Research indicates ‘gut feelings’ play role in financial trading

Sensitivity to "gut feelings" is a strong predictor of success in financial trading, according to research led by Cambridge university.

The study of 18 hedge fund traders found those with greater "interoception", which is the ability to sense the state of their body, made more money and survived for longer in hectic financial markets. Results are published in the journal Scientific Reports.

“Our results suggest that signals from the body, the gut feelings of financial lore, contribute to success in the markets,” the authors concluded. By combining body and brain, the best human traders can outperform computer algorithms, they said.

To assess interoception, the researchers measured the subjects’ ability to count their own heartbeats over varying periods, while at rest and without touching their pulse or any other part of their body.

The 18 volunteers, all male, were engaged in high-frequency trading, buying and selling futures contracts at an unnamed London fund during a particularly volatile time towards the end of the euro-zone crisis. They held their trading positions for short periods, from seconds up to a few hours – an activity that requires decision-making with split-second timing, based on the assimilation of large amounts of information flowing from news feeds and rapid recognition of price patterns.

Algorithms

By combining body and brain, the best human traders can outperform computer algorithms

“This niche of the financial markets is particularly unforgiving and selection acts quickly,” said John Coates, senior author, who used to run a Wall Street trading desk and then became a neuroscientist.

“While successful traders may earn in excess of £10 million (€11.7 million) a year, unprofitable ones do not survive for long.”

The traders as a whole were better at the heartbeat-detection tasks than a control group of Sussex University students, scoring an average of 78.2 per cent compared with 66.9 per cent for the controls. Within the study group, interoceptive ability predicted both profits generated and years of experience as a financial trader.

“Traders in the financial world often speak of the importance of gut feelings for choosing profitable trades. They select from a range of possible trades the one that just ‘feels right’,” said Mr Coates. “Our findings suggest they manage to read real and valuable physiological trading signals, even if they are unaware they are doing so.”

The researchers say the findings have implications for economic theory, undermining the “efficient markets” view that human participants cannot outperform the market consistently through superior skill or other traits.

“A large part of a trader’s success and survival seems to be linked to their physiology,” said Mark Gurnell of Cambridge, another member of the study team. “Such a finding has profound implications for how we understand financial markets.”

Stress hormones

Earlier research by the same team showed how varying levels of stress hormones affected the performance of financial traders.

The work should also inform the debate over whether computer algorithms can outperform human traders, Mr Coates added.

“If we focus on conscious mind and model it as a piece of software we will conclude that humans are doomed,” he said. “But if we recognise that body and brain act as a single functioning unit, that they form a parabolic reflector collecting signals inaccessible to the conscious mind, then we will also recognise how exquisitely we are constructed for rapid pattern recognition. Humans can indeed compete against the machines.” – Copyright The Financial Times Limited 2016