Your Own Worst Enemy. – Why it is so hard to develop a real ‘Behavioural Edge’ in Trading.

24th November 2017

Your Own Worst Enemy. – Why it is so hard to develop a real ‘Behavioural Edge’ in Trading.

a guest article by Steven Goldstein


The Dunning-Kruger effect is a behavioural bias which refers to people’s belief that they are more capable than they really are. This is a cruel trick played on traders by themselves which keeps most of them poor, and makes most brokers very wealthy. 

Imagine an aspiring boxer turning up for training in the gym, the boxer practices, has the kit, and has read a hundred books on ‘how to box and be a champion’, but has never been coached. Do you think he would ever be able to hold his own in the ring with a trained pro, let alone a decent amateur? There is a comparable example for this. Joe Savage was the British undefeated world Bare Knuckle Boxing Champion. In 42 fights he had terrified and defeated all opponents in the Bare-Knuckle world. He was the arch example of what I have described above. Strong, tough, but not refined or heavily coached. Savage believed there was no one in the world of boxing, bare-knuckle or professional, who he could not beat. He challenged all the top pro-boxing champions to fight him. At the time we were talking about the likes of Mike Tyson, Lennox Lewis and Reddick Bowe, they all turned him down, there was no upside for them. However, a journeyman heavyweight called Bert Cooper took up the challenge, his record was 38 wins, 31 losses. He did get to fight some of the top names, including Michael Moorer, and a 40-year-old George Foreman on his return to the ring after a long absence. – After a brutal 2 rounds with the aged Foreman, Cooper refused to come out for the third round. – 5 years after that, and with his career in decline, Cooper felt he had nothing to lose. Apparently, and facing the prospect of fighting someone who supposedly had the ability to kill a man with his punching, Cooper said, “If I die, I die.”. Thus Cooper accepted the challenge, and the fight took place in British Colombia in 1994. You can view a video of the fight below. I promise you, it is not a long clip. – After 35 seconds of quite awkward viewing, Savage hits the canvas for the first time. He gets up and takes the mandatory count. 18 seconds later, the Dunning-Kruger affected bare-knuckle boxer is felled again, this time going over like a giant oak tree, and struggling to move or get up. The ref stops the fight at that point. Actual boxing time, less than 1 minute.

How does this translate to trading.  Let’s start with you! – It is quite probable that as a trader or investor you consider yourself significantly better than the average trader, or at least with the potential to be significantly better than average trader. Perhaps you rate yourself in the top 20% of your peers, if not, the top 10%. However here is the thing: Most of your peers also share this view of themselves! – Most traders and investment professionals rate themselves at least in the top 20% of their peers. Now even with my limited math skills I know that cannot be right. Behavioural Finance has a name for this tendency to delude ourselves that we are far more capable than we really are: the Dunning–Kruger effect. Examples of the Dunning–Kruger effect include: 93 percent of U.S. students estimate themselves to be “above average” drivers. Whilst at one university, almost three quarters of the faculty rated themselves in the top 25 percent for their teaching abilities. If we were to assume the Dunning-Kruger effect does indeed apply to traders, this means that there are thousands, possibly even millions of traders all overestimating their abilities. These people are effectively paying away money for the privilege of sitting at the same table as the top traders. This delusion is exaggerated because people they don’t see the opposition, the enemy to them looks like this:

13925500 - tv illustration  business graphics on tv, the stock exchange trading

13925500 – tv illustration business graphics on tv, the stock exchange trading

The screen is of course just numbers and lines, totally abstract of course, but this is what people see as the enemy, and as such we believe this is something we can easily overcome. – But imagine you could see the real enemy: There are thousands, even hundreds of thousands, possibly millions of opponents, and many of them are far better prepared and capable than you. As a metaphor, consider you are stepping into a boxing ring with opponents far stronger, far tougher, and far better trained than yourself. You may have the boxing gloves and kit, but this is an example of what would be facing: 


Of course many of your opponents will not look like this. Many will also be out-of-shape, flabby, unfit and under-prepared individuals who will fall along the way, but opponents such as the one above will be amongst the last one’s standing. Without realizing it, you are stepping in the ring, against champions, and you don’t really have an edge.

What exactly is an ‘Edge’.

An ‘edge’ is that skill or ability which means you can consistently come out on top over time. Warren Buffett has a clear edge, legendary traders such as Paul Tudor Jones and Peter Brandt have an edge. The traders featured in ‘Market Wizards’ or ‘Momo Traders’ they have an edge. The less than 1% of the 450,000 day traders, featured in Terrance Odean and Brad Barber’s outstanding analysis of traders on the Taiwan Stock Exchange, who consistently outperform the market over the long-term, they have an edge. – Edges are, with a very few exceptions, behavioural. People who have an ‘edge’ do things in their trading and investment practices better than nearly everybody else. – They are the ‘Last Ones Standing’.

In trading and investment, you need to have an ‘edge’. Without an edge you simply will not win over time. It is the edge which enables you to withstand the inevitable drawdowns. I have worked with many traders as a coach and I have seen and met many good and a few great traders. The difference between the best and all the rest is their ‘behavioural edge’. These traders display and act better in all or most their trading activities. They also have superior ‘emotional intelligence’, superior ‘meta-cognition, and display superior behavioural traits of the type featured in the article ‘The 10 Behavioural Traits of Highly Successful Traders and Investment Professionals’.


