Hormones Drive Markets
I was listening to a podcast by Andrew Huberman on the Joe Rogan Experience on testosterone and cortisol and their effects on the human body. I was particularly struck by how these hormones affect stock market trading activity among individuals, so I decided to dig deeper into the topic.
First, let me offer a simple explanation of what testosterone and cortisol are and how they impact our overall mood, productivity, and energy levels throughout the day.
Testosterone
Testosterone is known as the male sex hormone. It should be noted that women have testosterone too. Most females don’t develop male characteristics because testosterone and other androgens act differently in their bodies, being quickly converted to estrogen. Testosterone is produced by the gonads and also the adrenal glands and regulates a number of functions alongside sperm production, such as:
· mood and energy levels
· sex drive
· bone mass
· fat distribution
· muscle size and strength
· red blood cell production
Cortisol
Cortisol is the stress hormone and is produced by the adrenal glands. Cortisol acts on different parts of the body and is involved in the following functions:
· the body’s response to stress or danger
· the body’s metabolism of glucose
· the control of blood pressure
· the reduction of inflammation
This is a simple explanation of the functions of the 2 hormones, although they play much more complex roles in the functioning of the human body and differ in their roles as we age. Knowing the basics of these hormones helps us to understand how they affect our ability to trade in the stock markets.
Higher Testosterone= Higher Profits?
We know that trading in the stock markets requires a firm control over the emotions. To see successful profitable days on a consistent basis one must be able to manage one’s emotions with an iron hand. Our hormones play a role in keeping our emotions and moods in check.
Elevated levels of testosterone help to build confidence in traders and thereby increase their risk taking ability. The hormone changes the way the brain calculates value and returns in the stock markets. Therefore, having a correct balance of the hormone in the body can lead to more rational decisions while trading in the markets.
Numerous studies have been conducted on the effect of testosterone on trading behavior. One of the more interesting of these is by the University of Cambridge’s researcher, John Coates, who was once a Wall Street trader himself.
https://www.ncbi.nlm.nih.gov/pmc/articles/PMC4489095/
The essential point is that traders assume that all behavior is conscious and rational, but they ignore the fact that signals from the body, both chemical and electrical, affect how we take financial risks.
For the experiment, the researchers recruited 49 male traders from a trading floor in the City of London. This floor employed approximately 200 traders who specialized in high-frequency trading. Only three of the 200 were female. The more successful traders were paid over £4 million a year.
Great care was taken to ensure that the traders all practiced the same style of trading and that their profits (P&L) reflected only their risk-taking skill. All traders therefore had equal access to capital and information.
The study draws attention to the fact, often overlooked by economists, that traders require more than a calculating mind; they must also possess confidence, an appetite for risk, and the ability to process information quickly. Furthermore, high frequency traders require additional skills because their rapid style of trading is a demanding physical activity: they engage in extended periods of vigilance and visual scanning, and they must react quickly in order to place a trade before others arbitrage it away.
Another interesting study from the University of Central Florida and Singapore Management University showed how alpha males, i.e., those with higher levels of testosterone, underperformed their peers who had lowers levels of testosterone because they traded more frequently, tended toward high-risk, high-potential stock picks, and were reluctant to sell losing stocks.
For the study, the researchers examined the investment performance of 3,228 male fund managers from 1,901 investment firms operating hedge funds between January 1994 and December 2015. To estimate each manager’s testosterone levels, the researchers measured their facial width-to-height ratio — a representation of pubertal testosterone exposure that has been linked to high testosterone levels in adults.
The researchers found that managers with wider faces underperformed low-testosterone counterparts by 5.8 percent per year after adjusting for risk. These results were not explained by differences in illiquidity, fund age, or fund size.
Linked the study below:
Cortisol making traders more risk averse and anxious?
Cortisol is a hormone secreted by the adrenal glands in response to moments of high physical stress, such as 'fight or flight'. Importantly, cortisol also rises powerfully in situations of uncertainty, such as volatility in the financial markets
Cortisol, known as the stress hormone, may cause traders to become extremely risk averse when financial markets are volatile. The activity of trading involves taking a certain amount of risk to achieve above average returns. The inability or unwillingness to take these kinds of risks can produce suboptimal results for traders.
The study by Coates referred to above showed that levels of cortisol rose 68 percent among traders over a two-week period when there was high market volatility.
This could also possibly explain why most of us as investors were unable to aggressively deploy our capital when global markets reached record lows in March 2020. We also saw a swift recovery in the markets which many of us were unable to capitalize on because of our hormones causing us to be risk averse to the situation.
On a lighter note, most of us have seen Wolf of Wall Street and the scene in which Matthew Mccounaghey’s meets a rookie in Leonardo Dicaprio, we can probably infer that Matthew Mccounaghey had elevated levels of testosterone and that is his style exuded a sense of confidence.
Bottom Line
We cannot deny the signals that the hormones in our human body provide us. It is wrong to assume that trading requires only mental discipline. The effective regulation of our hormones which is achieved through an active and healthy lifestyle plays a major role in the decisions we make as investors and traders.
We need to design processes based on our investment and trading styles. We should also reflect on how the environment affects our body, and fashion a set of processes appropriate to our lifestyle as well.