DETERMINANTS O F TRADING SUCCESS

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1 What you must do to become aware of your own psychological makeup and counter the hardwired inclinations of risk aversion How you can function in the realm of probabilities which is a significant part of the trading and investing world How to build on existing personality strengths so as to develop the ability to function in a goal-oriented way, learn to cut losses, and maximize winning bets Which psychological traps interfere with becoming a better trader and how you can overcome them And much more Whether you re a seasoned financial professional or an active individual trader, understanding the connection between trading and psychology can increase your chances of success. With The Mental Strategies of Top Traders as your guide, you ll quickly discover how to improve your chances of winning in today s increasingly unpredictable markets. Working with Ari is a luxury and an important part of any investment process. The constructive dialogue in The Mental Strategies of Top Traders keeps our team focused on the investment edge, the management of risk, and ultimately how to consistently achieve the full potential of our investment goals. JASON ADER, Hayground Cove Associates, LP While each investor is unique in their approach, the framework, anecdotes, and analysis set forth by Dr. Kiev will assist both professional and individual investors to improve upon their strategies to generate higher risk-adjusted returns. LARRY ROBBINS, CEO, Glenview Capital Management This book tackles the most complex and important human factor in the performance and potential of a portfolio manager. Ari does a terrific job of crystallizing the most important lessons you can learn in this. WAYNE HOLMAN, MD, Ridgeback Capital Management Mental strategies are the most important, yet least discussed, aspect of investing. Having worked with dozens of portfolio managers, I know from experience that the concepts presented in The Mental Strategies of Top Traders will have a greater impact on your investment performance than any how-to book on stock picking or portfolio management. MATTHEW S. GROSSMAN, founder, Plural Investments, LLC Ari s keen insight into the intellectual and psychological elements of traders minds has a significant impact on risk and the ability to take risk, which is essential in today s market. DAVID GANEK, Founding Partner and Head Portfolio Manager Level Global Investors, LP In his most insightful book yet, Kiev demonstrates how creative thought and innovation can dramatically increase the probability of success for any investment process. Using concrete examples and guideposts, he provides the reader with tangible tools and frameworks that clearly bridge the art and the science of investing. This book should be a permanent feature on any mustread list for investors. JASON H. KARP, Co-Chief Investment Officer, Carlson Capital LP ARI KIEV is a psychiatrist who specializes in organizational psychology, stress management, and leadership training. Having worked extensively for the past seventeen years with Steve Cohen s multibillion-dollar SAC Capital Advisors, he now heads up Kiev Consulting, which helps trading professionals learn a variety of transformational strategies to enhance performance and create a collaborative and synergistic culture. For more information about developing a custom designed performance maximization program for your company, visit PA N T O N E C + PA N T O N E B L A C K C T HE PSYCHOLOGICAL DETERMINANTS O F TRADING SUCCESS JACKET IMAGES: EXPERIENCED TRADER AL FRANCEKEVICH/CORBIS, THINKING MAN KRIS HANKE/ISTOCKPHOTO Dr. Kiev s unparalleled access to top hedge fund managers gives the reader an inside look at how they think about making money. You ll read about the thought process behind the decision makers and learn from their good and bad experiences. The Mental Strategies of Top Traders presents readers with an invaluable toolbox filled with lessons. DAVID FISZEL, SAC Capital Advisers LLC Through patient observation and in-depth discussion with traders at the top of their profession, Dr. Kiev has presented a step-by-step guide for every trader who wishes to take his performance to an Olympian level. KEVIN BECKER, CEO, Kiski Group LLC THE MENTAL STRATEGIES OF TOP TRADERS effort in times of mental stress and market volatility. Along the way, Kiev also examines: THE MENTAL STRATEGIES OF TOP TRADERS PRAISE FOR KIEV [ CONTINUED FROM FRONT FLAP ] $49.95 USA / $59.95 CAN MENTAL STRATEGIES THE OF TOP TRADERS PSYCHOLOGICAL DETERMINANTS OF TRADING SUCCESS T HE ARI KIEV PA N T O N E C + PA N T O N E B L A C K C Trading tends to be a winner-take-all activity where only a small number of traders are truly successful. Nobody understands this better than author Ari Kiev. Over the course of his career, this respected psychiatrist and trading coach has seen firsthand how challenging the financial markets can be. Now, with The Mental Strategies of Top Traders, Kiev identifies and analyzes the characteristics that can improve your trading endeavors and shows you how to cultivate them to gain that much needed edge. Filled with in-depth insights and expert advice, this reliable resource carefully examines the issue of successful trading by looking across a broad range of skill sets that are an essential part of this discipline including, among other things, a goal-oriented strategy, risk management, creative thinking, and a capacity for collaboration and leadership. Kiev supports his approach with interviews from contemporary traders and portfolio managers many of whom struggled during the financial crisis of 2008, but survived as well as case studies that provide a real-world picture of what it really takes to make it in today s markets. Page by page, Kiev explains how aspiring traders can develop the qualities that lead to trading success by establishing stretch goals; cultivating a sense of variant perception in order to develop unique trading ideas; avoiding emotional decisions; maintaining a sense of urgency about producing results; and increasing [ CONTINUED ON BACK FLAP ]

