widespread access to technical analysis software, etc.) is without doubt the cause of an increase in false signals and of a drop in CTA?s performance. This result can easily be applied to the black box and means that the trader must always have a head-start on his competition if he wishes to outperform the market.

In summary, the black box can help the trader but it is not the universal solution.

It often occurs that when a trader goes against the market, if his strategy works, it will be relevant and his independent spirit will acknowledged. If he fails, one would consider that he has an enormous ego. In the end is it not results and P&L that make a good trader?

Human nature is such that we are attracted by winners and that losers will be systematically discredited, despite established skills they might have. This basic reasoning is perfectly applied to trading. In the year 2000, the media was extremely negative towards Warren Buffet because he had not invested in technology assets. At the time we even considered him a “has been.” I was rather surprised by these unjustified criticisms. Warren Buffet justified his position by the fact that did not understand a lot about technology assets. He kept his composure and proved that his reasoning was right. This was not the case with certain big traders such as Stanley Druckenmiller or Julian Robertson who made the biggest investments in March 2000 for fear of missing the opportunity of the century. A good trader has a strong character which allows him to hold his own and to not doubt his skills even during unfavourable events. The P&L and the results are not significant in the short term. They are often the result of chance. Moreover, it is possible to generate an extremely positive performance in a favourable environment. Nevertheless, a good trader should be able to produce a positive performance over a long period, regardless of the market conditions. Thus, in the late 1990?s any novice could earn a huge amount of money and could buy himself any title. The good traders did not shine during this period for evident reasons. It is during the period that followed the March 2000 crash that true skills shone through and the amateurs were eliminated from the markets.

As I wrote in my book “The Art of Trading”, anyone can become a guru. You only have to be in the right place (preferably in an anglo-Saxon bank) at the right time (for example in a bull market or a bullish reversal) and then make some enlightening ideas known via the media. This approach was used by several gurus (Abby Cohen, Mary Meeker, Henry Blodget, etc.) which earned them a worldwide reputation. The bear market was able to see things more clearly and realised that it was only a flash in the pan...

In conclusion, what are the necessary qualities to be an exceptional trader in your opinion? What are the unacceptable mistakes?

In my opinion, the most important qualities to succeed in trading are :

 Discipline: The trader must not only develop a robust system but it must also be consistently applied. In addition, the trader must seek to continuously improve himself by questioning himself, by studying his position on a daily basis and by aspiring to perform on a higher level;
 Independence: the trader has to form its own view of the markets and avoid being influenced by others or questioning his views. He should obviously have all the necessary information to make a decision and then take action...
 Humility: the ego must be banned from trading. The trader who seeks to shine will not last long in this business. He must avoid becoming too happy after a series of gains, but must also accept his losses
 Tenacity: trading is one of the most difficult activities and requires courage to follow through.

So to paraphrase Jesse Livermore, “trading is not a game for the stupid, the lazy, the frail and the adventurers. They will die poor...”.