Risk-Taking Traders Born Not Made

A recent dispatch from the Proceedings of the National Academy of Sciences didn’t give us the next big development in stem cell therapies.  It didn’t tell us how the car of 2020 will be powered.  Instead, John Coates and his team of Cambridge researchers turned the powerful lens of science on the root cause of today’s market chaos: hormones.

Yes, dear reader, the most volatile market in recent history could easily point its finger at a trader’s biology.

The conclusion will surprise you. The longer a trader’s ring finger, the more money he’ll make in the City (this study comes from across the pond in London, where top earners took home over $4 million – until just recently).  They measured the men up, and looked at their previous 20 months of P&L (profit and loss statements).  They also saw how long they’d lasted in the City.

Those with the longest fourth digit made over five times the money of their less-well endowed colleagues.  The average salary was $537k.  The long-ring group netted a healthy $828k, while the shorties had to make do with $145k.

OK, OK.  I bet you’re saying: what’s a couple of inches of bone and flesh gonna tell us about hormones?

Don’t know diddly about Darwin?  Think it’s just about DNA?  The real work of evolution starts with hormones. And the reminder of some serious prenatal hormonal action lies in the ring finger.

The Finger of Destiny: High-Stakes Day Trader or Value Investor

Measures are always relative to something. In this case, it’s the second digit: — the index finger.  They call this indicator the 2D:4D. This ratio is set before birth and stays with us throughout life.  Those with the longer fourth digit relative to the second often display rapid-fire execution ability. (See also: aggression, fertility, confidence, and sporting ability).

http://news.bbc.co.uk/1/hi/sci/tech/695142.stm

The accidental in utero testosterone junkie may well be set for high-stakes finance on the trading floor, simply because the developing brain becomes wired with a greater sensitivity to testosterone’s effects.

But before you run to get a ruler, let’s take a further look at what these 44 well-measured men reveal about the evolutionary life of Wall Street.

Testosterone, Cortisol & Your Next Investment

Coates, now Senior Research Fellow in Neuroscience and Finance at Cambridge, got a hunch while running a trading desk on Wall Street during the “dotcom” bubble.  He worked elbow-to-elbow with traders, when he noticed the change in traders’ behavior from pre-bubble methods.

Coates began to suspect a chemical was involved.  Just like Diane Fosse in the Rwandan jungle, Coates observed testosterone-related dynamics…even if the “competition” was between a trader at Goldman Sachs on 85 Broad Street and one working on the same trade, thanks to electronic trading, for Merrill Lynch halfway round the globe in Seoul.

The “winner effect” works like this.  Take two males in competition.  Testosterone rises.  They spar.  The winner comes out with even more testosterone and takes on a new opponent, while the loser skulks off with less testosterone.  Repeat.  And repeat.

Now for the end game (looking a lot like, say, former Lehman Brothers’ alpha wolf, Dick Fuld): the males, seething with testosterone, become overconfident.  Most importantly, they have increased appetite for risk.  They patrol areas that are too large (viz. commercial and residential real estate) and they pick too many fights (anyone starting another mortgage-backed securities pool in 2007).

So Coates remarked in the dotcom bubble and so we stand today.  The fact is, the dotcom bubble didn’t weed out anyone on Wall Street, because Manhattan Island is not a pure “Darwinian” island.  Instead, everyone just got shuffled around from investment bank to investment bank.  Top brass protected their own, sitting on each other’s boards and securing the “alpha wolf” salary and bonus.

And, sure, fast action juiced by higher levels of testosterone, is more likely to turn a profit — an abnormally large one at that.  But there’s one catch: cortisol.

Cortisol, a stress hormone, is seething in global traders everywhere…it comes when there’s the crash.  It’s the “fight-or-flight” friend that raises blood pressure, increases immunity, desensitizes us to pain. How does that translate into finance?  Cortisol renders the trader price-insensitive.  Monetary policy won’t matter.  He’ll see risk everywhere.

That’s because, long-term, exposure to cortisol ravages mind and body.  It affects memory recall — handicapping judgment with the shackle of fear — whether justified or no.  Like a kid who touches a stovetop for the first time, so is the trader who fears jumping back in the game that just burned him.

Is it time to fire all of Goldman’s males and change the name to Goldwoman?  The reason, in fact, Coates zeroed in on the testosterone test, was that the few female colleagues on the floor, he said, did not display the same behavior. Tellingly, the woman’s 2D:4D is almost equal and she has about 1/10 the testosterone of a man.  But she’s still got to contend with cortisol.  So the Wall Street ecosystem will remain chained to biological reflexes whose usefulness we may or may not have outlived.

Next Time You Hire: Measure Your Money Manager’s Index Finger

Here’s one more reciprocal fact.  A reverse advantage falls to those whose 2D is longer than their 4D.  It concerns a long-term market approach.

Taking a look at average finger ratios in university departments showed that the math, science and engineering-focused sport a longer index.  As you might guess it also suggest higher exposure to the opposite of testosterone – estrogen – in utero.  Estrogen helps the right side of the brain develop: good for honing sharp analytical skills.

Perhaps Mr. Madoff’s clients could have checked his pointer finger first, and those of his Florida club-hopping, dupe-hunting reps. But maybe we’d be surprised to find lengthy index fingers there…after all, the scheme was a “long-term” approach.

Most interesting of all, is that Madoff’s own sons and heirs cut short dad’s survival on the Wall Street three-ring menagerie.  He revealed the root of their inheritance, and they turned him in.  This positively Greek development in finance deserves the ushering in of the Furies from the wings.

Regards,
Sam Buker

January 23, 2009