Professor of Finance and PhD student
Grenoble School of Management (GEM)
Professor of Finance
Grenoble School of Management (GEM)
Jean-François Gajewski* (photo)
Professor of Finance
Savoie Mont Blanc University
*Faculty member of the Business Science Institute
Article originally published on The Conversation France.
The profession of trader does not leave the public opinion completely indifferent. Although traders represent only a tiny part of the banking world, they have a prominent place in the popular imagery of the financial world.
If we combine the data from the annual study of the French Banking Federation, which estimates the number of employees in the French banking sector at 371,000, and that of the French Banking Association, which estimates that 1.3% of its members' employees are "market operators", we obtain an estimate of just under 5,000 traders in France.
Le trader, ce héros de cinéma
And yet, no less than six big budget movies have been released since 2010 about professional traders. It must be said that the profession of trader often involves making quick decisions on large sums of money: this small number of traders does not prevent them from having a significant impact on the financial markets. The sulphurous reputation of the profession, mainly due to the excesses of a few high-profile individuals during the previous decades, and the highly publicized cases of black sheep, indeed form a framework conducive to film productions.
As far as black sheep are concerned, we can particularly mention the Kerviel case in France, which continues to make headlines 8 years later, with the reduction of his sentence from 4.9 billion to 1 million after the appeal judgment on September 23. A film released in 2016 in theaters, The Outsider, is actually dedicated to him.
Neurofinance, a branch of finance that uses methods borrowed from neuroscience to address financial academic issues, has also taken an interest in this business. In particular, many studies have tried to understand, via these methods borrowed from neuroscience, what makes a "good trader".
A first area of study in neurofinance related to traders concerns emotions. Indeed, it has been known since Bechara et al. (1997) that risk management and emotions are more closely linked than it seems. In this case, it is interesting to study subjects who make decisions with a major risk component on a daily basis. Two preliminary studies show that traders do indeed experience strong emotions during trading periods. Their heart rate and skin conductance increase, and their heart variability decreases during periods of high volatility. However, do these emotions lead traders to make beneficial or harmful decisions?
Two academic studies provide some answers. In a sample of 80 individuals with portfolios averaging $35,000 and undergoing trading training, Lo et al. prove through questionnaires that traders with stronger emotional reactions to their daily profits were less successful.
This is confirmed by a qualitative study based on interviews. The interviews, conducted with over 100 professional traders, reveal the importance of emotional regulation in trading. Traders with more experience in the market seem to be better at it. One of the themes that emerged from the interviews was the famous "trader's intuition".
Theory of mind and intuition
As far as intuition is concerned, we can cite the very promising work of Peter Bossaerts and his team at Caltech. He conducted a study in which subjects were asked to observe an experimental financial market, where some traders had privileged information. The observing subjects did not participate in the market: they simply had to try to predict prices. At the same time, the subjects underwent an MRI scan.
The research team realized that one area of the brain in particular was activated - the area related to "Theory of Mind". Theory of mind is developed in children from the age of 2 and allows them to imagine the intentions and mental states of another person. It is by extension used for inanimate objects that seem to have intentions.
Researchers from Peter Bossaerts' team have shown that subjects with a good theory of mind are better at predicting future courses. This could be the origin of the trader's "intuition". If you want to test your "theory of mind" skills, you can follow this link.
This first research on theory of mind has created a real buzz in the field of experimental research in finance. These first results would tend to be tempered by papers in progress. Corgnet et al. point out that theory of mind has no real impact once one takes into account the ability to resist common behavioral biases. Hefti et al. point out that theory of mind only leads to success as a trader if one also has sufficient quantitative analysis skills. This last result would be in line with what we observe in reality on the financial markets. For example, a study published in the Journal of Finance shows that fund managers from US universities with higher entry requirements perform better. The reason for this performance remains unclear: it could be due to a better ability to select assets, better training or a better network to obtain information that is not widely available to the public.
A final branch of neurofinance has sought to establish links between trader performance and physiological characteristics. For example, there are several studies related to testosterone. Indeed, numerous studies in neuroeconomics tend to show that higher levels of testosterone would lead to greater financial risk-taking in students.
Neurofinance has therefore been interested in the testosterone levels of traders. An initial study by Coates et al. showed a link between morning testosterone levels and profit in 17 male traders in London. In another study of 44 traders, the ratio of the size of the ring finger to the index finger (2D:4D, an index of the level of testosterone received at the fetal stage) was found to be a predictor of the number of years in the markets and of long-term profit. In a third article on the subject, the author realizes that the 2D:4D ratio actually predicts the amount of risk taken by traders, which in turn is related to profits as we have already seen. If you are curious about your own 2D:4D ratio, it averages around 0.947 for a man and 0.965 for a woman - women receive less testosterone in the fetal stage. It should be noted that this ratio remains a very noisy and imprecise measure, by the admission of the psychology researchers who use it regularly.
Finally, a study by Sapra et al. (2012) shows that the number of years on Wall Street would be linked to a combination of genes that would lead to moderate risk-taking. This result is potentially less surprising than it seems, when we know that about 25% of our risk behaviors are linked to our genetics.
Although studies on the subject are still few and far between and need to be replicated on larger samples, it would seem that some traders may have predispositions, observable or measurable thanks to precise physiological characteristics, in the same way that some people have predispositions for certain sports. All things considered, the acquired part (education, training, experience, etc.) certainly plays a more important role than the innate part in the ability to practice the profession of trader. However, the innate part should not be neglected, especially in risk-taking in situations of very high uncertainty.
In this short article we have presented the latest results of neurofinance research on what makes a "good trader". The results of this research are fascinating, in the sense that they change greatly from the traditional paradigm of classical finance.
However, some rigorous reservations must be made. Studies on the subject are still few and far between, and because of the costs involved have often used small samples. They therefore need to be replicated. It is also clear that, in order to succeed in the financial markets, it is not all about the size of the index finger compared to the ring finger!
Article translated from French with https://www.deepl.com/translator
Jean-François Gajewski's articles on The Conversation France.
Jean-François Gajewski's books & articles via CAIRN.info.