̽��ֱ�� of Cambridge - financial

‘Gut feelings’ help make more successful financial traders

cjb250 — Mon, 19 Sep 2016 09:00:00 +0000

‘Gut feelings’ – known technically as interoceptive sensations – are sensations that carry information to the brain from many tissues of the body, including the heart and lungs, as well as the gut. They can report anything from body temperature to breathlessness, racing heart, fullness from the gut, bladder and bowel, and they underpin states such as hunger, thirst, pain, and anxiety.

We are often not conscious – or at least barely aware – of this information, but it provides valuable inputs in risky decision making. High-risk choices are accompanied by rapid and subtle physiological changes that feed back to the brain, affecting our decisions, and steering us away from gambles that are likely to lead to loss and towards those that are likely to lead to profit. This can enable people to make important decisions even before they are able to articulate the reasons for their choices.

Traders and investors in the financial markets frequently talk of the importance of gut feelings for selecting profitable trades. To find out the extent to which this belief is correct, researchers from the Universities of Cambridge and Sussex in the UK and Queensland ̽��ֱ�� of Technology in Australia compared the interoceptive abilities of financial traders against those of non-trader control subjects. Their results are published today in the journal Scientific Reports.

̽��ֱ��researchers recruited 18 male traders from a hedge fund engaged in high frequency trading, which involves buying and selling futures contracts for only a short period of time – seconds or minutes, a few hours at the most. This form of trading requires an ability to assimilate large amounts of information flowing through news feeds, to rapidly recognize price patterns, and to make large and risky decisions with split-second timing. This niche of the financial markets is particularly unforgiving: while successful traders may earn in excess of £10 million per year, unprofitable ones do not survive for long.

̽��ֱ��study took place during a particularly volatile period – the Eurozone crisis – so the performance of each trader reflected his ability to make money during periods of extreme uncertainty. ̽��ֱ��researchers measured individual differences in each trader’s capacity to detect subtle changes in the physiological state of their bodies by means of two established heartbeat detection tasks. These tasks test how accurately a person, when at rest, can count their heartbeats. Each trader was given a score which, essentially, measured the percentage of right answers, and these scores were compared against data from 48 students at the ̽��ֱ�� of Sussex.

̽��ֱ��researchers found that traders performed significantly better at the heart rate detection tasks compared to the controls: the mean score for traders was 78.2, compared to 66.9 for the controls. Even within the group of traders, those who were better at the heart rate detection tasks also performed better at trading, generating greater profits.

Strikingly, an individual’s interoceptive ability could be used to predict whether they would survive in the financial markets. ̽��ֱ��researchers plotted heartbeat detection scores against years of experience in the financial markets and found that a trader’s heartbeat counting score predicted the number of years he had survived as a trader.

“Traders in the financial world often speak of the importance of gut feelings for choosing profitable trades – they select from a range of possible trades the one that just ‘feels right’,” says Dr John Coates, a former research fellow in neuroscience and finance at the ̽��ֱ�� of Cambridge, who also used to run a trading desk on Wall Street. “Our findings suggest they’re right – they manage to read real and valuable physiological trading signals, even if they are unaware they are doing so.”

Although the results are consistent with recent studies showing that heartbeat detection skills predict more effective risk taking, the researchers caution that there may be other interpretations. For example, one study has found that heartbeat detection ability increases during stress, so it could be argued that heartbeat detection skills correlated with years of survival merely because experienced traders, taking larger risks, are subjected to greater stresses. ̽��ֱ��authors of the current study think this unlikely – in trading, as in many other professions, experienced and successful individuals, being more in control, are commonly less stressed than beginners.

̽��ֱ��findings also appear to contradict the influential ‘Efficient Markets Hypothesis’ of economic theory, which argues that the market is random, meaning that no trait or skill of an investor or trader – not their IQ, education, nor training – can improve their performance, any more than these traits and skills could improve their performance at flipping coins.

“A large part of a trader’s success and survival seems to be linked to their physiology. Such a finding has profound implications for how we understand financial markets,” adds Dr Mark Gurnell from the Wellcome Trust-Medical Research Council Institute of Metabolic Science at the ̽��ֱ�� of Cambridge.

“In economics and finance most models analyse conscious reasoning and are based on psychology,” Dr Coates continues. “We’re looking instead at risk takers’ physiology – how good are they at sensing signals from their viscera? We should refocus on the body, or more exactly the interaction between body and brain. Medics find this obvious; economists don't.”

