Trading is not just about risk assessment and fundamental and technical analysis. There seems to a biological component that is gradually percolating into the mainstream. John Coates' work that was reported in the Financial Times, and his 2012 book "The Hour Between Dog and Wolf: Risk Taking, Gut Feelings and the Biology of Boom and Bust" were my first introductions to this space.
I am not saying this is the best thing since sliced bread. I am not arguing that the findings are iron clad and all have been duplicated. I am suggesting the studies are provocative.
CNBC carried a report earlier this spring about a study of more than 3000 hedge fund managers conducted by the University of Central Florida and Singapore Management University. Using software that measures the ratio between the height and width of the face, which is an accepted proxy for testosterone level, and controlling for exogenous factors like risk and market environment, the study found that ... well, alpha was negative for alpha.
Those managers with higher testosterone underperform those with lower testosterone by 5.8% annually. They traded more frequently and showed a propensity for favoring lottery-like stocks. The higher testosterone managers were also more susceptible to what is technically called the "disposition effect," selling winners and holding on to losers. Interestingly, the research found that investors tend to prefer hedge fund managers that have the same level of testosterone as their own.
Here a relative hormonal level boosts the chances of certain behaviors. It is not so surprising. However, what is also fascinating is considering whether the causation arrow can be reversed. Then I stumbled on Jerry Useem's article in last summer's Atlantic, Power Causes Brain Damage.
Useem reminds us that this is not a new insight. He approvingly quotes Henry Adams that power is "a sort of tumor that ends up killing the victim's sympathies." What Useem does is to offer a snapshot of various studies that illustrate elements of Adams' insight.
A study extending more than 20 years by Dacher Keltner, a psychology professor at University of California, Berkeley, found that under the influence of power, people are more impulsive, less risk aware and less adept at seeing things from other points of view. This is understood as a paradox of power. The skills needed to attain power in the first place are reduced. Susan Fiske, a professor at Princeton, explained that power lessens the need to have a nuanced read of other people. Power diminishes the command of resources that previously had to be negotiated (broadly understood) to secure greater positions of power.
A creative way to demonstrate that powerful people have difficulty seeing things from someone else's perspective is by asking people to draw a letter E on their foreheads. Powerful people were three times more likely to draw it from their point of view as if they were going to look at it in their mind's eye, rather than as how someone else would see it. Powerful people are less able to identify what people in a picture may be feeling or how colleagues may respond to a comment or situation.
It is not simply behavior, but it appears that how the brain works changes under the influence of power. Sukhvinder Obhi, a neuroscientist at McMaster University in Ontario, used transcranial magnetic stimulation and found specific neural processes were impaired by power. It turns out that if most of us watch a video of someone squeezing a ball, our neural pathways mirror what would happen if we were squeezing the ball. This is less true for people in power. This "mirroring" is suspected to be the physiological basis of empathy.
It seems as if power primes our brains to screen out some types of information. This may be the necessary byproduct of decision-making and resource-allocation, but it is socially more obtuse. There appear to be some ways to mitigate the effects of power on behavior, though it may take more than awareness.