Friday, June 1, 2012 |
Movies about high-stakes finance like Wall Street and Margin Call make the trading floor look like an adrenaline-fuelled battle zone. The truth isn't far off. Research in neuroscience suggests that being a part of this whirlwind world of buying and selling leads to physiological reactions akin to fighting in a war zone or playing in the NBA playoffs. The pressure to perform is huge and the instinct to survive is powerful.
One man who knows much about this is John Coates, author of The Hour Between Dog and Wolf. He himself was a Wall Street stock trader for years. Born in Ottawa, Coates worked for firms like Goldman Sachs and Deutsche Bank during the dot.com boom of the 1990s. But his whole time in the game, he couldn't help but notice the behaviour of other traders. They seemed to operate contrary to how economics is supposed to work.
"Well, I think everybody was seeing it, but I guess I was particularly struck by how anomalous the behaviour was from the point of view of economics," Coates said on The Current during a recent interview.
"Traders on the floor had become delusional and euphoric ... They were putting on trades in ever-increasing size with worse and worse risk-reward trade-offs. And I thought this was odd because they hadn't been this way before the bubble, and after it crashed or popped, they weren't like that any more, in fact they were like revellers with a hangover. And they couldn't believe that they had just blown five years' worth of profits on a handful of stupid trades."
Coates himself wasn't immune to what was happening.
"On previous occasions, when I had been experiencing above-average profits and was expecting a big bonus, I felt something very similar. I sort of carried myself like a master of the universe, and it struck me almost like a bolt of lightning that what was going on was clinical. That there was some chemical that your body was producing that was basically having this narcotic effect on you. And I guess that's what got me starting to think about the influence of the body on financial risk-taking."
We'd like to think that financial trading is based on solid reasoning and rationality, but human beings are not robots, even if some purport to operate that way. Emotions get in the way. Fear can sink in. So can the natural instinct to fight. When by happenstance Coates got the opportunity to visit a neuroscience lab at Rockefeller University, he was "completely" hooked and found his new calling. Through studying neuroscience, Coates explored his theory about what he was seeing on the trading floor: that physiological changes happening within traders as they gain and lose vast amounts of money may be driving the instability of the financial markets.
"The trouble is right now we've got an unstable biology coupled with risk-management practices that expand risk limits during the bull markets and contract them during the bear, and a bonus scheme that rewards high-variance trading. So what we've got right now is nature and nurture conspiring to create disasters, and I think risk management has to be aware of that and start leaning against the biology."
Coates went on to put forward a suggestion. "I think also if there is the biological contributor to this instability, then a way of dampening it is to have more women and older men managing money because they have very different biologies from young men."