JOHN COATES

The Hour Between

Dog and Wolf

Risk-Taking, Gut Feelings

and the Biology of Boom and Bust

Dedication

For Ian, Eamon, Iris and Sarah

Epigraph

[The hour] between dog and wolf, that is, dusk, when the two can’t be distinguished from each other, suggests a lot of other things besides the time of day … The hour in which … every being becomes his own shadow, and thus something other than himself. The hour of metamorphoses, when people half hope, half fear that a dog will become a wolf. The hour that comes down to us from at least as far back as the early Middle Ages, when country people believed that transformation might happen at any moment.

JEAN GENET, PRISONER OF LOVE (1986, TRANS. BARBARA BRAY)

Contents

Cover

Title Page

Dedication

Epigraph

PART I : MIND AND BODY IN THE FINANCIAL MARKETS

Introduction

1 : The Biology of a Market Bubble

2 : Thinking with Your Body

PART II : GUT THINKING

3 : The Speed of Thought

4 : Gut Feelings

PART III : SEASONS OF THE MARKET

5 : The Thrill of the Search

6 : The Fuel of Exuberance

7 : Stress Response on Wall Street

PART IV : RESILIENCE

8 : Toughness

9 : From Molecule to Market

Acknowledgements

Notes

Further Reading

Index

Copyright

About the Publisher

When you take risks, you are reminded in the most insistent manner that you have a body. For risk by its very nature threatens to hurt you. A driver speeding along a winding road, a surfer riding a monster wave as it crests over a coral reef, a mountain climber continuing his ascent despite an approaching blizzard, a soldier sprinting across no-man’s land – each of these people faces a high chance of injury, even death. And that very possibility sharpens the mind and calls forth an overwhelming biological reaction known as the ‘fight-or-flight’ response. In fact, so sensitive is your body to the taking of risk that you can be caught up in this visceral turmoil when death poses no immediate threat. Anyone who plays a sport or watches from the stands knows that even when it is ‘just a game’, risk engages our entire being. Winston Churchill, a hardened campaigner from the most deadly wars, recognised this power of non-lethal risk to grip us, body and mind. When writing of his early years, he tells of a regimental polo match played in southern India that went to a tie-break in the final chukka: ‘Rarely have I seen such strained faces on both sides,’ he recalls. ‘You would not have thought it was a game at all, but a matter of life and death. Far graver crises cause less keen emotion.’

Similar strong emotions and biological reactions can be triggered by another form of non-lethal risk – financial risk-taking. With the exception of the occasional broker suicide (and these may be more myth than reality), professional traders, asset managers and individuals investing from home rarely face death in their dealings. But the bets they place can threaten their job, house, marriage, reputation and social class. In this way money holds a special significance in our lives. It acts as a powerful token distilling many of the threats and opportunities we have faced over eons of evolutionary time, so making and losing it can activate an ancient and powerful physiological response.

In one important respect, financial risk carries even graver consequences than brief physical risk. A change in income or social rank tends to linger, so when we take risks in the financial markets we carry with us for months, even years after our bets have settled, an inner biological storm. We are not built to handle such long-term disturbances to our biochemistry. Our defence reactions were designed to switch on in an emergency and then switch off after a matter of minutes or hours, a few days at the most. But an above-average win or loss in the markets, or an ongoing series of wins or losses, can change us, Jekyll-and-Hyde-like, beyond all recognition. On a winning streak we can become euphoric, and our appetite for risk expands so much that we turn manic, foolhardy and puffed up with self-importance. On a losing streak we struggle with fear, reliving the bad moments over and over, so that stress hormones linger in our brains, promoting a pathological risk-aversion, even depression, and circulate in our blood, contributing to recurrent viral infections, high blood pressure, abdominal fat build-up and gastric ulcers. Financial risk-taking is as much a biological activity, with as many medical consequences, as facing down a grizzly bear.

