Brain Function Links to Winning and Losing Traders

July 17, 2014
Shirley M. Mueller, M.D.

High earners become uncomfortable near a peak in the market and exit, while low earners continue to buy with unbridled passion, according to the results of a study.

Traders in experimental markets can be winners or losers or in-between—neutral. This, we would expect. But according to a recent study, there is something more thought-provoking. Now, the category traders fall into can be linked with brain function. We are truly in the future.

Colin Camerer from the California Institute of Technology in Pasadena, CA, along with colleagues from his own institution and others from the Virginia Tech Carillon Research Institute in Roanoke, VA, examined the correlation between neural responses and financial behavior. The Wellcome Trust Centre for Neuroimaging, University College London in London also participated.

Their paper, “Irrational exuberance and neural crash warning signals during endogenous experimental market bubbles,” published in the Proceedings of the National Academy of Science heralds back to Alan Greenberg, former chief executive officer of Bear Stearns, who oversaw the collapse of the company during the recent financial crisis.

In a nutshell, functional magnetic resonance imaging (fMRI) was performed in subjects that traded in 16 different sessions. fMRI is a representation of brain activity in real time. For each test, there were about 20 participants. The results revealed that the high earners sold into a rising market while low earners kept buying.

Sagittal MRI slice with the anterior cingulate cortex indicated in yellow. From Wikipedia.com.

At the same time, the nucleus accumbens, known as the pleasure center, was stimulated in both groups. There was a difference in the activity of the right insular cortex in the high and low earners. This structure is linked functionally to financial uncertainty and risk aversion from previous studies. It is also known to be active when negative feelings associated with disgust are generated or even when social discomfort related to unfair treatment or exclusion are experienced.

In the Camerer study, insula activity lessened in the low earners as the market accelerated, indicating they could allow their nucleus accumbens excitement to continue without inhibition. In the high earners, however, their insular activity became more pronounced just before they moved from buying to selling. It appeared to be a vital warning signal.

This is a direct quote from the authors:

A “neurobehavioral finding is a positive association between trading performance and selling when neural activity in the anterior insula is elevated. The insula signal may reflect increased perception of risk or of uncomfortable bodily states. The presence of an elevated insula signal in the high earners before the price peak, its concurrent absence in the low earners, its association with trading pattern changes, and the stronger neurobehavioral insula-selling link among high earners suggest that increased neural activity in the right anterior insula may an early warning signal for these individuals to begin switching from the risk to the risk-free asset.”

In other words, the high earners became uncomfortable near a peak in the market and exited. The low earners continued to buy with unbridled passion. Concurrently, the activity of the right anterior insula of the high earners increased, but significantly less so for the low earners. This correlation suggests a link between brain function and trading skill that contributes to the ability to trade successfully.

Further Reading:

Can Market Timing Ever Work for the Individual Investor?

Hardwired: The Physiology behind Financial Decisions