As I noted last week, the largest academic study ever conducted on day traders revealed that most lost money …. even during a bull market. But it also proved something quite positive: 15% of day traders were able to significantly out-perform the market each year.

The study proves proponents of the Efficient Market hypotheses, such as Princeton University economist Burton (Random Walk) Malkiel, to be at least partially wrong. Malkiel favors index funds over active managers who claim they can beat the market. He notes that although 30% of fund managers can outperform each year, very few beat their benchmark two years in a row. 

What accounts for the difference between a one-year wonder and a trader/investor able to consistently outperform?  Is it the confidence that comes from success? Contrary to that popular notion, I think success just as often breeds failure. Think about it.

SUCCESS IS ADDICTIVE

Success releases the neurotransmitter dopamine in the brain. Dopamine is the active ingredient in cocaine. In other words, success is potentially addictive. And, as in other addictions, there’s a risk.

  • Success makes it much more likely we will merely repeat the things that created the success and thereby fall behind the curve when the market changes.
  • Success seduces us to believe in our infallibility, making it difficult to engineer mid-course corrections sooner than later. The Nobel Prize winners who took down Long Term Capital Management exemplify this attitude. 
  • Success makes us confident and when confident we tend to think heuristically, not analytically. We are more likely to make snap judgments (blink), which preclude taking a closer look at what could be different this time.

KEY QUALITIES

It feels great to be right, but being right can cause us to inadvertently close our minds when we really need them to stay open. The Top Traders I’ve met are unusually humble and they tell me that they operate from a mindset of not knowing. They don’t over-identify with success, so they stay open-minded, flexible and able to quickly admit they are wrong without needing to defend a boastful ego. 

= = =

[Please tune in each Wednesday for Dr. Kenneth Reid’s  weekly trading coach column: The Dr. Is In. Got questions? Post a comment for Dr. Reid below. Click here for Dr. Reid’s free report on the mindset of the top 4%. ]