Neuroeconomics In Trading
Neuroeconomics is relatively new field to emerge in understanding decision making. It’s tied in with behavioural economics, which uses psychological insights into human behaviour to explain economic decision-making.
Neuroeconomics, by comparison, focuses on the brain function during decision making.
It’s as complex as you can imagine. Studying the brain is a never ending quest, but it’s one we are fascinated and excited with. How does it tie in with trading though?
Successful trading requires a lot of different things. It’s not just about having the correct beliefs, but also about:
The confidence to place your trades
The discipline to overcome standard biases
The ability to process information quickly so you learn from your mistakes
The stamina to not let fatigue influence your decision making.
It is as much psychological, and physiological, as it is logical.
So if physiological demands are a part of successful trading, it then begs the question, is there a biological trait blueprint that lends itself to more successful trading? Are some people hardwired to be more or less successful in the industry?
Let’s look at two very different experiments performed on traders in the field of Neuroeconomics.
Here’s a fun one. Hold your hand out and check the ratio of your ring finger (4D in the image to the right) and index finger (2D in the image to the right). If your ring finger is relatively longer, it means you have a low 2d: 4D ratio, and you could be destined to be a successful trader.
A study was done on a London trading floor, and it found that those with low 2d: 4D ratios had higher P&Ls.
It might look like a classic case of correlation but not causation, but in fact there is a physiological explanation. A longer ring finger indicates greater exposure to testosterone in the womb.
This in turn gives these traders a biological leg up by encouraging the development of the right mix of mental attitude and physical skills to succeed in scalping trading. These skills include fast thinking, extreme concentration, appropriate risk taking, and accurate gut reactions.
So can it be said that high testosterone levels is the answer to succeeding in trading? That was the general belief on Wall Street for years, so much so that older male traders would get artificial testosterone injections to “keep up” with their younger counterparts. Recent neuroeconomic studies have questioned this belief though.
A study on professional traders on Wall Street, who were given testosterone to take, found they actually made irrational decisions. They didn’t think situations through, they over bid, and they were less likely to realise they were wrong. Contrasting earlier evidence that pointed at high testosterone leading to higher profitability, this study showed that it can cause market volatility and ultimately crashes. This is because evolutionary wise testosterone is more about instinctive functions, like fighting and mating, not making good trading decisions.
Chemicals in our brain, like testosterone, can massively impact human behaviour.
The body and brain work together and each influences the other. They can impact for both a positive effect and a negative effort, and often you will think and act differently and not even know it.
So what does this mean? Firstly, it’s important to note the limitations of Neuroeconomics. Due to their high cost, experiments are typically done on a very small amount of subjects, and haven’t been replicated enough to make true determinations. Findings should always be analysed and questioned.
Furthermore, Neuroeconomics can often point to a stagnant conclusion - that there are things predetermined by the hardwire of our brains, which we cannot change. We don’t believe it’s so fixed. You might not be able to change your biology, but you can change your environment, and environment changes behaviour. For example if you trade right after working out, or sex, or watching your favourite team win, your testosterone levels will be higher than normal, which could lead to risky decision making. Instead, look at trading after a bout of relaxation, or after eating a meal. Make sure you are rested and relaxed. We’ll explore these environmental changes more in a future blog.
As exciting as Neureconomics is, it’s important to remember that although your genetic make up might be fixed, your behaviour patterns and habits are not. You have the power to change your outcomes.