Do You Need a High IQ to Be a Successful Trader?

Trading, in its various forms, is an activity that has the potential to be highly lucrative. 

There’s a prevailing notion that it requires high intelligence (or “IQ”) to be successful in trading. 

The reality, however, is much more nuanced. 

We look at the role of intelligence/IQ in trading and determine what really matters for success in this arena.

Key Takeaways: How Much Intelligence Does a Trader Need to Be Successful?

Traditional Intelligence: Is It Enough?

First, let’s explore the role of traditional intelligence. 

As defined by many, intelligence often refers to one’s ability to learn, understand, and apply knowledge. 

In a 2011 study published in the Journal of Finance, Grinblatt, Keloharju, and Linnainmaa found that:

“High-IQ investors are more likely to hold mutual funds and larger numbers of stocks, experience lower risk, and earn higher Sharpe ratios.”

In a study done on intelligence and trading performance in 2012 by the same authors, they found that:

“Controlling for a variety of factors, we find that high-IQ investors are less subject to the disposition effect, more aggressive about tax-loss trading, and more likely to supply liquidity when stocks experience a one-month high. High-IQ investors also exhibit superior market timing, stock-picking skill, and trade execution.”

Related: The Disposition Effect on Trading Performance

Emotional Intelligence: A Key Factor in Trading Success

Emotional intelligence, the ability to manage one’s emotions and the emotions of others, also plays a significant role in trading.

A 2014 study conducted by Wang et al found that emotional reactivity could impact trading performance negatively.

They concluded:

“The results showed that: (a) investors’ positive emotions were positively correlated with investment returns in a market with a unilaterally rising price, and the moderating effect of extraversion was significant; (b) investors’ negative emotions were negatively correlated with investment returns in a market with a unilaterally falling price, and the moderating effect of neuroticism was significant.”

Traders who had higher emotional intelligence demonstrated better decision-making skills under stress and were less likely to make impulsive trades.

Risk Intelligence: Making Calculated Decisions

Risk intelligence is another essential aspect of successful trading. 

A 2015 book by Dylan Evans, “Risk Intelligence: How to Live with Uncertainty” revealed that poker players and traders who exhibited high risk intelligence tended to make more profitable decisions. 

Evans defined risk intelligence as “the ability to estimate probabilities accurately.”

Traders need to assess the risk-reward ratio of every potential trade, and this ability is not necessarily linked to conventional intelligence.

The Role of Knowledge and Experience

Knowledge and experience in trading can’t be overlooked.

A comprehensive understanding of financial markets and trading strategies is paramount.

In a 2009 study by Seru, Shumway, and Stoffman, it showed that individual investors who were active for longer periods were more likely to earn higher returns, with a large aspect of that simply being attrition.

They wrote:

“We find evidence of two types of learning: some investors become better at trading with experience, while others stop trading after realizing that their ability is poor. A substantial part of overall learning by trading is explained by the second type. By ignoring investor attrition, the existing literature significantly overestimates how quickly investors become better at trading.” 

This supports the argument that experience, rather than pure intelligence, is a significant factor in trading success.

The Importance of Discipline and Consistency

Even with all the intelligence, knowledge, and experience, trading success is often determined by discipline and consistency. 

Research conducted by Odean and Barber in 2000 found that overactive trading often led to underperformance, generally by 6-7% per year.

Traders who adhered to a consistent strategy and avoided overtrading had better performance over the long term.

They write:

“Individual investors who hold common stocks directly pay a tremendous performance penalty for active trading. Of 66,465 households with accounts at a large discount broker during 1991 to 1996, those that trade most earn an annual return of 11.4 percent, while the market returns 17.9 percent. The average household earns an annual return of 16.4 percent, tilts its common stock investment toward high-beta, small, value stocks, and turns over 75 percent of its portfolio annually. Overconfidence can explain high trading levels and the resulting poor performance of individual investors. Our central message is that trading is hazardous to your wealth.”

The Role of Creativity, Vision, Intuition, Synthesis, Idea Generation, and Decision-Making in Trading and Investing Success

Traditional education systems have often been criticized for focusing primarily on measurable academic skills, which tend to emphasize memory and processing speed (because they’re easiest to measure) – as well as students’ ability and willingness to follow instructions.

Students are graded on their ability to remember and regurgitate information, process that information quickly during timed tests, and comply with the specific guidelines given for assignments and exams.

These skills, while valuable in certain contexts, don’t necessarily represent the full spectrum of skills needed in real-world scenarios such as trading and investing.

In trading and investing, creativity, vision, intuition, synthesis, idea generation, and decision-making skills can be argued as being more important than traditional “smarts.”

It’s also where humans set themselves apart from machines.

