THE PACIFIC FUTURES TRADING COMPANY
For some time, theoretical and empirical evidence suggested that the Efficient Market Hypothesis, the Capital Asset Pricing Model, and other rational financial theories did a good job of predicting and explaining the behavior of investors. However, recently, the „rationality‟ rationality‟ of financial markets - and more specifically investors - is a hot topic in the financial economics literature. Recent research has argued and shown that investors often make mistakes; they behave irrationally and exhibit a number of financially damaging biases, such as loss aversion, herding, overconfidence, and overreaction (Barber and Odean, 2001; DeBondt and Thaler, 1986; Fischoff and Slovic, 1980; Gervais and Odean, 2001; Huberman and Regev, 2001; Kahneman and Tversky, 1979). These irrationalities are frequently attributed to psychological factors such as fear, greed, regret, and other emotional responses to price changes and changes in personal wealth. A growing number of economists, psychologists, and financial-industry financial-industry professionals have begun to use the terms „behavioral economics‟ and „behavioral finance‟ finance‟ to differentiate themselves and their ideas from the standard, rational theories (such as the Efficient Market Hypothesis) in economics and finance. Akrisios Stathopoulos is the President of the Pacific Futures Trading Company (PFTC). Futures trading is a form of investment which involves speculating on the price of a commodity, such as gold, cotton, wheat, or steel, going up or down in the future. Futures are popular instruments amongst traders, tr aders, from private individuals through to multi-million multi -million dollar hedge funds. Founded in 1972, the Pacific Futures Trading Company is a second generation family owned business. With Akrisios as President, his brother Epifanio as Vice President of Finance, and his other brother Sirius as Vice President of Human Resources, the Stathopoulos brothers are strongly committed to creating customer satisfaction. Like futures trading, the Pacific Futures Trading Company has grown exponentially over the last decade. Hence, the company spends a lot of time and money on recruitment and training. In futures trading it is crucial to attract, screen, and select qualified people for the job and then to train these new employees employees to become become successful traders. To be a successful trader takes patience, but also determination, discipline, and education. Indeed, learning how to trade is a process that takes time. Despite the efforts that the Pacific Futures Trading Company has put into recruitment and training programs, its traders (even the most experienced ones) occasionally exhibit powerful emotional responses during certain market events, such as increased price volatility or sudden breaks in trends. As a result r esult of these emotional responses, r esponses, they occasionally make mistakes. Every now and then these mistakes have a profound financial impact on the company, its clients, and/or the trader. Over the years, Akrisious Stathopoulos has become increasingly interested in the effect of personality characteristics and emotional reactivity on the trading performance of investors. He has recruited, Sam Beam, a student from Cambridge to investigate the role of personality and emotions on trading performance. To find solutions for Akrisious‟ problem Sam has gathered initial information about factors that are possibly related to the problem. He has interviewed several traders of the Pacific Futures Trading Company and gathered books and research articles on behavioral economics and finance. Hence, he has got a feel for what is going down in the field of behavioral
finance. This has allowed him to develop the following problem statement: “What is the effect of personality and emotional reactivit y on the financial performance of day traders.” After Sam and Akrisious agreed on the purpose of Sam‟s research, Sam started examining specific variables as to their contribution on the financial performance of day-traders. He developed a theoretical framework that represents his beliefs on how certain variables are related to financial performance and an explanation of why he believes that these variables are associated with financial performance. From this theoretical framework, he has developed the following hypotheses to examine whether his theory was valid or not: H1: H2:
Extreme (positive and negative) emotional responses to market events have a negative effect on the trading performance of investors. Successful traders tend to be emotionally stable introverts who are open to new experiences.
To test these hypotheses Sam recruited 50 volunteers from a six-week training program for day-traders offered by Rose Bush, a well-known professional futures trader. The day-traders were asked to complete a questionnaire that recorded their psychological profile before the training program. During the training program day-traders were asked to fill out questionnaires at the end of their training day. These questionnaires were designed to measure the participants‟ emotional state and trading performance for that day. Sam used the following scales to operationalize the variables in his model: Zung‟s Self -Rating Anxiety Scale and Self-Rating Depression Scale, a public domain version of McCrae and Costa‟s NEO IP-R personality inventory instrument, the UWIST Mood Adjective Checklist, and the total profit/loss on paper trades for the day. After the data was gathered they were statistically analyzed to see whether the hypotheses that were generated were supported. The results from Sam‟s study support his first hypothesis. For Sam, these results indicate that there is a clear link between emotional reactivity of investors and trading performance. These findings suggest that traders may benefit from training in emotion management and coaching. By acquiring emotional management skills and techniques, traders may be able to better understand the impact that their emotions have on their behavior and performance. Also, it may provide them with techniques to better manage their emotions and hence to improve their performance. No evidence was found to support the second hypothesis. This suggests, Sam explained, that traders with different personality types may be able to function equally well after proper training and practice.
