THE HUMAN FACTORS OF FINANCIAL TRADING
The common thread in most studies dealing with financial decision-making deals with mathematical models of financial prediction, methods to “scientifically” absorb risk and make profit. A study by Miller (2001) found the capital asset pricing model (CAPM), and its scientific measure of risk of a stock, beta, to be unrepresentative of potential profit, and risk itself. From this model a statistic, beta, represents the risk a share or portfolio has in common with the market and is used to compare the risk of a stock to other shares, or to an index average (McInish & Srivastava, 1984). Further, Unser’s (2000) study found that expected utility theory was not able to adequately describe a person’s risk preference, and thus appropriate portfolio, similar to the CAPM’s apparent ineffectiveness. Indeed, sometimes a purely mathematical or scientific approach to profit does not always produce the results in theoretical or monetary terms. The focus overall, has often been just on an individual’s portfolio and, theoretical descriptions of it.
This narrow focus has precluded a focus on the individual investors themselves and human factors (Estes & Hosseini, 1988). As Felsen (1975) points out, successful investors often know themselves and their psychology of investing inside out. Therefore, the art of investing may require a scientific investigation into the individual investor rather than his/her portfolio. This involves investigating the individual investor’s method by which they make their judgments and decisions on shares and, their personality and cognitive biases. By investigating investors’ psychological factors, such as personality, that influence their decision-making, financial managers may be able to better recognise investors’ focus (McInish, 1982), and also accommodate for their clients’ personality, psychology, and risk for their portfolios (Sasveld, 1996), while individual investors can expand their self insight on their investment decisions. There is a direct need for a judgment and decision-making approach to be allied with a human factors approach in investigating decisions on the stock market (Felsen, 1975; Lauriola & Levin, 2001). This will involve both personality factors, demographic indices, and human factors in a financial investment context (Lauriola & Levin, 2001).
Cortexia has long been providing decision analysis services to the finance industry. We are able to accurately plot a trader’s personality, bias tendencies and risk thresholds in a coordinated manner. This allows a trader to be better prepared for their own psychology, and provide an unrivalled understanding of their own human factors in trading and human error. Over the years, our research has found the following:
- Certain traders are more and less prone to certain biases and thus financial human error types
- These biases and errors can be controlled and mitigated with workshops and pragmatic, on-the-job aids
- Personality has a significant impact on how risk averse a trader is, how judgments are made, and which shares a trader will be more attracted to
- Within personality the human factors of machiavellianism (self-interest, deception and manipulation) and value orientation (financial success, appearance and social recognition) have the strongest predictive power in terms of how a person will trade.
Cortexia: Leading Human Factors Consultancy Australia