This statement about biology and the financial markets may sound strange to ears accustomed to the teachings of economics. Economists tend to view the assessment of financial risk as a purely intellectual affair – requiring the calculation of asset returns, probabilities, and the optimal allocation of capital – carried on for the most part rationally. But to this bloodless account of decision-making I want to add some guts. For recent advances in neuroscience and physiology have shown that when we take risk, including financial risk, we do a lot more than just think about it. We prepare for it physically. Our bodies, expecting action, switch on an emergency network of physiological circuitry, and the resulting surge in electrical and chemical activity feeds back on the brain, affecting the way it thinks. In this way body and brain twine as a single entity, united in the face of challenge. Normally this fusion of body and brain provides us with the fast reactions and gut feelings we need for successful risk-taking. But under some circumstances the chemical surges can overwhelm us; and when this happens to traders and investors they come to suffer an irrational exuberance or pessimism that can destabilise the financial markets and wreak havoc on the wider economy.

To give you a mere inkling of how this physiology works, I am going to take you onto the trading floor of a Wall Street investment bank. Here we will observe a high-stakes world where young bankers can step up or down a full social class in the space of a single bonus season, one year buying a beach house in the Hamptons, the next pulling their kids out of private school. So consider if you will the following scenario, in which an unanticipated and important piece of news impacts an unsuspecting trading floor.

INCOMING!

It has been said of war that it consists of long stretches of boredom punctuated by brief periods of terror, and much the same can be said of trading. There are long stretches of time when little more than a trickle of business flows in through the sales desks, perhaps just enough to keep the restless traders occupied and to pay the bills. With no news of any importance coming across the wire, the market slows, the inertia feeding on itself until price movement grinds to a halt. Then, people on a trading floor disappear into their private lives: salespeople chat aimlessly with clients who have become friends, traders use the lull to pay bills, plan their next ski trip, or talk to headhunters, curious to know their value on the open market. Two traders, Logan, who trades mortgage-backed bonds, and Scott, who works down the aisle on the arbitrage desk, toss a tennis ball back and forth, taking care not to hit any salespeople.

This afternoon the Federal Reserve is holding a meeting of its Board of Governors, and normally these events are accompanied by market turbulence. It is at these meetings that the Fed decides whether to raise or lower interest rates, and should it do so it announces its decision at 2.15 p.m. Even though the economy has been growing at a healthy clip and the stock market has been unseasonably, even irrationally, strong, the Fed has dropped few hints of an increase. So today it is widely expected to leave rates unchanged, and by late morning most people across the trading floor haven’t a worry on their minds, and think of little else but whether to order sushi or pasta for lunch.

But just before noon there comes the merest breath of change, rippling the surface of prices. Most people on the floor do not consciously notice it, but the slight tremor registers none the less. Maybe their breathing quickens, maybe muscles tense just a bit, maybe arterial blood pressure increases ever so slightly. And the sound of the floor shifts, from the quiet buzz of desultory conversation to a mildly excited chatter. A trading floor acts as a large parabolic reflector, and through the bodies of its thousand-odd traders and salespeople it gathers information from faraway places and registers early signals from events that have yet to happen. The head of the trading floor looks up from his papers and steps out of his office, surveying the floor like a hunting dog sniffing the air. An experienced manager can sense a change in the market, tell how the floor is doing, just from the sight and sound of it.

Logan stops in mid-throw and looks over his shoulder at the screens. Scott has already wheeled his chair back to his desk. Their monitors display thousands of prices and flowing news feeds, blinking and disappearing. To outsiders the vast matrix of numbers seems chaotic, overwhelming, and finding the significant bit of information in the mess of prices and irrelevant news items seems as impossible as picking out a single star in the Milky Way. But a good trader can do just that. Call it a hunch, call it gut feeling, call it tradecraft, but this morning Scott and Logan have sensed a kaleidoscopic shift in price patterns well before they can say why.