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3 The Mental Strategies of Top Traders

4 Founded in 1807, John Wiley & Sons is the oldest independent publishing company in the United States. With offices in North America, Europe, Australia and Asia, Wiley is globally committed to developing and marketing print and electronic products and services for our customers professional and personal knowledge and understanding. The Wiley Trading series features books by traders who have survived the market s ever changing temperament and have prospered some by reinventing systems, others by getting back to basics. Whether a novice trader, professional or somewhere in-between, these books will provide the advice and strategies needed to prosper today and well into the future. For a list of available titles, visit our website at

5 The Mental Strategies of Top Traders The Psychological Determinants of Trading Success ARI KIEV John Wiley & Sons, Inc.

6 Copyright C 2010 by Ari Kiev. All rights reserved. Published by John Wiley & Sons, Inc., Hoboken, New Jersey. Published simultaneously in Canada. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, (978) fax (978) , or on the web at Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, (201) , fax (201) , or online at Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials. The advice and strategies contained herein may not be suitable for your situation. You should consult with a professional where appropriate. Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages. For general information on our other products and services or for technical support, please contact our Customer Care Department within the United States at (800) , outside the United States at (317) or fax (317) Wiley also publishes its books in a variety of electronic formats. Some content that appears in print may not be available in electronic books. For more information about Wiley products, visit our website at Library of Congress Cataloging-in-Publication Data: Kiev, Ari. The mental strategies of top traders : the psychological determinants of trading success / Ari Kiev. p. cm. (Wiley trading series) Includes index. ISBN (cloth) 1. Investments Psychological aspects. 2. Stocks Psychological aspects. 3. Speculation Psychological aspects. 4. Investments Case studies. I. Title. HG K dc Printed in the United States of America

7 For Phyllis, with all my love

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9 Contents Acknowledgments xi Introduction 1 CHAPTER 1 Intellect, Instinct, and Guts: Understanding the Psychological Profile 7 A History of Success 14 The Ability to Take Risk 15 Creativity and Originality 16 Self-Awareness, Self-Control, and Resilience 17 Teaching Traders Self-Assessment and Self-Control 18 Teamwork and Leadership 19 Putting It All Together 21 Case Study on Finding the Right Candidate 21 Job Requirements 21 Potential Candidates 22 The Bottom Line 25 The Perfect Candidate? 26 Chapter in Review 27 CHAPTER 2 Planning for Action: The Importance of Goal-Directedness 29 Making a Plan 30 Case Study on Setting a Goal 31 Case Study on Having a Variant Perception 35 vii

