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New study links testosterone and day traders' profitability

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Outside the New York Stock Exchange.

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The New York Stock Exchange

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Wall Streeters at the corner of the New York Stock Exchange.

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Traders in front of the New York Stock Exchange

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The New York Stock Exchange

Each day after the stock market closes, Wall Street traders filter out into New York’s financial district, jostling among tourists and metal coffee carts, heading off to drown their sorrows or toast their triumphs.

When J.M. Coates worked on the trading desks of Goldman Sachs and Deutsche Bank in the 1990s, he saw young men just like these swaggering along Wall and Broad streets. During the dot-com bubble, Coates tried to understand their odd, almost manic, behavior--impulsive investments, racing speech.

Now, as a research fellow at Cambridge University, where he’d gotten his Ph.D. in economics, Coates followed up on a “hunch”--that is, not yet a hypothesis--based on brain mapping studies he’d seen at Rockefeller University. He believed that natural testosterone and cortisol levels in traders affects their financial decision-making. In 2005, Coates tested his theory, measuring the steroids’ levels in 17 traders on a 260-trader London trading floor.

The resulting study, published last month in the Proceedings of the National Academy of Sciences, is called “Endogenous steroids and financial risk taking on a London trading floor.” Co-authored by Coates with Joe Herbert, it suggests that a trader’s higher morning testosterone level may contribute to the economic return of his investments, while cortisol levels are increased by risk and uncertainty. It also may be a preliminary step in helping researchers understand how bubbles and crashes function as they relate to increased levels of the steroids over time.

The research doesn’t perfectly capture financial performance, Coates said, because the period in which it was conducted was so calm from a financial standpoint, and the sample size was small: 17 traders over the course of eight days. Banks are hardly keen on allowing researchers in during volatile times like these, he said, let alone for a full business cycle, which could last five years and which would be required to fully establish causality.

In addition, the research applies to these particular day traders, who buy and sell bond and stock index futures within minutes, and may not apply to longer term trading. Even so, he said, the research is a first step toward a link between between the hormones and financial risk-taking and whether one directly affects the other.

Dr. Paul Zak, director of the Center for Neuroeconomics Studies at Claremont Graduate University in California, said the experiment was imperfect because testosterone levels can fluctuate from simply running to catch the subway. “Having said that, I love that they went into the field and did that--it takes the research right to where it’s applicable,” he said. “If I do it with college students in my lab, it’s one thing, but here we are right on the trading floor.”

The traders in Coates' study were swabbed in the cheek once in the morning and once at the end of trading. Coates and his fellow researchers found that those traders who had higher testosterone levels in the morning had more profitable days. “All of the comparisons we’re making are within an individual--and when his testosterone was higher [than his normal level], he made more money,” he said.

The confident swagger and alpha-male dominance of the Wall Street type is well known, but surprisingly, Coates’s research suggests that the best traders aren’t necessarily those with the highest testosterone levels. “If you could compare them to anybody,” he said, “it wouldn’t be Gordon Gekko,” the character portrayed by Michael Douglas in the 1987 film “Wall Street.” “It’d be Roger Federer or Tiger Woods.”

The successful traders aren’t cocky, Coates noted, but rather, “quiet and tight-lipped. The effect testosterone was having on these traders was very subtle--affecting the confidence they had in their estimates of probability.” The research suggests that testosterone may “underlie a financial variant of the ‘winner effect,’ in which a previous win in the markets leads to increased (and eventually irrational) risk taking in the next round of trading.” Which leads to bubbles or, in the case of increased cortisol--which would prevent the trader from taking risks--crashes.

One hypothesis that emerged from the research is that if the steroids’ levels remain elevated over long periods of time, they pass an optimum level and begin having adverse effects. “If these steroids reach extreme levels during bubbles and crashes, then these [traders] may become price insensitive and monetary policy may stop working,” Coates said.

“Economic theory finds it very hard to justify the existence of bubbles and crashes,” said Aldo Rustichini, an economics professor at the University of Minnesota. “But this research opens up many questions about how they form” and gives concrete evidence of hormones’ long-speculated upon effects on financial markets.

Camelia Kuhnen, an assistant professor of economics at the Kellogg School of Management at Northwestern University, said the research conforms to some of her own that indicates that emotions affect financial decisions. But, she said, Coates’s study could simply indicate that hormone levels are responding to competition. “When an athlete is getting ready for a competition, the testosterone goes up,” she said. “So having a high testosterone level could simply indicate you are in the game, you are ready to compete.”

Which is part of the reason Coates cautions against any traders thinking about pumping themselves full of testosterone before heading to work--a link exists, but its’ nature remains elusive. Hormone levels and financial decision-making are connected, but Coates is not suggesting high-testosterone individuals make bigger profits.

“It’s sort of hard to play around with your endocrine system, it’s so delicate,” he said. “And people who try screwing around with it end up ... in a lot worse shape than they were to begin with.”

E-mail: ncm2108@columbia.edu