One of the brain regions responsible for this early-warning system is the locus ceruleus (pronounced ser-u-leus), so called because its cells are cerulean, or deep blue. Situated in the brain stem, the most primitive part of the brain, sitting atop the spine, the locus ceruleus responds to novelty and promotes a state of arousal. When a correlation between events breaks down or a new pattern emerges, when something is just not right, this primitive part of the brain registers the change long before conscious awareness. By doing so it places the brain on high alert, galvanising us into a state of heightened vigilance, and lowering our sensory thresholds so that we hear the faintest sound, notice the slightest movement. Athletes experiencing this effect have said that when caught up in the flow of a game they can pick out every voice in the stadium, see every blade of grass. And today when the stable correlations between asset prices broke down the locus ceruleus tripped an alarm, causing Scott and Logan to orient to the disturbing information.

Moments after Scott and Logan have pre-consciously registered the change, they learn that one or two people on the Street have heard, or suspected, that the Fed will raise interest rates this afternoon. Such a decision announced to an unprepared financial community would send a tidal wave of volatility through the markets. As the news and its implications sink in, Wall Street, only a short while ago looking forward to calling it an early day, roils with activity. At hastily organised meetings traders consider the possible Fed moves – will it leave rates unchanged? Raise them a quarter of a percentage point? Half a per cent? What will bonds do under each scenario? What will stocks do? Having formed their views, traders then jostle to set their positions, some selling bonds in anticipation of a rate hike, which pushes the market down almost 2 per cent, others buying them at the new lower levels, convinced the market is oversold.

Markets feed on information, and the Fed announcement will be a feast. It will bring volatility to the market, and volatility to a trader means a chance to make money. So this afternoon most traders exude excitement, and many of them will make their entire week’s profit in the next few hours. Around the world bankers stay up to hear the news, and trading floors now buzz with a ludic atmosphere more commonly found at a fair or sporting event. Logan warms to the challenge and with a rebel yell dives into the seething market, selling $200 million of mortgage bonds, anticipating an exciting ride down.

By 2.10, trading on the screen dwindles. The floor goes quiet. Across the world traders have placed their bets, and now wait. Scott and Logan have readied their positions and feel intellectually prepared. But the challenge they face is more than an intellectual puzzle. It is also a physical task, and to perform it successfully they require a lot more than cognitive skills. They also need fast reactions, and stamina enough to support their efforts for the hours ahead when volatility spikes. What their bodies need, therefore, is fuel, lots of it, in the form of glucose, and they need oxygen to burn this fuel, and they need an increased flow of blood to deliver this fuel and oxygen to gas-guzzling cells throughout the body, and they need an expanded exhaust pipe, in the form of dilated bronchial tubes and throat, to vent the carbon dioxide waste once the fuel is burned.

Consequently Scott and Logan’s bodies, largely unbeknownst to them, have also prepared for the event. Their metabolism speeds up, ready to break down existing energy stores in liver, muscle and fat cells should the situation demand it. Breathing accelerates, drawing in more oxygen, and their heart rates speed up. Cells of the immune system take up position, like firefighters, at vulnerable points of their bodies, such as the skin, and stand ready to deal with injury and infection. And their nervous system, extending from the brain down into the abdomen, has begun redistributing blood throughout their bodies, constricting blood flow to the gut, giving them the butterflies, and to the reproductive organs – since this is no time for sex – and shunting it to major muscle groups in the arms and thighs as well as to the lungs, heart and brain.

As the sheer potential for profit looms in their imaginations, Scott and Logan feel an unmistakable surge of energy as steroid hormones begin to turbo-charge the big engines of their bodies. These hormones take time to kick in, but once synthesised by their respective glands and injected into the bloodstream, they begin to change almost every detail of Scott and Logan’s body and brain – their metabolism, growth rate, lean-muscle mass, mood, cognitive performance, even the memories they recall. Steroids are powerful, dangerous chemicals, and for that reason their use is tightly regulated by law, by the medical profession, by the International Olympic Committee, and by the hypothalamus, the brain’s ‘drug enforcement agency’; for if steroid production is not turned off quickly it can transform us, body and mind.

