Risky Trading As An Addictive High, Say Researchers

 

Every couple of years, a rogue trader, such as Jerome Kerviel of Societe Generale, bursts on the scene when losses in the billions are uncovered. Such a person is always considered a fluke, since normal people would not take such risks. According to a recent article by Jenny Anderson in The New York Times, however, the emerging field of neurofinance, combining psychology, neuroscience, and economics, reveals that there may be a bit of a rogue trader in each of us. Scientists in this field have discovered that people are hard-wired for money. People respond to high-stakes trading just as they would to the lure of sex or even drug addiction. The riskier the trades get, the more the brain craves the activity.

Brian Knutson, a professor of psychology and neuroscience at Stanford University, is a pioneer in neurofinance who is examining how the brain makes decisions. Knutson’s studies reveal that people sometimes get high on making money. “The more you think you can gain from the risk, the more you take the risk and the more activation in the circuitry,” Knutson said.

While Wall Street is skeptical of neurofinance, this field is gaining traction in some quarters. One of the findings in Jason Zweig’s book entitled Your Money and Your Brain: How the New Science of Neuroeconomics Can Help Make Your Rich is that the brain images of drug addicts on the verge of taking another hit are identical to those of money-making traders on the verge of placing another trade. Zweig says that repeated success at making money is “very similar to a chemical addiction and it becomes very hard to let go.”

The work of Nobel Prize-winning psychologist Daniel Kahneman demonstrates that individuals do not always act rationally when faced with uncertainty in the midst of making a decision. In fact, contrary to traditional economic thought, individuals faced with loss may actually seek to take more risk rather than less.

Psychiatrist and author Dr. Ari Kiev believes that many traders ? professionals and everyday investors alike ? fail to manage their risk. “It is more common for people to hold onto losers and see their investment go to zero, or shorts go to the sky, than it is for them to practice good risk management and get out.”

As neurofinance becomes better known and more widely accepted, perhaps claimants against brokerage firms may successfully argue that the firm failed to take this propensity for risk into account in supervising its traders and brokers.