The Hour Between Dog and Wolf: How Risk Taking Transforms Us, Body and Mind

by John Coates

Rising levels of testosterone increase Scott’s and Logan’s hemoglobin, and consequently their blood’s capacity to carry oxygen; the testosterone also increases their state of confidence and, crucially, their appetite for risk. For Scott and Logan, this is a moment of transformation, what the French since the Middle Ages have called “the hour between dog and wolf.”

A nonthreatening stressor or challenge, like a sporting match, a fast drive, or an exciting market, releases cortisol, and in combination with dopamine, one of the most addictive drugs known to the human brain, it delivers a narcotic hit, a rush, a flow that convinces traders there is no other job in the world.

Normally a sober and prudent lot, these traders were becoming by small steps euphoric and delusional. Their minds were frequently troubled by racing thoughts, and their personal habits were changing: they were making do with less sleep—clubbing till 4 a.m.—and seemed to be horny all the time, more than usual at any rate, judging by their lewd comments and the increased amount of porn on their computer screens. More troubling still, they were becoming overconfident in their risk taking, placing bets of ever increasing size and with ever worsening risk-reward trade-offs. I was later to learn that the behavior I was witnessing showed all the symptoms of a clinical condition known as mania (but now I am getting ahead of the story).

When traders enjoy an extended winning streak they experience a high that is powerfully narcotic.

should add, however, that in addition to the changed behavior among traders, another remarkable fact struck me during the dot.com years—that women were relatively immune to the frenzy surrounding Internet and high-tech stocks. In fact most of the women I knew, both on Wall Street and off, were quite cynical about the excitement, and as a result were often dismissed as “not getting it,” or worse, resented as perennial killjoys.

Hunger, thirst, pain, oxygen debt, sodium hunger and the sensations of heat and cold, for example, have accordingly been called “homeostatic emotions.” They are called emotions because they are signals from the body that convey more than mere information—they also carry a motivation to do something.

Steroids, like a drill sergeant, ensure that body and brain fall into line as a single functioning unit.

As testosterone levels rise, confidence and risk taking segue into overconfidence and reckless behavior. Could this upward surge of testosterone, cockiness and risky behavior also occur in the financial markets? This model seemed to describe perfectly how traders behaved as the bull market of the nineties morphed into the tech bubble. When traders, most of whom are young males, make money, their testosterone levels rise, increasing their confidence and appetite for risk, until the extended winning streak of a bull market causes them to become every bit as delusional, overconfident and risk-seeking as those animals venturing into the open, oblivious to all danger. The winner effect seemed to me a plausible explanation for the chemical hit traders receive, one that exaggerates a bull market and turns it into a bubble. The role of testosterone could also explain why women seemed relatively unaffected by the bubble, for they have about 10–20 percent of the testosterone levels of

In summary - when on a winning streak, take a break or get rekt

If testosterone seemed a likely candidate for the molecule of irrational exuberance, another steroid seemed a likely one for the molecule of irrational pessimism—cortisol.

To Wolpert, and many like-minded scientists, the tunicate is sending us an important message from our evolutionary past, telling us that if you do not need to move, you do not need a brain.

If we humans did not need to move then perhaps we too would prefer to ingest our brain, a metabolically expensive organ, consuming some 20 percent of our daily energy.

when faced by situations of novelty, uncertainty, opportunity or threat, you feel the things you do because of changes taking place in your body as it prepares for movement.

If we now add up all the time delays between an event occurring in the outside world and our perceiving it, we discover the following lovely fact. For events occurring at a distance, we see them first and hear them with a delay, as we do, for example, when seeing lightning and hearing the thunder afterward. But for events taking place close to us, we hear them, because of our rapid auditory system and relatively slow visual one, slightly in advance of seeing them. There is, though, a point at which sights and sounds are perceived as occurring simultaneously, and that point is located about 10 to 15 meters from us, a point known as the “horizon of simultaneity.”

glimpse into this process has been provided by a brain-scanning study of people learning the computer game Tetris. At the beginning of the study, large swathes of the trainees’ brains lit up, showing a complex process of learning and voluntary movement; but once they had mastered the game their movements became habitual, and brain activity in the cortex died down. Their brains now drew much less glucose and oxygen, and their speed of reactions increased markedly. Once the players had the knack, they no longer thought about playing the game. This study, and others like it, supports the old saying that when learning begins we are unconscious of our incompetence, and proceed to a stage where we are conscious of our incompetence; then when training begins we move to conscious competence; and as we master our new skill we arrive at the end point of our training—unconscious competence. Thinking, one could say, is something we do only when we are no good at an activity.