From the moment the rumour first spread, and over the past couple of hours, Scott and Logan’s testosterone levels have been steadily climbing. This steroid hormone, naturally produced by the testes, primes them for the challenge ahead, just as it does athletes preparing to compete and animals steeling for a fight. Rising levels of testosterone increase Scott and Logan’s haemoglobin, and consequently their blood’s capacity to carry oxygen; the testosterone also increases their state of confidence and, crucially, their appetite for risk. For Scott and Logan, this is a moment of transformation, what the French since the Middle Ages have called ‘the hour between dog and wolf’.

Another hormone, adrenalin, produced by the core of the adrenal glands located on top of the kidneys, surges into their blood. Adrenalin quickens physical reactions and speeds up the body’s metabolism, tapping into glucose deposits, mostly in the liver, and flushing them into the blood so that Scott and Logan have back-up fuel supplies to support them in whatever trouble their testosterone gets them into. A third hormone, the steroid cortisol, commonly known as the stress hormone, trickles out of the rim of the adrenal glands and travels to the brain, where it stimulates the release of dopamine, a chemical operating along neural circuits known as the pleasure pathways. Normally stress is a nasty experience, but not at low levels. At low levels it thrills. A non-threatening stressor or challenge, like a sporting match, a fast drive or an exciting market, releases cortisol, and in combination with dopamine, one of the most addictive drugs known to the human brain, it delivers a narcotic hit, a rush, a flow that convinces traders there is no other job in the world.

Now, at 2.14, Scott and Logan lean into their screens, gaze steady, pupils dilated; heart rates drop to a slow idle; their breathing rhythmic and deep; muscles coiled; body and brain fused for the impending action. An expectant hush descends on global markets.

THE INSIDE STORY

In this book I tell the story of Scott and Logan, of Martin and Gwen, and of a trading floor of supporting characters, as they are caught in the floodtide of a bull and then a bear market. The story will consist of two threads: a description of overt trading behaviour – how professional traders make and lose money, the euphoria and stress that accompany their changing fortunes, the calculations behind bonus payments – and a description of the physiology behind the behaviour. The threads will, however, lace together, forming a single story. Splicing the two will enable us to see how brain and body act as one during important moments in a risk-taker’s life. We will explore pre-conscious circuits of the brain and their intimate links with the body in order to understand how people can react to market events so fast that their conscious brain cannot keep up, and how they draw on signals from the body, the fabled gut feelings, to optimise their risk-taking.

Despite the traders’ frequent successes, the story follows the narrative arc of tragedy, with its grim and unstoppable logic of overconfidence and downfall, what the ancient Greeks called hubris and nemesis. For human biology obeys seasons of its own, and as traders make and lose money they are led almost irresistibly into recurrent cycles of euphoria, excessive risk-taking and crash. This dangerous pattern repeats itself in the financial markets every few years. Alan Greenspan, former chairman of the US Federal Reserve, puzzled over this periodic folly, and wrote of ‘innate human responses that result in swings between euphoria and fear that repeat themselves generation after generation’. Much the same pattern occurs in sport, politics and war, where larger-than-life characters, believing themselves exempt from the laws of nature and morality, overreach their abilities. Extraordinary success seems inevitably to breed excess.

Why is this? Recent research in physiology and neuroscience can, I believe, help us explain this ancient, delusional and tragic behaviour. Human biology can today help us understand overconfidence and irrational exuberance, and it can contribute to a more scientific understanding of financial market instability.

A simpler reason for bringing biology into the story is that it is, quite simply, fascinating. A story of human behaviour spiked with biology can lead to particularly vivid moments of recognition. The term ‘recognition’ is commonly used to describe the point in a story when all of a sudden we understand what is going on, and by that very process understand ourselves. It was Aristotle who coined this term, and since his day recognition moments have been largely the preserve of philosophy and literature. But today they are increasingly provided, for me at any rate, by human biology. For when we understand what is going on inside our bodies, and why, we are met with repeated Aha! moments. These range from the fun: ‘Oh, so that’s why I get butterflies in my stomach when excited!’ or ‘So that’s why I get goosebumps when scared!’ (The erector pili muscles in your skin try to raise your fur, to make you look bigger, just as a cat does when threatened. Most of your fur no longer exists, so you get goosebumps instead, but where it does you have a ‘hair-raising’ experience) – to the deadly serious: ‘So that’s why stress is so tormenting, why it contributes to gastric ulcers, hypertension, even heart disease and stroke!’