Most people make the huge mistake of thinking that the system or approach they use is the edge. The signals, indicators, news, research, information, data, or method that they use or subscribe to is not an edge. It is comparable to saying that boxing gloves, and knowing how to throw a punch, provide an edge. But every boxer in the ring has that, these are tools of the trade, they do not provide an advantage. Likewise, your ability to read and understand fundamental drivers of value, or to be able to read and interpret a chart, these are knowledge and tools, they are not an edge.

How the Dunning-Kruger effect limits people’s ability to develop their own behavioural edge.

“We’re blind to our blindness. We have very little idea of how little we know. We’re not designed to.” Daniel Kahneman.

Developing a behavioural edge is incredibly difficult to achieve, not only do most people overestimate their abilities, they also overestimate their abilities to develop their abilities. That is the perfect ‘closed loop’ of delusion. – Take a walk across any trading room or investment office and you will see the self-help, biographical, pseudo-psychology and behavioural finance books that litter trader’s desks. However just reading the lessons from these is never enough. We confuse reading new information and insights, with being able to effectively apply and embed them. It is a massive self-delusion. There is a huge difference between having information, and undergoing transformation. The biggest transformation in my trading career came when I was fortunate enough to be the recipient of coaching. It was offered to me as a trader when I worked for Commerzbank. At the time I had been a trader for 15 years, and yet 8 coaching sessions over 6 months with legendary coach Peter Burditt was to transform my trading career. – Coaching is the most powerful developmental activity one can undergo, it helps people to change, transform, incorporate and embed new behaviours into their working practices. – But most traders and investment professionals do not think they need this, and the culprit is ‘The Dunning-Kruger Effect’.

I am afraid most traders, impacted by the Duning Kruger effect, are Joe Savage, or at least what he represents. – The opposition most traders are up against, the ones you cannot see because they are represented by lines and numbers on a screen, they are the Bert Coopers out there. These people, who are stronger and better equipped than you, with a real edge, they know how to box in the financial markets. They may not be champions, but they are capable of taking your money from you. And of course there will be many real champions amongst that hidden group.LineBreak4

The percentage of traders who really have an ‘edge’.

It is often stated that around 10% – 20% of traders make money, however there is strong evidence that even this number maybe very generous. Often the research put out to back this comes from brokers who are looking to entice people. 10% – 20% may not sound very generous, but it is just enough to make people think ‘I can be one of those’. The best and most objective research I have seen is the aforementioned research from professors of finance Brad Barber and Terrance Odean. They, and their colleagues studied 15 years of performance data of day traders on the Taiwanese Stock Exchange. Amongst their findings, which covered around 450,000 traders, they found that ‘while about 20% of the traders earn profits net of fees in a typical year’, less than 1% of the traders (4,000 out of 450,000) were able to outperform consistently over many years. – Let that number sink in for a bit. – Less than 1% were able to perform consistently over many years.

If you are wondering who would be in that 99%+, I am afraid there is a good chance it could be you. And if you think that just because you work in a bank, investment firm or a hedge fund, and believe that you would not considered as being within that group. – Ask yourself this, have you ever been coached as trader, investment professional or portfolio manager? – You actually have an enormous edge by virtue of the resources and backing you have, but your own personal edge may not be as big as you think. In the past few years I have coached numerous banks traders,  energy firm traders, and portfolio managers in asset management firms and hedge funds. In the months and years after the coaching they have seen huge performance improvements. It was not that they were not able, quite the opposite, these people were high performers who did already have an edge, however there was far more of their potential which was untapped by the coaching.


Coaching helps people to develop their ‘Edge’.

Rather like in boxing, as in any sport, coaching helps individuals to develop their ‘Edge’, and where they already have an ‘edge’, it helps them to develop it even further. The coaching work I do with individuals is enormously powerful, it helps people to explore and examine all aspects of their trading and investment work and process. The coaching is a collaborative, process-focused, results-oriented activity which facilitates the enhancement of work performance, life experience, self-directed learning and personal growth for individuals. Coaching usually takes place in designated one-to-one ‘coaching sessions’ as a discussion and exploration between a coach and the individual, away from the trading floor and screens. – What are the outcomes? This varies from individual to individual. – Overall people are far more confident, have stronger self-belief and self-trust, they are less fearful, less stressed and less anxious, and far more resilient when it comes to their trading activities. They have a clearer understanding of their strengths and how best to leverage them to work their edge, and have a more developed level of ‘Emotional intelligence’. They understand their work in a different context and perspective which gives them additional insight, and in many cases they have enhanced their risk and money management practices. In terms of PnL, often they have seen huge performance improvements, in many cases traders have seen their results increase by a factor of 50 to 100%, and in some cases far more. 


Steven Goldstein is Managing Director at Alpha R Cubed, and work with banks, hedge funds and investment management firms to help them improve their people’s capabilities and performance. To know more about Alpha R Cubed, visit the website or email Steven at Follow Steven directly on Twitter. Also visit the ‘Behavioural Trading’ blog for more articles and to sign up for the ‘Behavioural Trading’ newsletter.

Post Tags: , , , , , , , , ,

Back to Latest Posts