Active Trading: A Matter of Intelligence?

Let's start this piece with a little test: In your opinion, which group of professionals are the most success at a intraday trading?

  • Accountants
  • Economists
  • Engineers
  • Airline pilots

According to Robert Deel, owner of a school in California that specializes in active trading, airline pilots tend to outperform at this type of activity. For one, they are able to make optimal decisions under pressure. Secondly, they recognize the importance of quickly minimizing losses, an essential attribute for a market trader.

Not surprisingly, for many people intellectual intelligence is the key to success in finance. Thus, it can be very difficult to accept that not every trade will turn a profit, which explains the lack of discipline in managing unprofitable positions. Despite investment strategies based on impeccable logic, we must deal with the uncertainty and randomness of the market. For example, although the surveys and experts predict a victory for Hillary Clinton in the upcoming US presidential election, it is possible that like the Brexit vote, the opposite occurs.

An active trader must recognize that intellectual intelligence has its limits. To do this, they must pay close attention to key aspects such as placing and monitoring trades, otherwise they risk ending up with a disappointing performance. In this regard, the MENSA investment club, which has the sole eligibility criterion of excelling in intelligence tests, has produced an average annual return of 2.5% between 1986 and 2001. During the same period, the S&P 500 has generated an average annual return of 15.3%!

Admitting one is on the wrong path and correcting it is a sign on intelligence.

In the 1980s, the renowned trader William Eckhardt felt that market success was entirely due to cognitive abilities unique to the individual and that active trading could therefore not be taught. However, his friend Richard Dennis, another prolific trader, had the completely opposite opinion. According to him, anyone could generate profits in the market as long as they acquire adequate training and above all, strictly respect risk management principles.

To settle the debate, William Eckhardt and Richard Dennis carried out the following experiment. First, they recruited 14 people with different backgrounds using ads in Barron's, the New York Times and Wall Street Journal. Then, after a two-week training period and a transitional phase for real time trading, Richard Dennis gave each candidate $1,000,000 in starting capital. Their mandate was simply to follow the rules dictated by the method proposed by Eckchardt and Dennis.

Predictably, this method was successful. These of traders, dubbed "The Turtles" generated a total profit of about $175 million over five years. This proved Richard Dennis right: profitable active trading requires skill development as well as strict adherence to risk management rules.

Unquestionably, this experiment shows that although intellectual intelligence can be useful to gain knowledge, it is clearly insufficient for success in the market. It is therefore essential to apply learned risk management concepts such as portfolio diversification, establishing an exit price for each trade (for example, the use of stop-loss orders), limiting the weighting of a security in a portfolio and establishing a maximum loss per position. Fortunately, any intelligent person is able to learn and apply these principles!

The author

Michel Villa

Michel Villa

Speaker, stock market blogger and trading coach