In a world where there’s a lot of talk of AI and algorithms taking over for content creators, coders, and other professions, that may be true in certain respects.

The human mind can’t compete with these tools when it comes to memory, processing speed, and raw calculation (a lot of the traits that happen to be valued in school).

But where humans do separate themselves is in the elements of creativity, common sense, synthesizing, envisioning possibilities, and intuition.

And those things are more difficult to teach and assess in school.

They’re also difficult to assess on traditional intelligence and reasoning tests.

Creativity

Creativity in trading can be linked to the ability to see patterns and connections that others may miss.

This involves applying creative problem-solving strategies to interpret data and predict market trends.

A creative trader can think outside the box, imagine various market scenarios, and develop innovative strategies to navigate these situations.

For example, the best traders don’t get fixated on a certain possibility or a certain line that may happen in the markets or economies. (And they certainly don’t speak in absolutes.)

They envision a range or distribution of possible outcomes, each with different probabilities associated with them.

In most cases, a prediction that’s very specific is very likely to be wrong because it’s just one possibility out of many that are possible.

They then take that information to make positive expected value trading decisions.

Vision

Vision is the ability to anticipate future trends and changes in the market.

A trader with vision has the foresight to anticipate shifts in market conditions, changes in economic policies, or technological breakthroughs that might impact various industries.

This forward-looking perspective can enable a trader to make profitable investments well ahead of the curve.

Vision can also refer to a business person envisioning what they want their business to look like and what they need to accomplish that goal.

It involves a higher-level perspective than the task-focused perspective that’s traditionally valued in school.

Intuition

Intuition in trading refers to an innate sense or feeling about what’s likely to happen or what the best course of action might be, which isn’t necessarily based on tangible evidence or logical reasoning.

While intuition should not replace detailed analysis, seasoned traders often use it as a guide to help confirm or question their analytical findings.

This gut feeling, if developed and harnessed properly, can act as an additional tool in a trader’s toolbox.

Synthesis

Synthesis involves the ability to take disparate pieces of information and combine them into a coherent, meaningful whole.

Traders are inundated with a plethora of data from various sources (and opinions – many of which naturally aren’t worth much).

The skill to synthesize this information – to see the bigger picture or narrative forming amid a sea of data points – is important in making informed trading decisions.

For example, for those who follow the financial media, it often looks like a bunch of random headlines.

But can you connect the dots to see meaning in the sequence of events to stay a step ahead of the competition?

Idea Generation

Idea generation is the process of coming up with new ways to approach trading and investing.

This could mean identifying new potential assets to invest in, developing novel trading strategies, or finding unique methods to interpret market data.

A trader who is good at generating ideas will be able to keep their strategies fresh and adapt to changing market conditions.

Decision-Making Skills

Decision-making skills are perhaps the most important for a trader.

Making trading decisions involves careful analysis, risk assessment, and, ultimately, the courage to act.

Good decision-making involves making informed choices quickly and confidently, and having the discipline to stick to a decision once it’s made, even despite all the inevitable market volatility that’ll follow.

School doesn’t necessarily develop your decision-making skills because you’re largely just following what other people tell you to do.

Raising Your Floor Can Be More Important Than Raising Your Ceiling

To raise your ceiling means to push the boundaries of your best performance, while raising your floor involves improving your worst performance.

Someone can be very intelligent but also be impulsive, have poor emotional control, handle their struggles ineffectively, and have other parts of their personality that drag down their performance.

The Importance of Raising Your Floor

Raising your floor can be more important than raising your ceiling in various contexts, including trading, investing, and even other areas of life like sports, health and fitness, and academics.

The rationale behind this lies in the concept of consistency and risk management.

In trading and investing, for example, success isn’t just about making the most profitable trades or investments.

It’s also about minimizing losses during less favorable conditions.

By raising your floor, you essentially reduce the negative impact of your worst trades, leading to overall better performance in the long run.

This is directly tied to the concept of risk management, an important aspect of successful trading.

Consistency Over Outliers

Another perspective on this concept is related to consistency.

In any endeavor, consistency of performance often trumps occasional moments of brilliance.

While raising your ceiling might lead to exceptional results occasionally, raising your floor ensures better outcomes more consistently.

This consistency can contribute to a steady growth curve, building confidence, and long-term success.

Some people are really good at some things simply because that’s what they’ve done every day (or almost every day) for a long time.

Real-Life Application and Importance

This concept can be applied in many real-world scenarios.

For instance, in sports, an athlete who can consistently perform well (even if not breaking world records or leading the league in certain statistical categories) can often be more valuable to a team than an athlete who occasionally performs brilliantly but inconsistently.

Their variance in performance can lead to coaches or managers not trusting them in critical situations, thus making them unplayable in the most high-leverage scenarios.

