Monday, 28 January 2013

Gut feeling, instinct, flair and knack: the recipe to be a successful trader?

One will find reference to these phenomena in academic and popular accounts on success in financial trading. Explanations based on gut feeling, instinct, flair and knack are usually given by research informants or author-cum-professionals to make a distinction between the bright and the drab on trading floors. Fenton-O'Creevy et al (2004) in their book titled Traders provide very telling accounts as such from investment bankers in the UK. According to these accounts, flair/knack seems to be some sort of amplified cognitive power, likened to those animal senses, which is argued to work at multiple times the capacity of ordinary human-beings, making gut feelings/intuitive judgments in the face of ever changing figures on computer screens successful. Traders also contrast this special cognitive type with "too much of an academic mind", albeit recognizing the importance of having sound technical knowledge on financial markets.  However there seems to be no agreement about the sources of  flair and intuition among traders. Is it about experience or god-given talent? Nor do they seem to agree on the reliability of flair and intuition as  reliable recipes for trading success. Some senior traders and trading floor managers are sceptical of their floor traders' justifications of trading actions/success based on flair and intuition as such accounts somehow “blackboxes” what traders actually think and do, and undermine their accountability and jeopardize their organization.

In the face of these mystifying accounts from their interlocutors, Fenton O'Creevy et al put forward “tacit knowledge” with two sub-categories to better capture the conceptual essence of flair and intuition. The first category represents the not-so-easy to articulate embodied knowledge of traders that comes from their trading and market experiences within a professional career perspective. It consists of personal heuristics and trading styles. The second category represents knowledge on a particular situation in the market and personal position taken. This is kept tacit because sharing it would jeopardize trader's chances of success. Abolafia (1998) writing about the analytic conclusions driven from his ethnography on Wall Street, Making Markets, mentions knack and intuition of traders (I think he specifically gets his inspiration from the bond traders he observed at investment banks on Wall Street). Abolafia understands knack/intuition as one of the cognitive tools of traders such as their institutionalized and shared myths and norms about how a number of markets and securities should move in tandem and what the price levels should be, given the historical and existing circumstances. These are part of the “market folklore” as Abolafia calls it.

Despite intimating a sense of durability and idiosyncrasy at individual level, the professionals' accounts on knack/flair and intuition/gut feeling are qualified in the above studies by the notion of reflexivity among traders, namely placing one's actions and thoughts within the context of other actions and thoughts, judging what these might be, and accounting for them in determination of one's trading strategy. The often quoted analogy, also present in Fenton-O'Creevy et al (2004), to explain reflexivity as a major driving force in financial market dynamics belongs to Keynes (1936). It is about a fictional selection contest held by a newspaper in which entrants are asked to choose the six most beautiful faces among the pictures of 100 female models presented in the paper. The winner is whose selection of the six is most similar to the average selection of the whole entrants. Keynes therefore argued that a more rational strategy than choosing according to one's own preference /judgment for beauty would be to take into consideration what other entrants would choose for the most beautiful six, with possible higher degrees of anticipating the outcomes of other entrants' anticipations as such. Keynes used this analogy to support his argument that  given the inherent lack of knowledge we have about the long-run (apart from the fact that we will all be dead!) it might be more profitable to assume that there is a convention or general truth in financial markets upheld by the aggregate of the participants on the state of things associated with market trading- albeit changeable in the very near future in the face of events unfolding- that determines market outcomes, and more profitable then to search for the properties of this truth and its dynamics of change, than to search for an intrinsic value of investments  existing independently of this social dynamic. If future is uncertain with respect to exact calculations or accurate forecasts, partly owing to lack of information and partly owing to the above described reflexive social dynamic in financial markets, then can we maybe better qualify these elusive concepts of knack/flair and intuition/gut feeling that are often evoked in scholarly and popular discussions about financial markets?

One succinct answer comes from a discussion, brought to my attention by my colleague Asgeir Torfasson from Gothenburg Research Institute, between two distinguished researchers on human decision making, David Kahneman and Gary Klein (2009). Klein represents a research school called Naturalistic Decision Making which simply conceptualizes intuition  as pattern recognition from cues available in an environment in which decision-maker has experience. Here the experience may refer to simple (non-professional) common-sense knowledge, for instance that to distinguish between cat and dog and how they ordinarily behave, or to more sophisticated knowledge of professionals such as stockbrokers, and to what Abolafia refers to as shared norms and myths about price levels. Kahneman' and his associates' understanding of intuition on the other hand is inspired by their heuristics and biases approach to human cognition and decision-making. In this approach, the focus is on how we substitute a target attribute, something we are required to estimate, with a cue that is ordinarily given or evoked in the task and does not statistically regress with the target attribute. Simply put, the heuristics and biases approach studies the ways in which we violate statistical properties of different realms of life, and instead see coherent plots or patterns in relation to common-sense or experience-based views about these realms.

