Often we think of serious investors as being hyper rational. Numbers are crunched. Charts are studied and then, “Bam!” let the trading begin. Sometimes a flurry of trades, based on pending or current news, spikes activity causing volatility and prices vastly over-or-undershoot.
Average investors (aka ‘regular Joes and Janes) fear volatility—or, at least have been coached by the investment industry to fear it. And, yes, those spikes and swoops are stomach-turning but can also result in out-sized profits.
According to an on-going study on the biology of risk by John Coates, a former derivatives trader turned neuroscientist, volatility or the anticipation of it jacks up our hormones, particularly testosterone. Increased profits appear to elevate testosterone levels which leads to excessive exuberance and increased risk-taking. Rational decision-making unravels and, when enough of those bad decisions accumulate, markets crash, causing havoc far-and-wide. Did someone say, ‘Bubble?’
Young men have naturally higher levels of testosterone than women and than older men. It’s no surprise then that women portfolio managers, being less vulnerable to testosterone-induced hysteria, have better performance in both good markets and bad ones. (This runs counter to conventional thinking that women are less rational than men. Alas, portfolio returns don’t lie.)
Wall Street/Bay Street machismo is alive-and-well. We love the snappy suits and fierce attitude boys but it comes with a big cost. Making the investment industry more women- and oldster-friendly would blend out the testosterone spikes that distort valuations and it just might make markets and investors a whole lot safer. (Either that, or its desk side testosterone spot checks during trading hours. Ouch!)
Homo Economicus is a fallacy. We are not purely rational beings. So it’s no surprise that the markets, as one of our own inventions, isn’t either.