Bitcoin: Is the Testosterone Market Turning into the Cortisol Market?

Neuroscience researchers have studied the effects of winning streaks on athletes, gamblers and investors. What have they learned? Winning leads to elevated testosterone levels. Which leads to elevated risk-taking.

In his 2012 book, “The Hour Between Dog and Wolf,” neuroscientist and former derivatives trader John Coates discusses how prolonged investment success can distort perceptions of our abilities. According to Coates and other researchers, bull markets and market bubbles may result from a phenomenon known as the “Winner Effect.”

It seems that winning streaks produce a kind of natural narcotic that can transform individual traders -- and even entire financial communities -- into ultra-confident, fearless warriors, primed for even more strenuous battles. Each successive win bathes the competitor’s brain with more euphoria-inducing chemicals, most notably testosterone. And each spike of testosterone leads to a new surge of confidence and risk-taking.

But as this feedback loop of success, testosterone and aggressiveness accelerates, investors can become intoxicated by success, making increasingly irrational and reckless decisions that can eventually result in disaster.

Humans have recognized the pitfalls of extreme success for centuries. It is said that in ancient Rome when a triumphant general paraded through town, a slave rode in the chariot with him holding a human skull -- called a memento mori, “a reminder of death” -- and whispered in the general’s ear: “Remember this, you are mortal.”

The ancient Romans knew that winning streaks can sow the seeds of failure.

What the Romans didn’t know was that the hubris resulting from winning streaks has a chemical basis -- the same hormone that causes men to grow beards also plays a key role in behaviors like aggression and dominance. 

In our hunter-gatherer past, the human brain’s chemical response to success helped ensure that the strongest males survived to pass on their genes. But the “Winner Effect” that 100,000 years ago promoted human survival, now may be promoting financial market bubbles.

The Winner Effect and the Loser Effect

Coates describes the Winner Effect this way:

“Two males enter a fight for turf or a contest for a mate and, in anticipation of the competition, experience a surge in testosterone, a chemical bracer that increases their blood’s capacity to carry oxygen and, in time, their lean-muscle mass. Testosterone also affects the brain, where it increases the animal’s confidence and appetite for risk. After the battle has been decided the winner emerges with even higher levels of testosterone, the loser with lower levels. The winner, if he proceeds to a next round of competition, does so with already elevated testosterone, and this androgenic priming gives him an edge, helping him win yet again.”

Scientists have shown that this testosterone feedback loop is at work in athletes, and may explain winning and losing streaks in sports. For instance, Coates cites a study in which researchers analyzed 630,000 professional tennis matches and found that the winner of the first set had a 60% chance of winning the second set and winning the match itself.

Research suggests the Winner Effect is also at work among traders in financial markets.  

In a real-time trading environment, Coates found that a trader's morning testosterone level predicted his day's profitability. He also found that a trader's cortisol rises with both the variance of his trading results and the volatility of the market. According to Coates, “testosterone and cortisol are known to have cognitive and behavioral effects, so if the elevated steroids were to persist or increase as volatility rises, they may shift risk preferences and even affect a trader's ability to engage in rational choice.”

The upward spiral of the Winner Effect cannot last forever. At some point elevated testosterone begins to have the opposite effect on success and survival. According to Coates, “Animals experiencing this upward spiral of testosterone and victory have been found after a while to start more fights and to spend more time out in the open, and as a result they suffer an increased mortality. As testosterone levels rise, confidence and risk taking segue into overconfidence and reckless behavior.”

It’s interesting to note that women have about 10–20 percent of the testosterone levels of men. Could it be that market winning streaks like the bitcoin surge (“bubble” if you will), driven predominantly by young male investors, are in-part fueled by the Winner Effect and the testosterone feedback loop?

Testosterone is “the hormone of economic bubbles,” and Cortisol, “the hormone of economic busts.” Neuroscientist John Coates

If so, we would expect the testosterone-driven winning streak to eventually become a victim of its own success. Then, as the inevitable losing streak sets in, another chemical rises to prominence – one that causes traders to increasingly focus on risk. While testosterone is the hormone of success, cortisol is the hormone of failure.

Cortisol is secreted by the adrenal glands in response to moments of high physical stress, such as ‘fight or flight’. Cortisol prepares us for possible action by releasing glucose and free fatty acids into the blood. It also suppresses bodily functions not needed during a crisis -- such as the digestive, reproductive, and immune systems.

From an evolutionary point-of-view, cortisol motivates the defeated animal in the Winner Effect to skulk off and lick its wounds. Because another confrontation with the victor could mean death. A series of defeats could result in a cortisol feedback loop, causing the loser to become increasingly cautious.

Importantly, in humans, cortisol has been found to rise powerfully in situations of uncertainty, such as volatility in the financial markets.

In this study published in the journal Proceedings of the National Academy of Sciences, researchers found that elevated cortisol made traders more risk-adverse. This effect was more pronounced in men than women. The study concluded that: “Physiology-induced shifts in risk preferences may be an underappreciated cause of market instability.”

Coates calls testosterone “the hormone of economic bubbles,” and cortisol, “the hormone of economic busts.” Those who remember 2009 and the aftermath of the financial crises (an ever-smaller group), can recall the almost palpable level of risk aversion among investors after so many were bloodied by the markets.

But these days, success – and testosterone -- rules, as investors worldwide celebrate historic winning streaks in many markets. Possibly it’s time for traders to copy the Ancient Romans, and place a memento mori skull on their desks next to their market monitors, lest they become deluded by hubris (and hormones) into taking foolish risks.

Mark Gaffney