Future stock: A pill for trading? February 6, 2006 - newsday.com
Late at night in a basement laboratory at Stanford University, Brian Knutson made a startling discovery: Our brains lust after money, just like they crave sex.
It was May 2004, and Knutson, a professor of neuroscience and psychology at the California university, was sending student volunteers through a high-power imaging machine called an fMRI.
Deep inside each subject's head, electrical currents danced through a bundle of neurons about the size and shape of a peanut. Blood was rushing to the brain's pleasure center as students executed mock stock and bond trades. On Knutson's screen, this region of the brain, the core of human desire, flashed canary yellow.
The pleasure of orgasm, the high from cocaine, the rush of buying a promising stock - the same neural network governs all three, Knutson, 38, concluded.
What's more, our primal pleasure circuits can, and often do, override our seat of reason, the brain's frontal cortex, the professor says.
In other words, stocks, like sex, sometimes drive us crazy.
Knutson says he knows how heretical his findings are.
Wall Street is dedicated to the principle that when it comes to money, logic prevails, that intellect matters in investing. The idea is enshrined in the economic theory of rational expectations, for which Robert Lucas won the Nobel Memorial Prize in Economic Sciences in 1995.
Lucas, a professor of economics at the University of Chicago, maintains that people make economic choices based on all the information available to them and learn from their mistakes. As a result, their expectations about the future - from the price of Citigroup Inc. stock next week to the earnings of General Motors Corp. next quarter - are, on average, accurate.
Why do some have a knack?
Or so the theory goes. In practice, of course, investors do foolish things all the time. Some gamble away fortunes on money-losing investments, doubling down when logic tells them to fold, or letting winnings ride when the rational person would cash out.
Others seem to have an uncanny knack for knowing when to buy and sell.
In the 1970s, Richard Dennis parlayed an initial stake of several thousand dollars into a $200 million fortune trading commodities in the Chicago futures pits. In the 1980s, hedge fund icon Paul Tudor Jones made $80 million by betting against U.S. stocks just before the market crashed. In the 1990s, billionaire investor George Soros, the man who beat the Bank of England, made $1 billion in an afternoon by short-selling the British pound.
The question that keeps nagging Knutson is this: Why do some traders get rich while others walk away losers? The answer, he says, may lie somewhere in the 96,000 kilometers (60,000 miles) of neural wiring inside our brains.
The results of the Stanford study, published in the September issue of Neuron magazine, have caused a stir among the small group of neuroscientists and psychologists who are mapping the human brain in hopes of understanding investor behavior.
New frontier
This controversial field, called neurofinance, may represent the next great frontier on Wall Street, says Daniel Kahneman, who won the 2002 Nobel Prize in economics for his pioneering work in behavioral finance, which fuses classical economic theory and studies of human psychology.
"The brain scientists are the wave of the future in the financial world," Kahneman, 71, says. "If you seek to maximize understanding, whether you're in academia or in the investment community, you'd better pay very serious attention to them." To proponents such as Kahneman, the potential of neurofinance seems virtually limitless.
One day, brain science may help money managers spot shifts in investor sentiment, says David Darst, chief investment strategist for the $700 billion individual investor group at New York-based Morgan Stanley. Armed with brain scans, psychotherapists may be able to hone traders' natural impulses of fear and greed.
Neuroscientists may even develop psychoactive drugs, or neuroceuticals, that make people better, more-profitable traders, Knutson and other psychologists say.
Look at Prozac. In the space of a few years, Prozac and other drugs have not only revolutionized the treatment of depression but also profoundly changed the way we view the mind.
People recognize that chemistry drives their brains, moods and behavior - and that chemistry can change them.
Trader drugs
Similar drugs, ones that improve a trader's decision making by 20 to 30 percent, may be just a few years away, says Zack Lynch, managing director of NeuroInsights, a San Francisco-based consulting firm that tracks the $100 billion neurotechnology industry. If these neuroceuticals work, they could rock Wall Street.
"The whole investment community will be scrambling to get these things," Lynch says.
So far, the hopes and claims of neurofinance have far outpaced its science. Few investment professionals have even heard of the field. Many who have dismiss it as hokum.
"It's the latest malarkey," says Richard Michaud, president of Boston-based New Frontier Advisors LLC, which manages $100 million in assets. Michaud, who has a doctorate in mathematics from Boston University, says neurofinance and its forerunner, behavioral finance, have no place on Wall Street.
"I find these so-called disciplines to be more of a marketing tool, a way of taking an ages-old market valuation problem and calling it something space-age," Michaud says. "I doubt it will be fruitful."
Knutson's response: Just wait. "Investors want to beat the market and become better traders," he says. "The first step is to know how the machinery works. The applications to exploit the machinery will soon follow."
For Wall Street, brain science eventually could mean big money, Morgan Stanley's Darst says. Securities firms spend millions of dollars annually researching companies and crunching numbers in an attempt to predict the financial future.
"Meanwhile, we spend peanuts on human psychology," says Darst, author of "The Complete Bond Book: A Guide to All Types of Fixed-Income Securities" (Random House, 1975).
"We have to take account of the deep atavistic and visceral traits and instincts that are triggering the buying and selling of securities."
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