Today human biology, perhaps more than any other subject, throws a light into the dark corners of our lives. So by mixing biology into the story I can more accurately describe what it feels like to take large financial risks; and I can do so moreover in a way that provides recognition moments for people who have never set foot on a trading floor. In fact, the physiology I describe is not confined to traders at all. It is the universal biology of risk-taking. As such it has been experienced by anyone who plays a sport, runs for political office, or fights in a war. But I focus on financial risk-taking, and do so for good reason: first, because finance is a world I know, having spent twelve years on Wall Street; second, and more importantly, because finance is the nerve centre of the world economy. If athletes succumb to overconfidence, they lose a match, but if traders get carried away on a flood of hormones, global markets founder. The financial system, as we have recently discovered to our dismay, balances precariously on the mental health of these risk-takers.

I begin by looking at the physiology that produces our risk-taking, filling in the background story for what follows. I then show, through a story set on a trading floor, how this physiology can mix with lax risk-management systems and a bonus system that rewards excessive gambling to produce a volatile and explosive bank. We watch as nature and nurture conspire to produce an awful train wreck, leaving behind mangled careers, damaged bodies and a devastated financial system. We then linger in the wreckage and observe the resulting fatigue and chronic stress, two medical conditions that blight the workplace. Finally we look at some tentative yet hopeful research into the physiology of toughness, in other words training regimes designed by sports scientists and stress physiologists to immunise our bodies against an overactive stress response. Such training could help calm the unstable physiology of risk-takers.

THE FEELING OF A BUBBLE

My interest in the biological side of the financial markets dates back to the 1990s. I was then working on Wall Street, trading derivatives for Goldman Sachs, then Merrill Lynch, and finally running a desk for Deutsche Bank. This was a fascinating time to trade the markets, because New York, and indeed America as a whole, was caught up in the dot.com bubble. And what a bubble that was. The markets had not seen anything quite like it since the great bull market of the 1920s. In 1991 the Nasdaq (the electronic stock exchange where many new-tech ventures are listed) traded below 600, and had meandered around that level for a few years. It then began a gradual yet persistent bull run, reaching a level of 2,000 in 1998. The Nasdaq’s rise was checked for a year or so by the Asian Financial Crisis, which reined it back about 500 points, but then the market recovered and took to the skies. In little more than a year and a half the Nasdaq shot up from 1,500 to a peak just over 5,000, for a total return in excess of 300 per cent.

The rally was almost unprecedented in its speed and magnitude. It was completely unprecedented in the paucity of hard financial data supporting the dot.com and high-tech ventures powering the bull run. In fact, so large was the gap between stock prices and the underlying fundamentals that many legendary investors, betting unsuccessfully against the trend, retired from Wall Street in disgust. Julian Robertson, for instance, founder of the hedge fund Tiger Capital, threw in the towel, saying in effect that the market may have gone crazy but he had not. Robertson and others were right that the market was due for a dreadful day of reckoning, but they also fully understood a point made by the great economist John Maynard Keynes back in the 1930s: that the markets could remain irrational longer than they, the investors, could remain solvent. So Robertson retired from the field, his reputation and capital largely intact. Then, early in 2000, the Nasdaq collapsed, giving back over 3,000 points in little more than a year, eventually bottoming out at the 1,000 level where it had begun a few short years before. Volatility of this magnitude normally makes a few people rich, but I know of no one who made money calling the top of this market’s explosive trajectory.

Besides the scale of the run-up and subsequent crash, another feature of the Bubble was noteworthy, and reminiscent of the 1920s, at least the 1920s I knew from novels, black-and-white movies and grainy documentaries – that was how its energy and excitement overflowed the stock exchange, permeated the culture and intoxicated people. For the fact is, while they last, bubbles are fun; and the widespread silliness attending them is often remembered with a certain amount of humour and fondness. I imagine anyone who lived through the bull market of the Roaring Twenties retained an abiding nostalgia for that heroic and madcap time, when futuristic technology, blithe spirits and easy wealth seemed to herald a new era of boundless possibility. Of course, life in its aftermath must have been even more formative, and those born and raised during the Great Depression are said to carry, even into old age, what the historian Caroline Bird calls an ‘invisible scar’, a pathological distrust of banks and stock markets, and a morbid fear of unemployment.