This simple point carries unexpected implications for economics. It is not often appreciated that financial decision making is a lot more than a purely cognitive activity. It is also a physical activity, and demands certain physical traits. Traders with a high IQ and insight into the value of stocks and bonds may be worth listening to, but if they do not have an appetite for risk then they will not act on their views and will suffer the fate of Cassandra, who could predict the future but could not affect its course. And even if they have a good call on the market and a healthy appetite for risk, yet are shackled with slow reactions, they will remain one step behind the market, and will not survive on the trading desk—or anywhere else in the financial world, for that matter.

“Remember this rule,” advises Kahneman: “Intuition cannot be trusted in the absence of stable regularities in the environment.”

Like the fact that your brain, like a muscle, requires blood, glucose and oxygen to operate. In fact your brain, which constitutes only 2 percent of your body mass, consumes some 20 percent of your daily energy.

Perhaps the same could be said of our self-control when we are working long hours at the office—we tend to snap more easily—or trying to stick to a diet, since the draining of glucose also drains us of resolve.

when reporting on a result that emerged from one of our studies, mentioned earlier, on hormones in traders. That study had found that when morning levels of testosterone in male traders were higher than average, the traders went on to make an above-average profit later that day. The reporter for The Economist suggested that traders could test themselves first thing in the morning, and if their biochemistry was not right, they should just go home.

As the rumor mill of Wall Street goes to work refining the story, it emerges that one of the governors of the Fed gave a speech last night to a small group of senior bankers in which he spoke in no uncertain terms about how concerned the Fed is by what it considers an unjustified rally in stocks. He made it known that the Fed will not tolerate a bubble and the threat it poses to the stability of the financial system.

As Berns says, research into dopamine has turned “upside down a basic tenet of economics,” for much of it has found, somewhat counterintuitively, that animals prefer to work for food than to receive it passively.

What he did in his study was place rats in a bare cage with two bottles they could drink from, one of which contained water, the other water laced with morphine. Not surprisingly, the rats preferred the bottle laced with morphine, and in time they became addicted to it. What Alexander did next was interesting. He repeated the experiment, only this time he placed the rats inside what he called Rat Park, a cage with a running wheel, foliage, other rats, both male and female, and so on. In other words, he provided the rats with an enriched environment. When placed in Rat Park the rats did not prefer the morphine-laced water, and did not develop an addiction. In light of later research we could speculate that these rats were getting the daily dopamine hit they needed just from normal forms of search, work and play. Indeed, recent research has found that an enriched environment is such an attractive alternative to drugs that animals addicted to cocaine, once returned to an enriched environment, will actually kick their habit.

The clear advantages testosterone bestows on athletes have also led to a much more controversial form of testing, the testing for an athlete’s sex. It had been suspected in some Olympic Games that gold medals in some women’s events had actually been awarded to men, so the practice began of testing female athletes to see if they were indeed what they claimed to be. At first this seemed a simple case of looking for a Y chromosome. If an athlete tested positive for XY, then he was a male. Simple. As a result of this test a handful of women at both the 1992 Barcelona and the 1996 Atlanta Olympic Games were disqualified. Unfortunately, the reasoning behind the tests was questionable. If a person has a Y chromosome then they do in fact produce testosterone, starting at the fetal stage. But what if that person has been born with a genetic disorder that makes them insensitive to testosterone? What if their testosterone receptors do not work? Then the testosterone will have no effect. This is precisely what happens in a condition called androgen insensitivity syndrome—people with a Y chromosome produce testosterone, yet it does not masculinize them. Since the default sex of a fetus is female, these people will appear to all the world as women. Are they women? They think so, and who is to tell them otherwise? In the end the issue of establishing sexual identity became intractable and politically fraught. Many women athletes found the tests invasive, far too public and almost medieva...

