Daily Management Review

Brain can be Trained for Trading – Really!


Brain can be Trained for Trading – Really!
When a stock market trader decides to put a bet on a stock, does he do that with his gut feeling or rationally evaluate the probabilities that the price will rise before you pull the trigger on a trade?
This is one question that has tormented analysts over the years.
One might be inclined to believe that mysterious X-factor some traders appear to have is rooted in a superior gut feeling that such traders possess. However pictures of people’s brains while they were evaluating trades were taken by researchers at the California Institute of Technology a few years ago.
And it was revealed that one probably opted for that gut feeling a lot despite being rational.
Which brain structures are associated with particular activities can be identified by neuroscientists using fMRI scans. For this experiment, researchers might have asked volunteers to solve a math problem while they are put in a machine to find out which part of the brain gets activated during such mental exercises. Researchers found that the activation occurred in parts of the brain associated with something psychologists call “theory of mind” by the math-related structures.
The ability to read other people is defined by this. “It’s a viewpoint on what another person is thinking and feeling and what they’re likely to do,” says Denise Shull, founder of the ReThink Group, a New York research and consulting firm that coaches financial professionals and athletes. Shull says that to process experiences in the world, humans unconsciously use theory of mind all the time.
Researchers set up a stylized market in the Caltech experiment which was published in details in “Exploring the Nature of Trader Intution” - a paper published in the Journal of Finance in 2010.
In a series of sessions, the researchers had participants trade two “stocks”. The portion of the payout that would come from each stock was revealed only after the session ended and the payoff from the two stocks together was fixed at 50¢. For example, one might pay 1¢ and the other would pay 49¢.
While in some sessions, participants were given a hint about what the payoffs would be, in other sessions, no additional information about the payoffs was given to the participants. Those participants might bid up one of the stocks based on that hint.
The sessions were videotaped and the trading during those sessions took place electronically. A different group of subjects watched replays later. The subjects were asked to predict what the next price would be after a researcher stopped the video. The observers could infer information about how stocks would move just from watching the prices and flow of orders in the sessions where some traders were acting on hints about the payoff.
The observers had engaged the theory-of-mind-related parts of their brains, showed the fMRI scans is the explanation. Also, the observers who were better at predicting prices did better on separate tests of theory-of-mind abilities.
Explanations of how uninformed traders infer new information and act on it in such a way that prices quickly come to fully reflect it was provided by the theory of mind.
Subsequent research also supports the idea that theory of mind may explain how information flows through markets, says Peter Bossaerts, an author of the Caltech study who’s now a professor of experimental finance and decision neuroscience at the University of Melbourne. “We have more evidence for it,” he said citing papers that show connections between theory of mind and market bubbles.
According to ReThink’s Shull, the mysterious X-factor isn’t such a mystery after all.

“I would describe the X-factor of risk judgment as part of a suite of emotional competencies that extends from knowledge to recognition to understanding,” she says.
Shull says that the mind is trainable. There’s a conscious version of the same type of processing, which she calls cognitive empathy although theory of mind is unconscious, Shull says. “Cognitive empathy is thinking about it and trying to do it intentionally, and that’s where you can train yourself,” she says.
“Cognitive empathy is thinking about it and trying to do it intentionally, and that’s where you can train yourself,” she says.