My recollections of the 1990s are of a decade every bit as hopeful and every bit as screwball as the 1920s. During the nineties we were entertained by middle-aged CEOs in black poloneck sweaters trying to ‘think outside the box’; by kids in their twenties wearing toques and yellow sunglasses, backed by apparently limitless amounts of capital, throwing lavish parties in midtown lofts and talking wacky internet schemes few of us could understand – and even fewer questioned. To do so meant you ‘just didn’t get it’, one of the worst insults of the time, indicating that you were a dinosaur incapable of lateral thought. One thing I definitely didn’t get was how the internet was supposed to overcome the constraints of time and space. Sure, ordering online was easy, but then delivery took place in the real world of rising oil prices and road congestion. The internet company that made the most heroic attempt to defy this brute fact was Kozmo.com, a New York-based start-up that promised free delivery within Manhattan and about a dozen other cities within an hour. The people who paid the price for this act of folly, besides the investors, were the scores of bicycle messengers breathlessly running red lights to meet a deadline. You would see groups of these haggard youngsters outside coffee bars (with appropriate names like Jet Fuel) catching their breath. Not surprisingly the company went bankrupt, leaving behind a question asked about this and countless similar ventures: what on earth were the investors thinking?

Perhaps the right question should have been, were they thinking at all? Were investors engaged in a rational assessment of information, as many economists might – and did – argue? If not, then were they perhaps engaged in a different form of reasoning, something closer to a game theoretic calculation: ‘I know this thing is a bubble,’ they may have schemed, ‘but I’ll buy on the way up and then sell before everyone else.’ Yet when talking to people who were investing their savings in newly listed internet shares I found little evidence for either of these thought processes. Most investors I spoke to had difficulty employing anything like linear and disciplined reasoning, the excitement and boundless potential of the markets apparently being enough to validate their harebrained ideas. It was almost impossible to engage them in a reasoned discussion: history was irrelevant, statistics counted for little, and when pressed they shot off starbursts of trendy concepts like ‘convergence’, the exact meaning of which I never discerned, although I think it had something to do with everything in the world becoming the same – TVs turning into phones, cars into offices, Greek bonds yielding the same as German, and so on.

If investors who had bought into this runaway market displayed little of the thought processes described by either rational choice or game theory, they also displayed little of the behaviour implied by a more common and clichéd account – the fear and greed account of investor folly. According to this piece of folk wisdom a bull market, as it picks up steam, churns out extraordinary profits, and these cause the better judgement of investors to become warped by the distemper of greed. The implication is that investors know full well that the market is a bubble, yet greed, rather than cunning, causes them to linger before selling.

Greed certainly can and does cause investors to run with their profits too long. By itself, though, the account misses something important about bubbles like the dot.com era and perhaps the Roaring Twenties – that investors naïvely and fervently believe they are buying into the future. Cynicism and cunning are not on display. Furthermore, as a bull market starts to validate investors’ beliefs, the profits they make translate into a lot more than mere greed: they bring on powerful feelings of euphoria and omnipotence. It is at this point that traders and investors feel the bonds of terrestrial life slip from their shoulders and they begin to flex their muscles like a newborn superhero. Assessment of risk is replaced by judgements of certainty – they just know what is going to happen: extreme sports seem like child’s play, sex becomes a competitive activity. They even walk differently: more erect, more purposeful, their very bearing carrying a hint of danger: ‘Don’t mess with me,’ their bodies seem to say. ‘I can handle anything.’ Tom Wolfe nailed this delusional behaviour when he described the stars of Wall Street as ‘Masters of the Universe’.