Does the winner effect occur in humans? The question is controversial. Many social scientists have denied the existence of winning streaks or what are called “hot hands” in sports, claiming that athletes and fans who believe otherwise are subject to an illusion. But I think the winner effect does exist among humans. First, let us look at the stats. My colleague Lionel Page and I have done just that. To do so we followed as closely as possible the protocol used by biologists when studying animals in the wild. Lionel searched for athletes who were equally matched for physical resources and motivation, and then tested to see if winning on its own contributed to further wins. He came up with what I think is the most rigorous test of the winner effect in sports. Lionel managed to find a database of 623,000 professional tennis matches; from this sample he considered only those between players who were ranked one seed apart; then within this subset he further narrowed his search to matches that went to a tie break in the first set; and even further, to tie breaks decided by the narrowest possible margin, two points. In short, he looked at tennis players who were as closely matched as possible in rank and in playing form on the day of the match. Studying only these close matches, he found that the winner of the first set had a 60 percent chance of winning the second one, and, since the matches considered were the best of three sets, the match. In sports, winning contributes to fur...

It is not surprising, therefore, that sports scientists spend a great deal of time figuring out how to raise testosterone levels in their athletes—legally, of course. We are in the curious situation of harboring within our bodies chemicals that can unlock our full potential—kindling our competitive spirit, focusing our attention, granting access to our metabolic resources, raising us to a state of flow—yet we cannot readily access them. How frustrating! We hold the keys to victory within us, but usually we cannot find them. We would love to self-administer these drugs, but it cannot be done by a mere act of will; you cannot simply say, “I want lots of testosterone now!” or “I want to play my best, now!” It just does not work. Instead we must engage in all sorts of occult rituals and physical exercises before our bodies will even consider our request for more power. The situation is comparable to having money in the bank but being unable to touch it, unless, say, you perform some ceremonial dance, at which point the gates protecting your fortune swing open.

In fact, it has been found among ice hockey players that replaying a video of a previous win can increase their testosterone levels and thus their chances of winning the upcoming game.

My colleagues and I found further evidence that this molecule influences a trader’s profitability, and we did so more or less by chance. When I was on the trading floor conducting the first study, I brought a stack of science papers with me to read during downtime. One of these recounted an experiment in which the author, John Manning, had taken handprints from a group of football players, and found that their ability and success could be predicted from the lengths of their index and ring fingers, and specifically from the ratio of the two. This ratio, known as 2D:4D, meaning second digit length divided by fourth, could predict sporting ability because, Manning claimed, it gauged the amount of testosterone the athletes had been exposed to in the womb, a longer ring finger relative to index indicating higher androgen exposure. The idea at first seemed crazy to me, but also fun, so I began collecting handprints from traders. Later, when the back office of the trading firm sent me the P&Ls of these traders, I found to my amazement that their 2D:4D ratios predicted their profitability over the previous two years. What was even more astonishing was that their 2D:4D ratios predicted how long these traders had survived in the business. The results suggested that a hormone these individuals had been exposed to before they were even born was predicting their lifetime performance in high-frequency trading.

This is fuckin nuts

But we did make some headway in answering this question in the previously discussed study that looked at traders’ Sharpe Ratios, in other words how consistently they made money, their P&L corrected for the amount of risk they took in making it. In this study we used the traders’ Sharpe Ratios as a measure of skill, and asked quite simply, does testosterone improve traders’ skill, or does it increase the amount of risk they take? What we found was that testosterone did not improve their Sharpe Ratios, but it did increase the risk they took. We retain the belief that testosterone also has effects on the traders’ visuo-motor scanning and speed of reactions, although we will not be able to test this in the field. What our trading-floor studies did highlight, however, was that testosterone, a signal from the body, was having a large effect on the risk taking of traders, rising with above-average profits and increasing risk taking. These experiments thus provided good preliminary evidence that the winner effect does in fact occur in the financial markets.

Equally powerful psychological effects have been documented among athletes and recreational users who are “ripped” on anabolic steroids. Harrison Pope and David Katz, two psychiatrists from Harvard, found that many of these people succumb to mania, a psychiatric disorder in which the patient becomes euphoric and delusional, and experiences racing thoughts and a diminished need for sleep. In one case, a university athlete on steroids, after buying a sports car he could not afford, became so convinced of his invincibility that he asked a friend to film him driving the car into a tree, to prove he could not be hurt. In other cases users of steroids have committed criminal acts, and in their defense have blamed their behavior on testosterone, a legal strategy that has come to be known as “the dumbbell defense.” We have to interpret these cases with caution, because the athletes were taking steroids at levels far higher than can occur naturally in our bodies. Yet their behavior is not unlike what I observed in many traders during the dot-com bubble.