This can lower their overall value. A good player that plays a steady “B” game can be more valuable than a player that has an “A” game but a terrible “F” game (e.g., they spiral when things don’t go well for them).

An example would be a basketball player who gets into a negative head space when his shot doesn’t fall or a poker player who plays too aggressively after a bad beat and loses more money accordingly.

Or, of course, a trader who “revenge trades” after a series of losses.

Some traders can be very unproductively affected by their emotions or mood on that particular day, which can lead to a performance rollercoaster, as we covered earlier in the article.

Similarly, in academics, a student who consistently understands and applies concepts well may have a stronger foundational knowledge than a student who crams for exams and isn’t motivated to study much in between.

Overall

While striving to push the limits of our best performance is a vital part of growth and achievement, we shouldn’t overlook the value of consistently performing above a certain standard.

Raising your floor – improving your worst performance – can often lead to more consistent success and stability than merely focusing on raising your ceiling.

It’s about mitigating the downside to enhance the overall performance, an approach that can make a significant difference in long-term success.

Warren Buffett and Charlie Munger have always commented that their success has more to do with not doing anything stupid rather than doing anything smart.

Warren Buffett: Other people doing dumb things is what creates good opportunities

Problems With Intelligence and Connection With Trading Success

Let’s look at the problems with intelligence and its connection to trading success.

Tough to Define

First, it’s tough to even define intelligence.

For example, is creativity intelligence?

If it is, is it adequately accounted for in traditional intelligence and reasoning tests like Mensa, SAT, etc.?

“Right-brained” traits are generally more difficult to test for than “left-brained” traits.

Problems with the Tests Themselves

One shouldn’t let their ability be defined by things like intelligence tests, which lack standardization, test for a relatively narrow cross-section of skills and abilities, and often just spit out a simple scalar quantity that fails to take into account the wide dimensionality in skills, abilities, and values that people have.

These tests have different formats, emphasize different skills and abilities, and have various scoring systems. For example, one IQ test might have a standard deviation of 15, another might have 16, and another might have 24.

Traditional intelligence, as measured by IQ tests, assesses certain cognitive abilities such as verbal comprehension, working memory, and processing speed.

However, these assessments have limitations and their connection to trading success can be misunderstood.

Limited Applicability

IQ tests often simply test the ability to perform well on that specific exam, and may not have widely applicable insight into one’s aptitude for a range of academic pursuits, careers, and so on.

Some people could get similar scores and be very, very different people in terms of cognitive skills and abilities, and in what they value.

Likewise, somebody with a much lower score could be much more skilled and or have more natural ability for something than someone with a significantly higher score.

Motivation and Preparation

On top of that, IQ tests often measure one’s motivation and preparation for the exam.

You can get a better score on them by preparing for them (certain styles of questions tend to be common) and being motivated to do well.

Someone “smart” can have a “low IQ” just because they don’t care that much and don’t put in the effort to score well.

Doesn’t Measure Flexibility and Adaptation

Intellectually gifted individuals often excel in learning systems and applying rules.

However, trading environments are dynamic and require flexible thinking, which isn’t always a strong suit for those with high performance on IQ tests. Not because they don’t necessarily have those skills, but simply because those traits aren’t sufficiently measured.

Risk Perception

High performance on an IQ test doesn’t necessarily mean one can adequately assess risks, leading to less-than-optimal trading or investment decisions.

It’s vital for traders to have an accurate perception of risk to make balanced investment decisions.

Overall Limitations of IQ as a Predictor of Success

IQ tests don’t measure other vital forms of intelligence needed in trading, such as emotional intelligence (EQ) and risk intelligence, or the difficult-to-measure traits we mentioned earlier (e.g., creativity, intuition, synthesis).

These forms of intelligence play a significant role in trading success, as they encompass skills such as stress management, emotional regulation, and risk evaluation.

Conclusion

While a certain degree of intelligence is beneficial for trading, it is not the sole determining factor for success. 

Emotional and risk intelligence, along with knowledge, experience, discipline, and consistency, play equally, if not more, significant roles. 

Trading is a complex endeavor that requires a multifaceted set of skills and attributes, and reducing it to a single measure of intelligence doesn’t capture the full picture. 

Successful trading, therefore, is less about being the smartest in the traditional ways it’s measured (memory and processing speed) and more about being well-rounded and adaptable.

While the analytical aspect of trading is important, the role of creative and intuitive skills should not be underestimated.

Creativity, vision, intuition, synthesis, idea generation, and decision-making skills can give traders an edge, helping them navigate markets and making their trading strategies more robust and adaptable.

Each of these skills complements the others and, together, they form a comprehensive skill set for successful trading and investing.