Here the static and dynamic properties of the realm with reference to causal and statistical relationships and how they can be learned or anticipated are the most important determinants of whether intuition can succeed in the cognitive task at hand. For instance Kahneman and Klein (2009) refer to different environments such as high validity, zero-validity, and wicked- where feedback is actually misleading. Each of these environments implies different levels of certainty in the way observed patterns lead to anticipated outcomes. Another important assumption made regarding intuition is that it is 'automatic, arises effortlessly, and often come to mind without immediate justification' (page 519). Yet, 'skilled intuition', which thrives on experience and knowledge in a specific domain, is distinguished from the intuitive heuristics we use in situations not necessarily relevant to our specific expertise such as anchoring our estimates with reference to a value given in the task. Drawing on the research made in both approaches, Kahneman and Klein make several observations about finance professionals and financial markets in their article. The summary is that finance professionals, as experts, are not that bright in making judgments for the long-term and on larger, interwoven and close to zero-validity domains that the financial markets and their surrounding environs are. These environs are argued to be unlike the narrow and high validity domains in which for example a fireman or a midwife operate and has better mastery. Is it therefore not surprising that major financial crises continue to happen almost in a cyclical manner and smart investors and traders consistently fail to correct those less-smart professionals and their mistakes?

Two points can complement the discussion of intuition in financial markets by Kahneman and Klein- although it should be stated here that the authors refer to finance professionals as one the many examples for professional groups that do not perform very well in prediction tasks- other professional groups such as psychologists are mentioned too with reference to their failure in such tasks owing to our tendency to see coherent plots instead of using our statistical and logico-scientific reasoning. The first is the origins or basis of intuitive judgments:  calculative models, conventions and formulas; ongoing market experience including social connections and reflection on how models actually work; and organizational and institutional frameworks in which financial trading happens. The second is related to these epistemic sources, and what sociologists call “social construction of reality”. Simply put, as a domain of activity, financial markets can be conceptualized as epistemic fields constituted of roles, norms, and classificatory schema generated, shared, internalized, performed and modified by members of the domain. Of course, there are multiple subdomains in financial markets, marked by geography, securities traded, historical evolution and so on, and there are distinguishable epistemic conventions such as calculative models within a subdomain. However, a general awareness of these domains and deeper reflexive knowledge about the domain where one operates underpin one's cognitive and calculative activities, including intuition and more complex cognitive and decision tasks such as valuing an option contract and calculating how other actors calculate- these belonging to what Kahneman and Klein (2009) classify as System 2 in human cognition, System 1 being intuition and heuristics.

The type of reflexivity Keynes referred to is not incompatible with the social construction of reality as both notions combine personal judgment/calculation with judgment/calculation on what others think and do, and thus allow for strategic action. From a practical point of view, these analytic observations can also cast sociological light on the recurring puzzle of why behavior of traders and analysts are seemingly imitative (one high profile case is the Long-term Capital Management's failure, that powerful hedge-fund part-run by Nobel laureates in economics- MacKenzie, 2003 provides a very accessible sociological explanation for non-specialists), and why there happens dangerous and crisis-generating lock-ins or second-order dangers with reference to financial models and qualitatively traceable conventions to evaluate financial securities (see Holzer and Millo 2005 for a conceptual and empirical discussion;  MacKenzie 2011 on such origins of the credit crisis of 2007/8; and Beunza and Stark 2011 for reflexive strategic action gone wrong in the case of quantitative finance/merger arbitrage community). Once socially constructed, these socio-technical devices and conventions can trap their creators and users in a cognitive and calculative bubble.

To come back to flair and intuition and to conclude this essay, I think Fenton O' Creevy et al and Klein et al better capture the sociological essence of intuition. Flair and intuition are not mystical cognitive processes. They cannot be pinned down to individual psychological and error-prone pseudo-statistical/scientific reasoning either. The extant sociological literature demonstrates that cognition and decision-making happen in socially constructed socio-technical environments where actors have varying depths and breadth of knowledge about their immediate sub-domains and the larger field of financial market. In this context, intuition can be seen as quick pattern recognition, followed by a judgment on what happened and/or what will happen. Intuitive success and flair can therefore be partly explained by where in this socially constructed environment individuals position themselves, and with what types of capital sources (i.e., economic, cultural (epistemic) and social) they pursue their own interests. Nevertheless, even positions and the socio-technical systems financial markets are do not stay put. As discussed above, there are second order dangers or cognitive-blindness that parts or the whole of the strategically or naively internalized evaluative conventions can generate. I think there is no need to mystify flair and intuition or to couch system-allowed successes as monumental testimony to powers of intuition and special talents and skills. I think more interesting are the stories of those prophets who warn in euphoric times about impending second-order dangers and existing cognitive-blindness generated by shared models and conventions of thinking and making decisions.


Abolafia, M (1998) Markets as Cultures: An Ethnographic Approach in M. Callon (ed) Laws of the Markets. Blackwell, Oxford. 69-85.

Beunza, D. and Stark, D. (2011) From Dissonance to Resonance: Cognitive Interdependence in Quantitative Finance. Available at

Fenton O’Creevy, M., Nicholson, N, and Soane, E. and Willman, P. (2004) Traders: risks, decisions and management in financial markets. Oxford University Press, Oxford ,

Holzer, B., and Millo, Y. (2005) From Risks to Second-order Dangers in Financial Markets: Unintended Consequences of Risk Management Systems. New Political Economy 10(2): 223-246.

Kahneman, D. and Klein, G. (2009) Conditions for Intuitive Expertise: A Failure to Disagree. American Psychologist. Vol. 64, No. 6, 515–526

Keynes, J.M (1936) The General Theory of Employment, Interest and Money. Available at

MacKenzie, D. (2003) Long-Term Capital Management and the sociology of arbitrage. Economy and Society, Volume 32 Number 3: 349–380

MacKenzie, D. (2011) The Credit Crisis as a Problem in the Sociology of Knowledge. American Journal of Sociology. Vol. 116, No. 6, pp. 1778-1841.

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