Investors during bubbles seem to come equipped with special eyewear that permits them to view all economic news as bullish. Weak economic growth spells lower interest rates, so stocks and risky assets rally; strong economic growth means healthy balance sheets for both corporations and households, so stocks and risky assets rally. The dollar strengthens, and this means foreigners love U.S. assets, so they rally; the dollar collapses, and this aids exporters and hence the economy, so assets rally. With this kind of spin no news dampens animal spirits for long, so by noon the stock market, celebrating the impending lower rates, has started to rally, and rally strongly. By the end of the day the S&P stands 3 percent higher. Scott is mesmerized by his risk-management system, hooked electronically to the screens, for it calculates in real time the P&L on both his S&P contracts and his stock-to-bond spread trade; and toward the end of today not even he can remain calm as the number climbs to almost $15 million, bringing his year to date close to $32 million, more than he has made in his best full year.

OCCASIONALLY, IT SEEMS, WHEN THE WORLD DRIFTS UNKNOWINGLY to the edge of an abyss, nature conspires to prolong a particularly glorious summer, as if to forestall the impending disaster, or to heighten the irony future historians will read into the prelude. Take, for example, the idyllic summer of 1914, coming at the end of the elegant and oblivious years leading up to the First World War known nostalgically as the Edwardian Summer. Or the New York autumn in 1929, when a heat wave lingered after vacationers had returned from the beach.

Under stress we imagine patterns that do not exist. A striking real-life example of this phenomenon is reported by Paul Fussell in his astonishing book The Great War and Modern Memory. Troops living in the trenches during the First World War, under the most unimaginable conditions of fear and uncertainty, were deprived of reliable information about the war because the official army newspaper contained little but inaccurate propaganda. In the absence of reliable information, and in desperate need of it, troops fell prey to rumor in a manner not seen since the Middle Ages—rumors of wraithlike spies conversing with frontline troops before disappearing into the mist; of angels in the sky over the Somme; of a factory behind enemy lines called the Destructor where bodies of Allied soldiers were rendered for their fats; of tribes of feral deserters living in no-man’s-land, preying on injured soldiers. Traders during a financial crisis suffer from an equally wretched vulnerability to rumor and suspected conspiracy. Every bank, individually or collectively, at one time or another is going under; hedge funds, huge ones of course, conspiring to push down the markets; the Chinese dumping Treasuries; the UK defaulting on its sovereign debt; broker suicides. Each rumored catastrophe is now given as much credence, and has as much effect on markets, as hard economic data.

Of the conditions affecting traders, a particularly unfortunate one is known as “learned helplessness,” a state in which a person loses all faith in his ability to control his own fate. It has been found that animals exposed repeatedly to uncontrollable stressors may pathetically fail to leave the cage in which this experiment was conducted if the door is left open. Traders, after weeks and months of losses and volatility, may similarly give up, slumping in their chairs and failing to respond to profit opportunities they would only recently have leaped on. In fact there is some evidence suggesting that people like traders might be especially prone to this sort of collapse. Banks and hedge funds commonly select traders for their tough, risk-taking, optimistic attitude.

A telling sign of the onset of learned helplessness is the subsiding of anger on the trading floor, anger being in fact a healthy sign that someone fully expects to be in control. During a crisis, when swearing dies down, fewer phones are smashed, and anger is replaced by resignation, withdrawal and depression, chances are traders have succumbed to learned helplessness. Once stress in the financial world has reached this pathological state, governments must step in, as they did in 2008–9, and do the job that traders can no longer perform—buy risky assets, reduce credit risk, lead the traders, now reduced to a shell-shocked state, out of the slough of despond.

