I was recently approached by a top hedge fund about profiling the best traders in the world. Profiling really refers to finding those psychological characteristics that will best predict success. And I believe that I'm one of the world's experts in that area since we have a huge database of psychological profiles of traders. I've been testing traders since 1982 to help them discover their strengths and weaknesses. The instrument that I've developed, The Investment Psychology Inventory, does an excellent job of that.
However, if you were to numerically rank the best traders in the world, they are probably people who can take $100 million dollars or more and make 20% per year on that money consistently. There are probably only about 20-30 such traders in the world, so how do you profile those traders? And even if you could get a thorough profile of all such traders, their numbers are so small that your data might not be that meaningful. Such are the issues of profiling.
After spending some time thinking about the whole issue, I now believe that my company has developed everything possible to do the task. However, it involves a lot more than just a psychological profile. In fact, it involves a number of assessments.
First, you need their psychological profile. I would expect traders who can make 20% per year or more on large amounts of money to generally fall in the top 10% of our database on all the skills we measure.
Second, I would look for their trader type. We now believe that there are approximately 15 trader types, but that most top traders would fall into only five or six specific categories. As a result, I'd want to look at their trader type.
Third, I'd want to look at accountability. All top traders must believe that they are personally responsible for the results that they get. This leads to certainly qualities. Either 1) they have tremendous discipline to do what needs to be done to be a top trader or 2) they have a strong desire to constantly work on themselves to improve. They are constantly working to maintain an optimal mental state for top performance and they are constantly looking at their beliefs to see if they are useful.
Fourth, we can now quantitatively measure systems and determine how good they are, regardless of the type of trading that people do. I call this the System Quality Number or SQN ™ for short. For example, someone who has a system with an SQN of 5 definitely has a much better trading system than someone who has a SQN of 3. I would expect most of the world's top traders to have systems with SQNs of 5 or better. And the exciting thing about the SQN, is that we can measure it for various market types.
Fifth, one of the big secrets (that most people don't understand) is that position sizing (the variable that controls how much throughout the course of a trade) is the key to meeting your objectives. I expect that most top traders understand this concept at some level. However, this can be taught and can be used to improve performance dramatically. And the higher the SQN, the easier it will be to use position sizing to meet your objectives. Thus, if your SQN was only 3.5, you still could be one of the best traders in the world if 1) you had thorough control over your personal psychology; 2) totally understood how to use position sizing to meet your objectives; and 3) have mastered the sixth quality which is the ability to minimize the impact of mistakes upon your trading.
Sixth, the next secret of the top traders is that they know how to minimize the impact of mistakes. I've talked about this in prior tips, but let's say that the expectancy of your system is 1.2R. You make 100 trades per year, so you should be able to make about 120R per year. However, let's say that every month you make one mistake. That mistake costs you 5R. So in one year, you'll make about 60R worth of mistakes, and your total return is now only 60R. Your mistakes will have cost you half of your potential returns. Top performing traders know how to negate the impact of mistakes.
Lastly, there are certain fundamental skills that all top traders will have such as 1) how to get the information you need; 2) how to execute orders; 3) how to organize yourself; etc. I'd expect all top traders to have these specific qualities.