̽��ֱ��research was largely funded by the Economic and Social Research Council, the European Research Council and the Dr Mortimer and Theresa Sackler Foundation. Additional support was provided by the National Institute for Health Research Cambridge Biomedical Research Centre.

Reference
Kandasamy, N, Garfinkel, SN, Page, L et al. Interoceptive Ability Predicts Survival on a London Trading Floor. Scientific Reports; 19 Sept 2016; DOI: 10.1038/srep32986

Financial traders are better at reading their ‘gut feelings’ than the general population – and the better they are at this ability, the more successful they are as traders, according to new research led by the ̽��ֱ�� of Cambridge.

In economics and finance most models analyse conscious reasoning and are based on psychology. We should refocus on the body, or more exactly the interaction between body and brain. Medics find this obvious; economists don't

John Coates

Rafael Matsunaga

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Traders’ hormones ‘may destabilise financial markets’

cjb250 — Thu, 02 Jul 2015 13:00:03 +0000

Researchers simulated the trading floor in the lab by having volunteers buy and sell assets amongst themselves. They measured the volunteers’ natural hormone levels in one experiment and artificially raised them in another. When given doses of either hormone, the volunteers invested more in risky assets.

“Our view is that hormonal changes can help us understand traders’ behaviour, particularly during periods of financial instability,” said Dr Carlos Cueva, one of the lead authors of the study, from the Departament of Fundamentos del Análisis Económico at the ̽��ֱ�� of Alicante.

̽��ֱ��researchers think the stressful and competitive environment of financial markets may promote high levels of cortisol and testosterone in traders. Cortisol is elevated in response to physical or psychological stress, increasing blood sugar and preparing the body for the fight-or-flight response. Previous studies have shown that men with higher testosterone levels are more likely to be confident and successful in competitive situations.

̽��ֱ��authors of the new study suggest the findings should be considered by policymakers looking to develop more stable financial institutions.

Dr Ed Roberts, one of the lead authors of the study, from the Department of Medicine at Imperial College London, said: “Our aim is to understand more about how these hormones affect decision making. Then we can look at the environment in which traders work, and think about whether it’s too stressful or too competitive. These factors could be affecting traders’ hormones and having an impact on their risk-taking.”

First the researchers measured levels of the two hormones in saliva samples of 142 volunteers, male and female, playing an asset trading game in groups of around ten. Those who had higher levels of cortisol were more likely to take risks, and high levels in the group were associated with instability in prices.

In a follow-up experiment, 75 young men were given either cortisol or testosterone before playing the game, once with the hormone and once on a placebo. Both hormones shifted investment towards riskier assets. Cortisol appeared to directly affect volunteers’ preference for riskier assets, while testosterone seemed to increase optimism about how prices would change in the future.

“ ̽��ֱ��results suggest that cortisol and testosterone promote risky investment behaviour in the short run,” said Dr Roberts. “We only looked at the acute effects of the hormones in the lab. It would be interesting to measure traders’ hormone levels in the real world, and also to see what the longer term effects might be.”

Economists have long recognised that the unpredictability of human behaviour can make financial markets unstable. John Maynard Keynes wrote of “animal spirits” and Alan Greenspan and Robert Shiller alluded to “irrational exuberance” as a possible cause of overvaluations in asset markets. However, scientists have only recently begun to explore the physiological basis for this phenomenon.

Professor Joe Herbert, a co-author of this study from the Department of Clinical Neurosciences at the ̽��ֱ�� of Cambridge, reported in an earlier field study that traders made significantly higher profits on days when their morning testosterone levels were above their daily average, and that increased variability in profits and uncertainty in the market were strongly correlated with elevations in their cortisol levels.

̽��ֱ��research was funded by the Economic and Social Research Council.

Reference
Cueva, C et al. Cortisol and testosterone increase financial risk taking and may destabilize markets. Scientific Reports, 2015.

Adapted from a press release by Imperial College London

̽��ֱ��hormones testosterone and cortisol may destabilise financial markets by making traders take more risks, according to a study published today in Scientific Reports.

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Sleepwalking into the Euro nightmare

sjr81 — Sat, 09 Nov 2013 08:59:23 +0000

Professor Jesper Jespersen, an economics expert and visiting overseas fellow at Churchill College, will use his lecture ‘A European Nightmare: How could the economists be so wrong on the Euro?’ to suggest Greece’s need for another multi-billion bailout - and call for a fundamental shift in economic practice to prevent the break-up of the Eurozone as we know it today.