Data on the financial industry is sparse, but private health insurance companies throughout the United States and the United Kingdom reported a surge in claims for peptic ulcers, stress and depression after the credit crisis began in the autumn of 2007. In July 2008, for example, British United Provident Association Ltd., the United Kingdom’s largest private health insurer, reported that the number of employees from financial institutions seeking treatment for stress and depression had risen 47 percent from a year earlier. The World Health Organization also warned about the rise of mental-health problems and suicide with the advent of the credit crisis and the subsequent recession. Recently, a few years after the event, we are starting to get hard epidemiological data on the fallout from the credit crisis. One study has found that during 2007–9 there was a spike in the rate of heart attacks in London, and this occurred against a backdrop of a decreasing incidence of heart attacks in the rest of the UK. The authors estimate that this surge in heart attacks in London led to an additional two thousand deaths, and resulted, they suggest, from the impact of the credit crisis on the financial district. A market crash may thus produce not only an economic disaster but also a medical one. In the myriad ways described here, the stress response, as it builds and ramifies over the course of weeks and months, worsens the credit crisis. The bodily response initiated to handle the stres...

Sports scientists know, for instance, that to build lean-muscle mass and expand aerobic capacity athletes must endure a training process that shocks their muscles and taxes their cardiovascular systems, to the point of inflicting mild damage to tissues, and then punctuates this process with periods of rest and recovery. Stress, recovery, stress, recovery—when calibrated to exhaust an athlete’s resources, but only just, and then replenish them, the process can expand the productive capacity of a broad range of cells in the athlete’s body. When coaches time this training regime just right they can tune their athletes so that they arrive on the day of competition with the optimal amount of glucose, hemoglobin, adrenaline, cortisol and testosterone coursing through their arteries. What the scientists studying toughening have found is that a somewhat similar process of challenge and psychological loading followed by recovery can tune our brain and nervous system so that we too approach stressors with resilience and an optimal mix of hormones, neuromodulators and nervous-system activation.

Sports scientists and medical doctors know that our catabolic mechanisms, such as cortisol-producing cells, must be kept on a short leash. To repeat, a catabolic hormone is one that breaks down energy stores, such as muscle, for immediate use. Cortisol, as mentioned, is thus crucial in supplying us with energy when we mount an all-out physical or mental effort, but it is in many ways too powerful, and should be administered sparingly. By breaking down muscles and converting them into immediately usable forms of energy, cortisol in effect strip-mines our body for nutrients. If it is not turned off quickly, after a few days, a couple of weeks at the most, our body begins to disintegrate under its caustic influence. We come to suffer, as surveyed in the previous chapter, a broad range of physical ailments, as well as anxiety and a tendency to view events as threats rather than challenges.

It is during our downtime, when catabolism is turned off, that anabolic hormones step in and rebuild our depleted energy stores so that we have fuel to draw on next time we are called into action. These anabolic hormones include testosterone and growth hormone, which together convert amino acids into muscle and calcium into bone; insulin, which removes excess glucose from the blood and deposits it in the liver; and a chemical called insulin-like growth factor (IGF), which rejuvenates cells throughout the body and brain. A healthy person, and to a greater extent a tempered athlete, will have a high ratio of anabolic to catabolic hormones, a ratio known as the growth index. A high growth index indicates a robust capacity to rebuild one’s body after a period of destruction, a condition that Bruce McEwen, together with Elissa Epel and Jeannette Ickovics, has termed “thriving.”

In reptiles, the vagus orchestrates a primitive reaction to threat—freezing into a motionless state. Reptiles freeze in order to conserve their limited energy and avoid detection. This freeze response was subsequently passed on to mammals, in which it proved useful as a way of feigning death when a threat loomed. Something like the freeze response is also activated in mammals living or feeding in water, such as seals, in order to slow heart rate and metabolism and conserve oxygen when diving to great depths. The vagal freezing response lingers to this day in most mammals, and can show up under circumstances of extreme danger. When escape from a predator is deemed impossible, a mammal can call on this ancient reaction, and its physiological systems will more or less shut down. Movement ceases, breathing slows, heart rate drops, sensitivity to pain decreases—pathetically, the animal may provoke cardiac arrest and die from its own reaction to threat rather than from the predator itself. Something like this phenomenon has been observed in wild rodents trapped in water they fear they cannot escape. These poor animals, realizing the futility of struggle, frequently opt for freezing and cardiac arrest, some of them even diving into the depths, drowning themselves. Presumably they do so to trigger a dive-induced freezing, leading to a rapid and painless death.

