For a long time, economics as a science never considered the impact of our biochemistry and thinking patterns on financial decisions. Behaviour was thought to be driven by a rational mind; specifically it was believed that people are capable to efficiently measure the rewards and costs of every possible decision with the precision of a computer. For that reason, the markets have to be rational too. The impulsivity or irrationality that often governs our private lives has no connection to finance, for finance and the word “money” can render our emotional self into a faultless calculator.
There is a certain sense of triumph emanating from this model of economics. We are capable, we are in control, logic is all that’s needed.
Unfortunately, there is plenty of disproving evidence against the rational mind-rational markets theory. Otherwise, how would we explain the countless irrational choices that we made as investors? Why, if a rational mind governs, we so often ended up to a market crash or a market bubble?
Well, because human nature is not only rational but also emotional. And we do not only have a mind but also a body.
Mind and body are so closely interconnected that it would be a fundamental error to ignore their influence on every aspect of our life, including finance,trading and investing.
Body, hormones and trading
In Forex Trading, as in other forms of trading, the biochemical mechanism that drives our thinking patterns, emotions,attitudes and decisions involves our hormones and in particular, testosterone and cortisol.
John Coates, Wall Street trader and neuroscientist, in his book “The hour between dog and wolf; Risk taking,gut feelings and the biology of boom and bust” writes:” During moments of risk taking, competition and triumph,of exuberance, there is one steroid in particular that makes its presence felt and guides our actions-testosterone.” He believes that the rise of testosterone also impacts financial markets and calls testosterone “the irrational exuberance molecule”. He also states that cortisol could be the candidate of the “molecule of irrational pessimism” and goes on explaining its action in financial settings. His book is a compelling read for anyone interested in the biology and psychology of trading and has inspired the infographic below.