Jespersen, who previously advised the Danish Parliament on monetary union policy, says that despite reports of limited growth and rising optimism in some quarters, recession, social unrest and political turmoil will only worsen while crushing austerity measures continue to bite in central and southern Europe.

“This is a nightmare that could have been prevented. But the real nightmare is yet to come,” said Jespersen. “ ̽��ֱ��economists who said monetary union would bring growth and stability were entirely wrong. Instead of trusting mathematical models that claimed such a crash would happen only once every thousand years - and losing sight of the realities - they should have stuck to real economics.

“People were blinded by the perceived benefits of integration rather than the actualities. They said the system could be detached from political interference; but those who imagined that were either naïve in the extreme or were part of the elite that stood to gain from monetary union.”

Now, argues Professor Jespersen, only a profound and fundamental rebalancing of economic hierarchies and financial policy can save from ruin those parts of Europe most affected by the unemployment and social crises.

He argues the most effective way to save Europe from its looming nightmare would be for Germany to accept its hegemony and reduce its huge balance of payments surplus – a surplus larger than that of China’s. Germany could display solidarity with its struggling European neighbours by using more money domestically and abroad, rather than strengthening its own position by accumulating more foreign assets. Then, the notion of a fairer, better balanced Eurozone, could be more likely.

However, the idea of Germany or any other surplus country eschewing national gains for the necessary stabilization of the common currency is not respected, perhaps hardly understood, and therefore largely inconceivable; a problem Jespersen argues has dogged the notion, and reality, of European monetary union from the beginning.

“ ̽��ֱ��Euro countries are too different to make the idea of a single currency work by itself,” added Jespersen. “ ̽��ֱ��EU Commission, the surplus countries and most economists say that countries in difficulty should just do as Germany has done. But that is a political and logical impossibility because all countries within a monetary union cannot run balance of payments surpluses. For every surplus country there has to be a deficit country otherwise the equation does not add up. So, Germany and other surplus countries have to reduce their balance of payments surpluses.”

Jespersen will also use his lecture to frame today’s current woes in an historical context; looking at the position of Germany before and after both World War One and Two and examining its status as Europe’s economic superpower.

He will also contemplate that for some nations, falling out of the Eurozone and returning to a sovereign currency, may be in the best long-term interests of the country as well as the EU as a whole, even if it proves inconvenient for the European elite in Brussels and for the economists who misjudged the consequences of a single currency.

Jespersen pointed to the 15 years of growth Britain enjoyed following ‘Black Wednesday’ and its exit from the Exchange Rate Mechanism – as well as Argentina’s departure from the currency board arrangement – as positive examples of what can be achieved. Jespersen argues that the European economy would ‘definitely benefit’ and begin growing from such a rebalancing; pointing to the growth of all EU member states outside the Euro (except Britain) since 2010.

“Things are getting worse from a social point of view,” said Jespersen. “ ̽��ֱ��welfare systems of some southern European countries are in ruins in an unfair attempt from Berlin (and Brussels) to require balanced public sector budgets. Unemployment is still running at more than 25 per cent in Spain and Greece. Tensions are huge. Greece will need one more rescue package – they will default if they don’t get it. But there is an elite and a bureaucracy in Greece that has really benefited from the Euro and is still in favour of the Euro. There is huge Greek wealth abroad while the working people get their pensions cut.”

Jespersen said a worst-case scenario might see the Euro being dissolved all together except for a ‘greater German area’ including Germany, Austria and perhaps the Netherlands and Belgium. Breaking up the German/French axis would herald the dawn of an entirely different European landscape.
He added: “ ̽��ֱ��present talk of tiny green shoots of growth as a vindication that ‘the medicine was right’ is misplaced. One should not forget that a balanced growth process implies 1.5-2 per cent yearly growth. Britain and Europe at large are still far below the normal growth rates. Growth, due to austerity policies, has been much slower than it could have been; therefore total unemployment in Europe is higher than ever before in the entire post-war period. Austerity is wrong from a growth perspective. Something has to change before prosperity will return to Europe.”

Professor Jespersen’s lecture takes place at 6pm on Monday, November 11 in the Bevin Room, Churchill College. All are welcome to attend.

Eurozone countries are still careering towards a financial and social ‘nightmare’ of their own making according to a leading academic speaking at Cambridge ̽��ֱ�� on November 11.

This is a nightmare that could have been prevented. But the real nightmare is yet to come.

Jesper Jespersen

Avij

Euro bank notes and coins

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