Biology of Risk-Taking

Biology of Risk-Taking

Navigating around financials is one factor to beating the markets another less known and equally important part of the winning equation is to understand the biology of risk-taking.

Could financial turbulence have more to do with our lack of understanding about the biology of risk-taking rather than monetary policy?

Practically every type of activity in our daily life entails some type of risk. Should I cross the road now or wait? Do I buy, sell or hold? In both examples, the pedestrian and the investor/trader is undertaking a risky activity with the latter using some type of analysis (either technical or fundamental analysis) and the former using spatial awareness to respond. But risk-taking is more than just an intellectual activity.

Something else is going on in the naked ape’s body and it is the biology of risk-taking, how risk-taking affects the body and the mind that is less known outside the neuroscience circle.

So how does the biology of risk-taking play out when the pedestrian or the trader/investor is confronted with risk which also raises stress levels?

Stress hormones, adrenaline (fight-or-flight hormone) and cortisol are pumped into the bloodstream, the heart and breathing speeds up so that muscles and brain in the human body are being oxygenated, on standby fueled and ready to perform at it best in order to survive another day. The human body is being primed for action (either hunker down or charge). In a fast moving market a trader will decide to either charge like a bull or stay put on the sideline and hibernate like a bear, in other words, it is the biology of risk-taking (stress hormones) rather than currency liquidity that is fueling market volatility.

Neuroscientists have shown that we do not process information as a computer does (with its binary on and off states), dispassionately; we react to it physically.

Moreover, the biology of risk-taking plays an even greater role when we are exposed to novelty and uncertainty. Being exposed to the “great unknown” releases cortisol (produced by the adrenal glands) which is the primary hormone responsible for the stress response.

But too much cortisol can cause high blood pressure, mood swings, which is show as anxiety, depression or irritability, rapid weight gain, an increase in thirst and the need to urinate frequently.

So the biology of risk-taking in a trading environment suggests that it is the state of the trader’s/investor’s body (in other words their hormones) that predicts their appetite for risky assets.

But it is when you look at the biology of risk-taking in the context of the “winner effect” and how it impacts hormones the body and the mind that the topic gets really interesting.

The “blow-up traders” these are traders which have lost their banks near to one billion dollars in loss-making trades (and sent their banks circling the drain) where nearly always previous star traders- big winners. In short, big wins boost hormone levels, but adrenaline (the body’s nature cocaine) can also be highly addictive, hence the phrase “adrenaline junky.”

The biology or risk-taking means that a winner can become addicted to taking on more and more risk in search of their next adrenaline fix.

The winner is being primed to fail spectacularly.

What’s more investment banks encourage winners (risk takers) with ever more capital to take on even greater risks to get their next adrenaline high?

But the biology of risk-taking suggests that after a win traders need to leave the house and give their body time to adjust to healthy hormone levels.