How 'Risk Personality' Influences Trading and Investment Performance

Imagine an aspiring sprinter who is physically tall, slim and wiry. The sprinter trains and practices hard, and develops the skills required for sprinting success, however he was one major disadvantage, his body type is not ideal for sprinting. In athletics, having the appropriate physique provides a clear edge.

In financial markets, the equivalent to athletics physique, is ‘Risk Personality’; characteristic patterns of thinking, feeling and behaviour when taking and managing risk and dealing with uncertainty. 

In the same way that athletes are physically different, so people possess different risk personalities which can provide an edge in their trading.

Risk Personality

The above FT headline was from an FT article. It related to research carried out by a group of senior academics which highlighted the degree to which personality affected ‘Risk Taking’ performance of senior bankers.

One of the starkest findings from this research paper, was that “Style”, a category which included personality, talent and work ethic, accounted for as much as 72% of the difference in banker’s risk behaviour. By comparison, aspects traditionally considered relevant, such as remuneration, accounted for only 4%, and education and age accounted for just 5% of the differences.

Understanding personality can help shine a powerful light on your behaviour and help uncover marginal edges which could help you re-calibrate how you trade.

Personality Testing can also be a powerful aid to firms looking to help improve and match employees, recruits and potential hires. It can also be used to help improve team performance, and support teams and businesses to improve how they work and function, when used with development and growth initiatives.

Different Risk Personalities. 

Myself and two colleagues carried out some private research where we analysed the Risk Personalities (Risk Type) of a wide population of individuals engaged in financial risk taking roles. This includes Traders, Portfolio Managers and Investment Managers at a number of investment banks, energy trading firms, fund management firms, and hedge funds.

We analysed over 100 individuals using a 'Risk Profiling' tool called the ‘Risk Type Compass’. This tool focuses objectively on people's risk-taking behaviours.

The Risk Type Compass is a psychometric tool developed by 'Psychological Consultancy Ltd'. It is built upon decades of research into human personality and risk behaviour, and categorises people into different risk personality groups, known as ‘Risk Types’.

The graphic below shows the Risk Type Compass, with the 8 different risk types. Each individual falls into one of the Risk Types, plus a neutral 'axial' grouping in the middle. 

Each 'Risk Type' reflects different characteristics which influence how a person is likely to behave, think and act when faced with high risk situations. 

The next graphic highlights the full distribution of successful traders in the population tested. We eliminated traders with less than 5 years’ experience from the group, to ensure we focused only on those who we felt had proved an ability to sustain their success. This left 78 risk-takers with experience ranging from 5 to nearly 50 years. 

Developing an ‘Edge’ for greater success 

I will return to the research shortly, but first it is important to understand the concept of 'edge' in trading. Developing an 'edge’ takes skill, hard-work, persistence, and other numerous factors. However, the value of this is slightly diminished if the individual is not working in a way which is congruent to their risk personality (Risk Type). 

An example of this occurred with an FX options trader I coached at an investment bank. This individual had been doing the job for about 10 years, however he was rarely achieving the levels of performance his potential suggested he could. This individual' Risk Type was ‘composed’, which meant he was calm, self-assured and rarely flustered in the face of uncertainty. However his trading approach seemed consistent with that we typically witness from traders on the other side of the compass, the ‘Excitable, Intense, and Wary’ types. 

When I explored this, it became clear that his learning experiences in his formative years were with people of the ‘Excitable, Intense, and Wary’ types. These types tend to do well in typical Spot FX type roles. And indeed his early years were as on the Spot FX desk. 

These people's influences and the requirements of the role had shaped his behaviours and approach. However FX options trading is a very different job, with different requirements and skills needed. 

The Risk Type Compass assessment, together with the coaching programme, helped raise awareness of this for the individual and helped highlight how his personality type was actually far better suited to an options trading role than a pure Spot FX trading role. 

Discovering this had a profound effect on the individual, he suddenly felt far more at ease in this role, and soon, together with the coaching, he started to modify his approach to a style more congruent to the needs of the role.  

Over the next few months his performance started to improve, and eventually it took-off in a way he had previously never experienced. He described it as like having the shackles removed. 

We have many similar examples of this effect over the years. It is not the approach per se that is incorrect, but an approach that was incompatible to a person's ‘Risk Type’. 

I feel that too often people are mentored, learn from, or are influenced, by ‘generic’ or ‘inappropriate’ trading approaches which handicaps and hinders their development and ultimately undermines their chances of success. As a result time, energy and resources are misallocated, individuals are held back from reaching their potential, and organisations suffers due to the sub-optimality connected to this. 

The Risk Type Compass and Risk Style 

Returning to the research: In trading and investment, there are certain types of risk-taking and risk management styles suited to certain Risk Types. 

This graphic below shows discretionary risk-takers only (We have removed market-makers from the analysis). In this graphic we have colour coded risk-takers into three discrete groups: 

1) ‘Directional’ in their approach. 

2) ‘Portfolio’ or ‘Relative Value’ in approach. 

3) ‘Optionality’ or similar volatility type  Risk-takers.

There are clear distinctions between the areas of the graphic being populated by the different types of approach. These areas are highlighted on the smaller graphics below:

Directional Risk-Takers show a clear bias towards the centre and left of the compass. The left side of the compass tends to be populated by risk-takers who are influenced by emotional/intuitive aspects relative to an more rational/evidence based approach. 

Individuals who have a preference for ‘directional’ trading are able to use the emotions of the markets to ‘feel’ the market. They have an edge by using their intuition and trusting their sensing abilities to cut through the noise. They seem particularly adept at finding value by reacting to market dislocations and opportunities, and seem to sense where markets are over-stretched or likely to extend the current move.

