John Coates – The Biology of Trader Gut Feelings

John Coates’ research recently featured in the New York Times, Financial Times, Le Figaro and Reuters

“I set up this study to answer a simple question – are gut feelings merely the stuff of trading mythology? or are they real physiological signals? I suspected from my days of trading that hunches were real and valuable, that when I scrolled through the range of possible futures one just ‘felt right’. Then, after leaving Wall St and conducting several trading floor studies, I noticed an intriguing pattern to many of my results: the traders’ physiological reactions to volatility and risk often diverged from their psychological responses; and further, the physiological responses were more accurate. For example, traders’ cortisol levels track volatility in their P&L and the market more closely than do the traders’ conscious assessment of risk.

If our physiology is such a good risk manager, is it possible that traders who produce stronger physical responses to the markets and who are better at sensing these ‘gut feelings’ make better traders? I had mulled this possibility in my book, and the chapter on gut feelings has generated a great deal of inquiry from the corporate and sporting worlds. So I secured access to a hedge fund and we set about answering the question in a more controlled manner.

Within physiology the term ‘gut feelings’ is a colloquial synonym for interoception, the branch of our sensory system that monitors our internal, homeostatic condition. The most common test of interoceptive sensitivity is heart beat awareness (HBA), your ability to count your own heartbeats. We used this test on a group of hedge fund traders and found that: 1) their average score was a std higher than that of the non-trading population (ie, traders may be relatively more sensitive to bodily signals); 2) within the cohort of traders HBA score predicted relative profitability; and 3) most stunning, HBA score predicted how long the traders survived in the markets (ie, the markets select for traders with good gut feelings).

What is extraordinary is that nobody – and I mean nobody – is aware of this driver of profitability and survival. Academic economics and finance is so focused on conscious reasoning that they completely miss the real action, which is taking place in the dialogue between brain and body. They have studied the tips of the flame rather than the base.

The implications are intriguing. People question whether human traders can compete against algos. If we focus on conscious mind and model it as a piece of software we will conclude that humans are doomed. But if we recognize that body and brain act as a single functioning unit, that they form a parabolic reflector collecting signals inaccessible to conscious mind, then we will also recognize how exquisitely we are constructed for rapid pattern recognition. Humans can indeed compete against the machines.

Finally, we were able to ask what predicted interoceptive sensitivity.We found that markers of fitness (heart rate, BMI, heart rate variability) predicted the traders’ ability to generate and sense gut feelings – the fitter you are the more tympanic you seem to be, registering the faintest flicker in your body. This could be an important public health message: my experience is that if you tell people to get fit because they will be healthier, or live longer, or be more attractive, you get weak compliance. But tell someone they will make more money and, brother, you get a determined compliance!”

To read John Coates speaker profile, click here. Or either to have a look to different articles on this topic please click on the following newspapers: New-York Times – Financial TimesReutersLe Figaro.