10 viii CONTENTS Personality Factors and Goal-Setting 42 Recognizing Goal-Directed Individuals 44 Case Study on Recognizing Goal-Directedness 47 Fred s Strengths: The Three Cs 47 Fred s Weaknesses: The Three Is 48 Goal-Directedness in Turbulent Times 50 Own Your Stuff 51 ReviewtheGameFilms 51 Switch Gears? 52 Be Realistic 52 Stay True to Your Strengths 52 Maintain Focus 53 Chapter in Review 54 CHAPTER 3 Fire in the Belly : The Ability to Take Appropriate Risk 57 A Picture of Successful Risk Management 57 Trading Philosophy 59 Handling Drawdowns 59 Head versus Heart 60 Reviewing Risk Statistics 60 Examining Personality Factors 63 Learning to Upgrade Your Performance 71 Chapter in Review 77 CHAPTER 4 Thinking Outside the Box: The Importance of Ingenuity 79 Case Study on the Satisfaction of Creative Thinking 80 The Strategic Thinker 81 Case Study on Learning to Be Creative 82 Idea Construction 88 Developing a Variant Perception 88 Case Study on Creative Thinking 89 Idea Evaluation Checklist 92 Defining Expectational Analysis 94

11 Contents ix Case Study on Knowing the Business 95 Case Study on Expectational Analysis 100 Raising Your Conviction 103 Idea Velocity 105 Idea Timing 105 Idea Completion 106 The Psychological Dimension 109 Case Study on Communicating Effectively 111 Chapter in Review 114 CHAPTER 5 Separating Emotions and Decisions: The Ability to Be Self-Aware 117 Case Study on the Emotion of Drawdowns 118 The Source of Fear 121 Case Study on Trading Stress 123 Self-Esteem and Self-Discipline 125 Learning from Drawdowns 128 Case Study on Self-Assessing During Drawdowns 129 Getting Comfortable with the Uncomfortable 131 Case Study on Being Comfortable with Discomfort 132 Teaching Traders Self-Assessment and Self-Control 136 Managing Stress Well 136 Chapter in Review 140 CHAPTER 6 Nurturing Team Players: Listening, Learning, and Working Together 143 Characteristics of a Team Player 144 Responsible 144 Positive and Encouraging 145 Competitive 148 Coachable 149 Finding Complements to Your Team 151 Case Study on a Comparison of Traders 153 The Importance of Communication 155 Chapter in Review 159

12 x CONTENTS CHAPTER 7 Leadership: Directing Success 161 Empowering a Culture of Change 162 Case Study on Creating a Culture of Change 162 Encouraging Responsibility 171 Case Study on the Challenges of Responsibility 173 Exploring Potential Leaders 176 Case Studies on Finding Potential Leaders 177 Endeavoring for Success 183 Case Study on a Failure to Lead 184 Chapter in Review 189 Index 191

13 Acknowledgments Many people have helped me with this book. I am especially grateful to the hedge fund managers who have provided me with the opportunity to explore the interface between trading and psychology. I want to thank Tricia Brown for helping me organize many hours of interviews with traders and for her efforts in helping me to edit several versions of the original manuscript. As in the past, much of this would not have been done without the support of my beloved wife, who has always been there to encourage me to stay focused on the project through the many stages of its progress. xi

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15 Introduction From my perspective, investing is not simply a fair coin-toss where everyone has the same chance of winning or losing. There is no question that some people consistently outperform other players. So, the question becomes, How can you increase your chances of winning? That question is the driving force behind this book. While I cannot define a stepby-step formula for trading success, I have outlined various attributes of successful traders in the hope that by learning more about them you can improve your own odds and the odds of those around you. Certain psychological characteristics of successful people obviously can be found in successful traders and portfolio managers. However, there is something unique about investing that requires some additional, seemingly incongruent, characteristics. For example, the most successful investors will have a high tolerance for risk-taking in a controlled way. They will also have a capacity for making rapid decisions with insufficient information but with sufficient thoroughness and discernment to increase the probability of success. They will have a strong desire for wins but have a tolerance for losses. They will know how to recover from failure and to persevere because at least 40 to 50 percent of their trades are going to be wrong. Of course, I have explored many of these themes in my earlier books. In Trading to Win, I discussed the commitment to win as opposed to trading to avoid losing. Trading in the Zone tackled the issue of how an individual can get outside his own skin and function in an objective way, zonefocused and intensely concentrated on the present moment in the context of a longer-term objective. The Psychology of Risk addressed overcoming fears and inhibitions about the possibility of losing, and Hedge Fund I consider the terms PM and trader completely equivalent; therefore throughout the course of this manuscript I will use them interchangeably. 1