Not highlighted in these graphics, but relevant to this discussion: Individuals placed towards the top of the compass display more ‘risk-averse’ behaviours, whilst individuals towards the lower side of the compass tended to display greater levels of ‘risk-tolerance’. We see this manifest itself in risk-takers towards the topside tending to be more tactical, using price action to identify value and typically holding risk for shorter periods. Whilst risk-takers towards the lower side tend to be more strategic with a clearer ‘big-picture’ bias. They typically place more emphasis on ‘macro / fundamental’ drivers of value, and tend to ride market volatility whilst holding risk for longer periods. 

‘Portfolio’ or ‘Relative Value’ risk-takers have a clear bias towards the right side of the Risk Type Compass. The right side tends to be populated by risk-takers that have a preference for using logic and rational/evidence-based approaches to finding value and managing risk. They prefer to adopt approaches which remove some of the emotional influences from their decision-making. They also have a preference for using a modelling and systematic approaches to identify value as a way of cutting through the noise and filtering out the emotion.  

Options and volatility based risk-takers are predominantly distributed towards the lower right-hand side of the compass, with a couple of notable exceptions. 

Managing an options portfolio, with its many additional ‘moving-parts’ and constant high exposure to risk, seems best suited to a hedged/portfolio approach where risk can be warehoused, and value extracted from active management of the warehoused portfolio. 

Given the complexity of these products and the high levels of volatility and uncertainty present, we tend to see this suits an approach where emotional influences are reduced, where a bigger picture perspective is valuable and where running large portfolios with many moving parts is optimal.  

Additionally, options/volatility trading and pricing requires a mindset suited to a modelling approach, which again mitigates against individuals on the left hand side who tend to be more intuitive and subjective in their approach. 

The high levels of risk and large volatility present in options portfolios, means that this is well suited to individuals more comfortable with ambiguity and uncertainty. Thus not surprisingly, we are seeing types engaged in options trading tend towards the lower side of the Risk Type Compass. 

There are a couple of notable exceptions which if anything proves the rule: The ‘Options Trader’ in the ‘Excitable’ Risk Type group for example, is a ‘short-dated’ options trader. ‘Short-dated’ options have a maturity of just a few days, and in some cases, just a few hours. These are notoriously difficult to model and are impacted heavily by liquidity factors. 

The second example is an individual who is in the ‘Intense’ group. This individual, under ‘undue influence’, adopted an ‘options’ approach to taking and managing risk. Previously he had been a ‘tactical’ directional trader. His performance diminished significantly since adopting this approach, which was inappropriate for his Risk Type. 

Developing your 'edge' by understanding ‘Risk Type’. 

It is beyond the scope of this article to explore in detail how we build upon the understanding of risk personality to help individuals develop their ‘Edge’. However, I will briefly add that our work with risk personality and the subsequent discussions and explorations which result from this are highly illuminating and help the individual in many cases to generate higher levels of performance. 

Risk Personality Profiling is central to our approach of understanding risk disposition, and leads to further qualitative explanation and discussion to help raise awareness of and improve risk behaviours.

The ‘Risk Type Compass forms the basis for ‘Prompted Self-Discovery’, where the coach supports and facilitates the individual to discover more about themselves as a risk-taker, this includes: 

• Understanding one’s personality and how it influences the way they think, behave and act.
• Becoming more self-aware, in the moment and bigger picture.
• Improving how one manages within heightened levels of uncertainty and ambiguity.
• Becoming more conscious of human behavioural aspects and how they impact /distort perception and decision-making.
• Developing metacognition, the ability to think about how one thinks.
• Developing self-belief and trusting one’s process and practice.

Wrap-up 

There are many ways in which understanding ‘Risk Personality’ can help financial market businesses and individual risk takers. 

At the micro level it can help improve personal risk performance. At the business level it can lead to better team performance, improve recruitment and hiring, and ensure that new talent and hires are successfully matched to their role and on-boarded into the business. At the systemic organisational level it can help improve risk culture, help firms understand their Risk DNA more clearly, thus improving risk management, senior leader risk taking and decision-making, and improve leadership functioning and performance. 

There are many other ways in which deepening understanding of individual, team and organisational personality can lead to enhanced business performance which can have profound effects for the business. 

In our own work, its application, allied to powerful coaching methods, have been the catalyst for significant performance improvements which in many cases to significantly improved levels of sustained profitability. 

Article by Steven Goldstein

Steven Goldstein is a Performance, Team and Executive Coach who focuses on helping improve the 'mindset' aspects of Risk and Financial Markets' people and businesses.

Core to Steven's work is the belief that everyone has the potential, often latent or hidden within them, to surpass where they are and to grow into what they want to be. He views trading as two concurrent battles a person engages in; one with the markets and one with their self. To succeed a person must win both. As a coach, Steven works predominantly on helping his clients win the battle with their self.    

Prior to becoming a coach Steven worked for more than 20 years as a Rates and FX trader at some of the world’s leading investment banks. See Steven's Full Profile.

If you are curious about how Steven could help you or your business, please email him at info@alpharcubed.com. or call +44 (0)7753 446097. 

To know more about the work of AlphaRCubed and their broader performance and growth development services, please view their brochure at this link, or by clicking on the advert below. 

About AlphaMind

AlphaMind is a joint venture between AlphaRCubed and the Mark Randall Consultancy which seeks to help people develop and cultivate optimum mindsets (An Alpha Mindset) for trading and investing success. We offer workshops, group development programmes, and one-to-one coaching to people and individuals in Financial & Commodity Markets

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