There is a conventional belief that our interactions with the financial markets are primarily driven by rational and conscious cognitive processes. However, recent research has shed light on the intricate relationship between interoception and decision-making, offering significant insights for professionals in the financial sector.
Interoception is our ability to detect and interpret subtle signals from our internal bodily systems. These signals are crucial in maintaining physiological homeostasis, ensuring our body's equilibrium. Leading scholars, such as Lisa Feldman Barrett (2016), propose that all mental events, including cognitive processes, emotions, perception, and actions, fundamentally influence the body's constant drive to maintain homeostasis. This perspective suggests that decision-making is inherently connected to bodily experiences and motivated by the body’s imperative to sustain energy balance and survival.
In practical terms, consider the brain a vigilant guardian of your physical well-being. It continually anticipates and satisfies the body's physical needs, whether it's quenching thirst, satisfying hunger, or responding to stress—all in pursuit of maintaining optimal conditions for survival. Within this framework, it becomes evident that decision-making is an embodied process driven by our body's intricate signals and motivated by the necessity to preserve physiological equilibrium. This perspective highlights the significance of physiological sensations in decision-making, often encapsulated in expressions like "gut feeling" or "cold feet."
In financial trading, where precise and timely decisions are paramount, "gut feelings" or, more technically, interoceptive sensations play a vital role in our decision-making without our conscious awareness. These sensations originate from various bodily organs, including the heart, lungs, and gastrointestinal. They encompass a spectrum of cues, from fluctuations in temperature to breathlessness, heightened heart rate, and digestive signals. Importantly, these sensations operate outside the realm of conscious awareness.
Nevertheless, these subtle physiological cues hold profound significance, particularly in high-stakes trading scenarios. During these critical moments, our body orchestrates rapid and nuanced physiological adjustments, providing real-time feedback to the brain. This feedback, often unspoken but keenly felt, directly influences our trading decisions. It acts as a compass, steering us away from choices that may result in financial losses and guiding us toward options with the profit potential. What's remarkable is that this intuitive process empowers us to make crucial decisions before we can consciously articulate the underlying rationale.
Financial traders frequently emphasise the significance of "gut feelings" when selecting profitable trades. To empirically substantiate this notion, a pioneering study conducted by researchers from the Universities of Cambridge and Sussex in the UK, in collaboration with Queensland University of Technology in Australia, undertook a comparative analysis of the interoceptive abilities of financial traders against a control group of non-traders—their findings, published in Scientific Reports, illuminate insights into the nexus between physiology and financial success.
The study recruited 18 male traders from a hedge fund specialising in high-frequency trading, a domain that demands rapid assimilation of information, swift recognition of price patterns, and high-stakes decisions executed within fractions of a second. Thriving in this arena poses formidable challenges; while successful traders can amass substantial earnings exceeding £10 million per year, those who fail to generate profits are swiftly displaced.
What elevates this study to a level of particular intrigue is its temporal context – unfolding against the backdrop of the Eurozone crisis, a period characterised by profound financial uncertainty. This unique circumstance facilitated the evaluation of each trader's capacity to accrue profits during volatile periods. The researchers gauged individual disparities in traders' abilities to detect subtle changes in their physiological state by employing established heartbeat detection tasks quantifying the traders' degree of interoceptive awareness. Subsequently, these scores were contrasted with data from 48 students at the University of Sussex, serving as the control group.
The outcomes were striking. Financial traders significantly outperformed the control group in the heartbeat detection tasks, registering a mean score of 78.2, surpassing the control group's score of 66.9. Even more compellingly, among the traders, those who excelled in the heartbeat detection tasks also demonstrated superior trading performance, ultimately yielding higher profits. However, the most intriguing finding is that an individual's interoceptive ability has the potential to predict their endurance in the financial markets. The researchers unveiled a direct association by correlating heartbeat detection scores with years of experience in the field.
These findings emphasise the importance of instincts or "gut feelings" when making risky decisions and suggest that traders may unknowingly leverage valuable physiological signals in their trading strategies. While these results align with recent studies suggesting that heartbeat detection skills indicate effective risk-taking, the researchers acknowledge the potential existence of alternative explanations. For instance, some studies propose that heartbeat detection ability escalates during stressful situations, potentially leading to the inference that traders with heightened interoceptive skills might be exposed to greater stress levels due to their engagement in more substantial risks. Nonetheless, the authors of this study consider this scenario unlikely, given that experienced traders, who generally exhibit greater control, often experience lower stress levels than novices.
These discoveries directly challenge the established 'Efficient Markets Hypothesis' (EMH) within economic theory. The EMH contends that financial markets are inherently stochastic and fully assimilate all available information, suggesting that no individual trait or skill can enhance the performance of an investor or trader. The idea that a significant portion of a trader's performance in financial markets is intricately linked to their physiological makeup carries profound implications for our understanding of financial systems.
In economics and finance, conventional models have traditionally focused on conscious reasoning and cognitive elements. However, it’s imperative to undergo a paradigm shift towards a more holistic perspective that explores the dynamic interplay between the body and the mind. To better understand risk-takers' performance, we must delve deeper into their physiological responses and adeptness in deciphering signals from their bodily systems. Although this perspective may be well-recognised by medical practitioners, it has, somewhat surprisingly, remained inconspicuous within the purview of economists.
Andrew Lo, a distinguished financial economist and professor at MIT Sloan School of Management, resonates with these viewpoints. He has achieved prominence for critically examining the EMH's assumptions and postulations. In particular, Lo has questioned the stringent interpretations of the EMH, offering an alternative framework known as the Adaptive Markets Hypothesis. His argument contends that market participants do not adhere strictly to rational or irrational behaviour but adapt their actions in response to shifting market conditions and personal experiences. This adaptive conduct can result in fluctuations in market efficiency over time. Moreover, Lo has been a proponent of behavioural finance. This field delves into how psychological and emotional factors can give rise to market inefficiencies, highlighting that investors are occasionally rational, and their actions may deviate from the predictions of traditional financial models.
The findings of this study offer a profound perspective on the relationship between success in the financial domain and the subtle signals emanating from our physical existence. Understanding and harnessing the power of interoceptive sensations can be a differentiator for traders seeking an edge. It's about acknowledging the intricate interplay between body and mind and leveraging this understanding to navigate the complexities of financial markets with greater precision and insight.
References:
Kandasamy, N., Garfinkel, S. N., Page, L., Hardy, B., Critchley, H. D., Gurnell, M., & Coates, J. M. (2016). Interoceptive ability predicts survival on a London trading floor. Scientific Reports, 6(1). https://doi.org/10.1038/srep32986
