With the year coming to a close, I’ve spent intensive time at a number of trading and investment firms helping money managers maximize their 2018 performance. Interestingly, one set of questions has stood above all others in the recent meetings: How can I evaluate the positioning in an asset class or stock? What is the sentiment about the market? How crowded is this trade? Underlying these questions is the notion that the herd of market participants generally produces subnormal returns. If we can figure out what the herd is doing, we can position ourselves to benefit from their follies or, at the very least, act on our own views when those are least crowded.
My distinct observation has been that the people most likely to ask these questions are those with views and market exposures similar to others. Managers trading highly idiosyncratic strategies and markets don’t really think about the herd. Their processes are sufficiently unique that they don’t have to worry about the actions of others. Those most concerned seem uneasy perhaps because they sense that they are operating in a crowded space.
The social psychologist Robert Cialdini offers a provocative generalization: 95% of people are imitators and only 5% are initiators. By definition, imitators are those so influenced by others that they rarely initiate their own ideas and actions. Team Cialdini cites a fascinating Scientific American report from Krystal D’Costa regarding why people don’t return their shopping carts to the designated areas. It turns out that some people are regular returners and others are not, but most of us are influenced by the return behavior of those preceding us. If the lot is littered with stray carts, we are more likely to abandon our cart. A neat lot is more likely to lead us to return our cart and preserve neatness. What’s more, when people have circulars left on their windshields, they are more likely to throw those on the ground and litter when the car is in a lot with stray carts. A neat lot leads to less littering. D’Costa explains, “…as a situation broaches on deviance, more people will trend toward disorder; once we have permission to pursue an alternative action, we will do so if it suits us.”
In other words, we are easily influenced by factors outside of our awareness. That makes us imitators, not initiators.
At the trading firm SMB, Mike Bellafiore introduced a concept called “the playbook.” The idea is drawn from sports teams: just as a coach has a collection of plays to run on a football or basketball team, a trader can create a collection of “setups”–observable patterns of supply and demand–that guide buying and selling decisions. The playbook concept is interesting because it pushes traders to be initiators. Developing traders discover the patterns that make sense to them and translate those into favorable reward-to-risk opportunities. Indeed, every trader on the SMB desk has their playbook.
In spite of that, it is not unusual for traders on the floor to be trading the same exact stocks in the same direction. Once a “stock in play” hits the radar for experienced, successful traders, it is likely to be followed by many developing traders. To be sure, some of this following reflects useful mentoring. Even in mentoring situations, however, one would expect each trader to trade the opportunity his or her own way. For many traders, that is not the case. Despite researching “initiator” patterns, they act as “imitators”.
In the past several weeks, I initiated conversations with three of the most successful traders at the firm. All are doing much better than they had the year before, and all are solid seven-figure earners with superior risk-adjusted returns. To a person, they are making money doing things they hadn’t done the year before. For example, some are trading different time frames; some are making greater use of options; some have expanded the universe of what they trade. Their success stemmed from being initiators: they followed a fresh path that was not one others were seeking.
So how can we become better at initiating? D’Costa’s work suggests that an important step is to remove ourselves from surroundings that influence us. Much of our vulnerability to the herd, Cialdini has found, is not due to direct persuasion but to “pre-suasion”: our prior exposure to situations and settings that nudge us in particular directions. Our physical and interpersonal settings help shape our thoughts and decisions.
Over the years, I have been struck by the degree to which successful portfolio managers have sought solitude as part of their trading processes. Some retire to separate office space to conduct their research; some engage in meditation on a routine basis; some wear headphones while on the trading floor. I once asked a manager what he was listening to while on the floor. He smiled and said, “Nothing!”. It turned out that the headphones were of the noise-cancelling variety and created an influence-free zone for his decision-making. In her book, Susan Cain cites “quiet” as a key element in “the power of introverts.” It is precisely their immersion in their own processing that enables them to be creative initiators of ideas. Too often, she notes, it is the noise of collaboration that kills creativity.
One very talented quantitative money manager, a great example of Cain’s introverts, also wore headphones in his office. It turns out he used them to immerse himself in beautiful classical music. It was “pre-suasion” at its best, a priming to filter out the noise of office politics and emails, and create a mind space receptive to the appreciation of complexity. That money manager has been a consistent innovator in both academic and investment arenas.
In a world of smart phones, non-stop chats, and social media postings, quiet and solitude are difficult to come by. Yet those are precisely the factors that may help us become creative initiators and effective leaders. Our settings influence our performance every bit as much as our “playbooks”. With focused quiet, we are most likely to find our own paths.
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