Today we harbor within our bodies all three vagal reactions. Each of these may be initiated when we are caught in an escalating confrontation, beginning with the most recently evolved one, and then proceeding to the older ones. Our first reaction to a challenge is accordingly social engagement, in other words, talking, making eye contact, calming down the situation. If this diplomacy fails then we reluctantly fall back on the older fight-or-flight reaction. Should even this fail and neither victory nor escape from the threat proves possible, then we may lapse into the ancient reptilian state of freezing or giving up or feigning death or in extreme and very rare cases dying a voodoo death. In the course of this confrontation we have regressed millions of years in evolutionary time.

One type of toughening regime is especially intriguing, and that is exposure to cold weather, even to cold water. Scientists have found that rats swimming regularly in cold water develop the capacity to mount a quick and powerful arousal, relying on adrenaline more than cortisol, and to switch it off just as quickly. When subsequently exposed to stressors they are not as prone to learned helplessness. Some tentative research has suggested that much the same thing occurs in humans. People who are regularly exposed to cold weather or who swim in cool water may have undergone an effective toughening regime that has made them more emotionally stable when confronted by prolonged stress. It is surmised by some researchers that the exercise itself, coupled with acute thermal demands, provides these people with an enviable pattern of stress and recovery. Perhaps the same effects could result from the Nordic practice of a sauna followed by a cold plunge.

Thermal stress is a natural part of our life, so if it is eliminated a fundamental part of our physiology may atrophy. The great physiologist Walter Cannon hinted at something like this back in the 1920s. Displaying an extraordinary prescience, he worried about the advent of central heating, air conditioning and hot running water, because these conveniences threatened to deprive us of the opportunity of exercising our systems of thermoregulation. “It is not impossible,” Cannon warned, “that we lose important protective advantages by failing to exercise these physiological mechanisms, which were developed through myriads of generations of our less favored ancestors. The man who daily takes a cold bath and works until he sweats may be keeping ‘fit,’ because he is not permitting a very valuable part of his bodily organization to become weakened and inefficient by disuse.” Today we may be paying a high price for our modern comforts. In fact, Cannon’s fears of a decline in fitness may have been justified: recent evidence suggests that the widespread adoption of climate control in home, car and office may be one cause of the current obesity epidemic. The disappearance of thermal stress from our lives may have another unintended consequence: it may have largely eliminated a valuable toughening process.

This guy was way ahead of his time.

In a novel situation we do not know what to expect, so our body mounts a preparatory stress response. That much is perfectly understandable. What is less obvious is that it does not seem to matter whether the novelty is welcome or dreaded, for either can exacerbate chronic stress. This conclusion emerged from a study by two psychiatrists who compiled a list of life-changing events, known as the Holmes and Rahe Social Readjustment Rating Scale, which they used to predict future illness and death. They found that all the obvious stressors, such as divorce, the death of a spouse or financial difficulties, predicted a heightened risk of illness and death. But also high on their list were more welcome changes, such as marriage, the birth of a child, a change of job or, incredibly, outstanding personal achievement. While these events were no doubt welcome, they added novelty to the lives of the recipients, and that could later take a toll on their health. Our complete unawareness of the damage being inflicted on us at such times is one reason hypertension and heart disease are called silent killers.

Findings such as these can change the way we handle chronic stress. When we are mired in stress, what we desperately need to do is minimize the novelty in our lives. We need familiarity. But quite often we seek out the exact opposite, responding to chronic stress at work, for example, by taking a vacation in some exotic place, thinking that the change of scenery will do us good. And under normal circumstances it does. But not when we are highly stressed, because then the novelty we encounter abroad can just add to our physiological load. Instead of traveling, we may be better off remaining on home turf, surrounding ourselves with family and friends, listening to familiar music, watching old films. Exercise, of course, can help, in fact there are few things better at preparing our physiology for stress. But when someone is this far into chronic stress its effects, suggests Stephen Porges, are mostly analgesic, possibly because exercise treats us to a shot of natural opioids. Again, what we really need is familiarity.

