The Evolution of Risk-Taking
Trading is one of the hardest day jobs in the world – what drives those who succeed at it?
Welcome back to Mind Over Money, I’m Kevin Cook, your field guide and story teller for the fascinating arena of behavioral economics.
Today my guest is a PhD candidate from the University of Greenwich in London who is studying the risk-taking behavior of traders from the perspective of evolutionary psychology.
Belinda Vigors wants to know if successful traders are doing anything different when making decisions under uncertainty and stress than us mere mortals who wrestle with our cognitive biases and unknown depths of neurochemistry and neuro-circuitry that drive our emotional habits.
Before we meet Belinda, I want to give you some background for our discussion that is actually causing a rift in the field of behavioral economics, at least for those of us who apply it to markets and trading.
I have been a long-time fan of Daniel Kahneman -- who is the only psychologist ever to win a Nobel Prize -- for his work on decision making under uncertainty and risk. He practically invented the discipline of behavioral finance.
And the cognitive biases that he has discovered and named over 4 decades have given us a rich vocabulary with which to talk about people (and traders) acting stupid and irrational with money and risk.
Since I am also an eager student of neuroscience, I simply look at the two fields as different but complementary ways of describing and understanding decision making. As I like to say, the behavioral gang studies us from the OUTSIDE-IN, while the brain gang studies us from the INSIDE-OUT.
An Affinity for Randomness and Ambiguity
But Kahneman’s 2011 book Thinking Fast and Slow has caused some extra controversy in the twilight of his long career because he may be not only oversimplifying how our decision making works, but also limiting any believer’s choice of solutions or therapies.
In other words, his System #1 and System #2 for thinking -- the fast and emotional vs. the slow and rational, respectively -- don't appear to integrate with the findings of brain science very well, which would argue for much more complexity especially as emotion and neurochemistry are concerned.
Kahneman also no longer likes describing humans as “irrational.” But then how do we explain all sorts of self-sabotage regarding money, risk and long-term goals? Or, how about truly self-destructive behavior like crime and violence?
And Kahneman’s theories are not based on any clinical work in helping people or traders change their thinking and decision-making. Since I did not read Thinking Fast and Slow, in today’s podcast I share a quick review by a thoughtful investor who explains quite well why the theories may be very limiting.
Ravee Mehta, a portfolio manager and author of The Emotionally Intelligent Investor: How Self-Awareness, Empathy and Intuition Drive Performance, says that Kahneman’s systems miss much of the significant skill, discipline, and what I call an “affinity for randomness” that traders can develop when they become more aware of their emotions and intuition.
Here’s an excerpt from Mehta’s 2012 blog, “Daniel Kahneman is Wrong (at least when it comes to investing)”...
I humbly disagree with Kahneman, a Nobel laureate, and some other prominent psychologists when it comes to “fast-thinking” and investing. They argue that the stock market is too complex and random for intuition to be developed. They believe that the randomness causes people to build incorrect association biases. This argument is flawed. While the overall market may seem complex and random, there are many patterns within it that recur frequently. The best money managers recognize patterns developing ahead of most. They also can develop useful intuition because they are honest with themselves about the role luck had in their success. The intuitive decision-making that is involved with investing is much more complicated than other types of decision-making. However, that does not mean that we should abandon trying to better develop and use gut instincts when we invest.
The Evolutionary Path of Trader Brains
Cognitive biases, emotional habits, and intuition are definitely interesting. But what really gets me excited is talking about how our brains work. And that invariably leads to discussions about our evolution.
So I was really excited to bring in a young student of this complex collision between behavioral science and of one of the hardest jobs on the planet, trading.
Belinda Vigors explains how traders may be dealing with risk in terms of “need thresholds” and survival goals. She bases part of her theories about emotion on the work of psychologist Jennifer Lerner of Harvard whose research examines the distinct effects of fear, anger, and happiness on risk perception and risk preference.
Be sure to listen to the podcast to hear my full conversation with Belinda.
Kevin Cook is a Senior Stock Strategist at Zacks Investment Research where he runs the TAZR trading service.