Bubble and Bust

In animals testosterone-fueled perpetual winners eventually get careless. "The hormone gets to a point where it starts to impair their judgment," he says. "They start going out in the open too much, they pick too many fights, they neglect their parenting duties. It turns into stupid risk-taking." In humans the desire for ever greater risks can destroy careers (we're looking at you, Eliot Spitzer)—or even, when it catches on en masse, whole economies.

That's where the reverse of the winner effect—call it the "loser effect"—comes in. After a loss testosterone levels in males come right back down, and levels of cortisol surge instead. Cortisol, a stress hormone, is the brake to testosterone's gas pedal, and what sends it spiraling up is uncertainty—just the kind of condition a trader would encounter in a suddenly volatile market. "If you have chronic exposure to cortisol, you start to recall bad memories more often and you see risk everywhere," says Coates. "This hormone may make traders dramatically risk-averse." Just as testosterone increases in an economic bubble, cortisol may rise in a recession. That, says Coates, is yet another reason that central-banking policies sometimes can't halt an economic downslide. "At some point, what people are responding to is more than price levels."

Traders shouldn't take Coates's study as advice to start doping they way athletes do in hopes of increasing their testosterone. For one thing, the research doesn't necessarily show that men with high testosterone levels always make better traders, especially in the long run. Putting aside the other traits a trader needs for success—intelligence, specialized knowledge, the ability to function on three hours' sleep—there's more to risk-loving behavior than the amount of testosterone a man has. He also needs to be physically sensitive to the chemical. If his body doesn't have many receptors reacting strongly to its effects, the amount of the hormone in his bloodstream doesn't really matter. "I don't think high baseline levels of testosterone tell you anything," says Coates. "All we care about is the effects of these androgens, not the amounts."

The study also doesn't mean that men are better traders than women. The winner effect hasn't been found in females; the act of competing increases their levels of testosterone, but whether they actually win or lose the game has no observed effect. That could mean that women are less likely to get so "addicted" to success that they seek it out aggressively by taking risks, says Coates. It also means they may be less likely to succumb to testosterone-fueled stupidity—the downside of the winner effect.

Anecdotally, Coates says that during his Wall Street days he thought that "women traders didn't seem to be as affected" by irrational exuberance. A 2001 paper in the Quarterly Journal of Economics backs up that observation. "In areas such as finance," it found, "men are more overconfident than women." As a result, male stock traders tend to do more buying and selling than female traders do. Each trade costs money, and over the long term that money adds up. In the final calculus, according to the 2001 paper, it's men, not women, who underperform.

The key to success on the stock market, then, may be letting the hormones flow just enough—benefiting from the boost in confidence but not letting it get out of hand. "The really good trader," says Coates, "is the one who feels these things but knows how to control them. He knows when to pull the plug and go home." Testosterone may be good stuff, but don't put too much stock in it.

© 2008