As we have seen, the dive reflex, triggered when you splash or submerge your face in cold water, can engage the vagus and slow the heart, breathing and metabolism. Breathing exercises, involving slow, deep breaths from the diaphragm, rather than short, shallow ones from the chest, can also bring the vagus online, as will similar practices, suggest Porges, such as “playing wind instruments, singing, and even expanding the duration of phrases when talking—all will have a profound effect on vagal influences to the heart.” The calming effect of controlled breathing is a well-known biofeedback practice. It also forms an important part of yoga, meditation and some Eastern religions, especially the Buddhist art of mindfulness, in which mind and body are united through a focused attention on breathing. This exercise may have further benefits: the neuroscientist Read Montague and his colleagues have found that people practicing Buddhist meditation engaged their gut feelings more than others, and as a result made more rational choices in a financial decision-making task. Research into stress, the vagus and gut feelings is in this way building a bridge between East and West. We have only just started to understand and harness the power of the vagus nerve. Can we increase vagal tone? Can we train this nerve to come online sooner and act more powerfully, so we rely less on the metabolically expensive fight-or-flight response, or worse, the full stress response, with its attendant high ...

Another powerful antidote to the physical damage wrought by uncertainty and uncontrollability is social support. A circle of close friends and family, and a supportive management team at work, can be a particularly potent force in mitigating the damage of stress. Just how potent became apparent from a study on stress and mortality conducted in Sweden. The researchers interviewed 752 men, asking them to indicate how many serious life events had occurred to them recently, such as divorce, being fired or financial troubles. Seven years later, the researchers followed up on the men. The death rate among those who had reported being chronically stressed was three times higher than among those who had reported no stress. However, among the men who did report stress, those who had a supportive circle of friends and family showed no correlation at all between the stressful life events and increased mortality.

Middle management during crises often acts like those dominant monkeys that, when subjected to stress, take to bullying juniors. Senior management should therefore restrain middle managers from venting their frustration on traders (and salespeople), no matter how hard that is, no matter how deserving of termination they may be. If this sounds as if I am arguing for a cozy and supportive atmosphere for traders who may well have helped blow up our financial system, I am not. I am concerned rather with stabilizing risk preferences among a financial community that may develop, as a crisis wears on, into a clinical population. Once that happens, the entire economy suffers.

Tortoise makes his employing bank $10 million a year for five years, and receives a yearly bonus of $1 million. Hare makes $100 million a year for four years, receives a yearly bonus of $20 million—the higher percentage payout is to keep this star from leaving for a hedge fund—but in the fifth year loses $500 million and receives no bonus. Despite Hare’s huge loss, he does not have to repay his past bonuses. Doing our sums, we find that at the end of five years Tortoise has made the bank $50 million and has been paid $5 million, while Hare has lost the bank $100 million yet has pocketed $80 million.

The fable of the two traders is simple enough, yet the strategic calculation underlying Hare’s choice of trading style has acted like an acid eating away at the integrity of our financial system. Anyone taking risks soon realizes that his interests lie in maximizing the volatility of his trading results and the frequency of his bonus payments. This strategy increases his chances of being paid at “high-water marks,” like the years when Hare made the bank $100 million. And what works for traders also works for their managers, and even the bank’s CEO: all have concluded that to maximize their long-term wealth they should focus on short-term profits. Besides, if next year all the Hares blow up, then all the banks blow up together, and no single person or bank looks bad. Perhaps most dangerous of all, though, is that with the backing of management, traders opting for Hare’s strategy are given the freedom to increase their risk just when the system least needs it, during bull markets. In this way risk-management and the insidious logic of bonus calculations work to amplify the destabilizing biology of risk taking. One way to tame these tidal waves of risk taking and keep life on the trading floor safely between the tidelines is to institute a bonus scheme that pays traders once a business cycle (approximately four to five years), instead of once a year. If traders are profitable over a few years, they can begin to draw on their bonus pool. But if, like Hare, they lose all their ...

In short, nature and nurture, biology and management, both contribute to creating financial crises, and both need to be addressed if we are to mitigate them. I and my colleagues found evidence that management has more than enough clout to tame the beasts lurking within risk takers. For we found, in one of the studies previously mentioned, both high testosterone levels and high Sharpe Ratios (i.e., high profits relative to the risk taken) in the same traders. How can that be? If testosterone increases a trader’s appetite for risk, could it not just as easily lead to rogue trading? Probably. But on the floor where we carried out the study, the managers employed a draconian risk-management system—pulling the plug quickly on losing trades and telling traders to sit on their hands when not in the zone—combined with a profit-sharing scheme, and this had effectively harnessed the traders’ risk appetite. On this trading floor, nature and nurture combined to encourage prudent and profitable risk taking. In trading, as in sports, we concluded, biology needs the guiding hand of experience and well-structured incentives.