“Be cool” is good advice for day-traders, according to an academic study that found those with the most intense emotions had the worst performance.
Researchers at the Massachusetts Institute of Technology and the State University of New York determined traders did best when their emotions weren’t running too hot or cold.
“Emotion seems to be important for proper decision-making, but only in reasonable doses,” said Andrew Lo, a finance professor and director of MIT’s Laboratory for Financial Engineering.
Lo, who co-authored the study with Dmitry Repin, also of MIT, and Brett Steenbarger, of SUNY’s Upstate Medical University, tracked dozens of day-traders over the course of five weeks in the summer of 2002, when the market dropped about 20 percent.
Day-traders who participated in the study provided a daily assessment of their emotional state, along with details on their daily trading, including profits and losses. The traders, who were enrolled in an online trading program, had accounts ranging from $200 to $1.8 million and varying degrees of success at trading on paper and in reality.
Traders with extremely intense emotions had the worst overall trading performance, researchers found. Traders with the best performance had reactions somewhere in the middle, stronger than those reporting little emotional response, but not intensely happy when their trades did well or down in the dumps when they didn’t.
“Having an intermediate range of emotion response seems to be the sweet spot,” said Lo.
Researchers also found there isn’t necessarily a trading personality marked by aggressiveness, for instance. The researchers said that suggests “different personality types may be able to perform trading functions equally well after proper instruction and practice,” provided they don’t get too emotional about profits or losses.
Lo said the researchers someday hope to create tests that employers could use to evaluate whether applicants would make good traders. They also would like to develop an online program that would allow individual investors to determine if they are too emotional to make wise financial decisions for themselves.
For now, the researchers are focusing on studying short-term traders and Lo acknowledged it isn’t clear if results from that group will hold true for long-term investors.
“Warren Buffett is a successful investor. I’m not sure how he would do as a day-trader,” said Lo.