It's been a long time since the dot-com days of "irrational exuberance," but John Coates remembers them well: he lived them. As a Wall Street trader, he watched as his co-workers drove stock prices into the stratosphere and themselves into a frenzy. "They were acting like they were on a drug," he says.
Since then Coates has left Wall Street for the University of Cambridge and dedicated his time to figuring out what that drug was. In this week's Proceedings of the National Academy of Sciences he announces his results: it was testosterone. In a new study he reports that traders who start the workday with high testosterone levels make more money on that day than their low-testosterone colleagues do. A hot day on the market sends their levels of the natural steroid up even more, Coates says; under the influence of their own hormones, they start to take bigger risks in hopes of bigger rewards.
Classical economic theory assumes that people make financial decisions in a rational way. But Coates's finding is part of a growing body of work explaining why, in reality, they often don't: they're at the mercy of their biology. This school of thought helps illustrate how economic trends can get out of control, ballooning until they burst. It also suggests one reason why central banking is so tricky: policymakers don't often take hormones into account. "[Former Federal Reserve chairman] Alan Greenspan spent his whole career trying to control economic bubbles," says Coates. "I don't think he realized he was up against steroids."
Coates first started thinking about testosterone in traders when he came across the so-called "winner effect," a phenomenon that has been observed in the lab for more than a decade. In animals, success at a given task begets a boost in testosterone, which in turn begets a number of changes in the brain. An animal pumped up on testosterone makes decisions faster, tries harder to win and is willing to take risks that a more timid counterpart—perhaps one with a record of failure—won't go for.
"When he goes into the next round of competition, the testosterone gives him an advantage," says Coates, "and he may win again. It's a feedback loop." The winner effect has been examined in human male athletes, too, with the same results: a win releases more testosterone, which increases the player's chances of succeeding the next time around.
But winning can't go on forever, and, in fact, the kind of risky behavior needed for extreme success often leads instead to spectacular failure. That too owes something to hormones: too much testosterone can ultimately cloud a person's judgment. "Testosterone may help you make decisions faster," says Coates, "but it doesn't help you make better ones."
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.