What does market volatility have to do with biology? According to John Coates, former Wall Street trader turned neuroscientist, and author of The Hour between Dog and Wolf, plenty. Coates argues that traders’ irrational financial decisions can be linked to two hormones–testosterone and cortisol–that come out in force during the excesses of bull and bear markets.
In his 2010 study, Coates explored the “winner effect” in the animal kingdom whereby a male that wins a battle generates more testosterone, which helps him to win the next fight. However, eventually the animal surpasses the optimal level of testosterone and starts to become impaired and over-confident. “Animals go out in the open, pick too many fights, patrol areas that are too large and there are increased rates of predation. Risk taking becomes risky behavior. That’s exactly what is going on in Wall Street,” Coates said.
In fact, Coates believes that elevated levels of testosterone played a major role during the 2008 global financial crisis. Speaking at a recent conference, he said, “Every blow-up in a bank of $1 billion or more occurs at the hands of a trader at the end of a multi-year winning streak. You become euphoric, delusional and overconfident. You take way too much risk and there are terrible risk-reward trade-offs.”
On the other end of the spectrum, Coates notes that cortisol, a hormone present during times of heightened uncertainty, can delay or weaken economic recoveries.
Coates insists that traders and wealth managers alike need to understand the biological drivers of risk taking before they can effectively manage investment risk. How can traders make less risky decisions? Coates suggests a balance of men and women in the trading room! In an opinion published in The New York Times, he observed that “Women and older men have a fraction of the testosterone of young men, so if more of them managed money, we could perhaps help to stabilize the markets.”
Increasingly, traders also are utilizing fitness monitors to increase their awareness of the physical triggers that lead to irrational decision-making. To gain similar clarity, individual investors might keep a simple notebook and record their emotions behind buy and sell decisions.