It was this behaviour more than anything else that struck me during the dot.com era. For the undeniable fact was, people were changing. The change showed itself not only among the untrained public but also, perhaps even more, among professional traders all along Wall Street. Normally a sober and prudent lot, these traders were becoming by small steps euphoric and delusional. Their minds were frequently troubled by racing thoughts, and their personal habits were changing: they were making do with less sleep – clubbing till 4 a.m. – and seemed to be horny all the time, more than usual at any rate, judging by their lewd comments and the increased amount of porn on their computer screens. More troubling still, they were becoming overconfident in their risk-taking, placing bets of ever-increasing size and with ever worsening risk–reward trade-offs. I was later to learn that the behaviour I was witnessing showed all the symptoms of a clinical condition known as mania (but now I am getting ahead of the story).

These symptoms are not unique to Wall Street: other worlds also manifest them, politics for example. One particularly insightful account of political mania has been provided by David Owen, now Lord Owen. Owen, a former Foreign Secretary and one of the founders of the Social Democratic Party, has spent most of his life at the very top of British politics. But he is by training a neurologist, and has lately taken to writing about a personality disorder he has observed among political and business leaders, a disorder he calls the Hubris Syndrome. This syndrome is characterised by recklessness, an inattention to detail, overwhelming self-confidence and contempt for others; all of which, he observes, ‘can result in disastrous leadership and cause damage on a large scale’. The syndrome, he continues, ‘is a disorder of the possession of power, particularly power which has been associated with overwhelming success, held for a period of years and with minimal constraint on the leader’. The symptoms Owen describes sound strikingly similar to those I observed on Wall Street, and his account further suggests an important point – that the manic behaviour displayed by many traders when on a winning streak comes from more than their newly acquired wealth. It comes equally, perhaps more, from a feeling of consummate power.

During the dot.com years I was in a good position to observe this manic behaviour among traders. On the one hand I was immune to the siren call of both Silicon Valley and Silicon Alley. I never had a deep understanding of high tech, so I did not invest in it, and could watch the comedy with a sceptical eye. On the other, I understood the traders’ feelings because I had in previous years been completely caught up in one or two bull markets myself, ones you probably did not hear about unless you read the financial pages, as they were isolated in either the bond or the currency market. And during these periods I too enjoyed above-average profits, felt euphoria and a sense of omnipotence, and became the picture of cockiness. Frankly, I cringe when I think about it.

So during the dot.com bubble I knew what the traders were going through. And the point I want to make is this: the overconfidence and hubris that traders experience during a bubble or a winning streak just does not feel as if it is driven by a rational assessment of opportunities, nor by greed – it feels as if it is driven by a chemical.

When traders enjoy an extended winning streak they experience a high that is powerfully narcotic. This feeling, as overwhelming as passionate desire or wall-banging anger, is very difficult to control. Any trader knows the feeling, and we all fear its consequences. Under its influence we tend to feel invincible, and to put on such stupid trades, in such large size, that we end up losing more money on them than we made on the winning streak that kindled this feeling of omnipotence in the first place. It has to be understood that traders on a roll are traders under the influence of a drug that has the power to transform them into different people.

Perhaps this chemical, whatever it is, accounts for much of the silliness and extreme behaviour that accompany bubbles, making them unfold much like a midsummer night’s dream, with people losing themselves in ill-fated delusions, mixed identities and swapped partners, until the cold light of dawn brings the world back into focus and the laws of nature and morality reassert themselves. After the dot.com bubble burst, traders were like revellers with a hangover, heads cradled in hands, stunned that they could have blown their savings on such ridiculous schemes. The shocked disbelief that the reality sustaining them for so long had turned out to be an illusion has nowhere been better described than on the front page of the New York Times the day after the Great Crash of 1929: ‘Wall St.,’ it reported, ‘was a street of vanished hopes, of curiously silent apprehension and a sort of paralyzed hypnosis.’

IS THERE AN IRRATIONAL EXUBERANCE MOLECULE?

As I say, the overconfident behaviour I describe is one that most traders will recognise and most have experienced at one point or another in their careers. I should add, however, that in addition to the changed behaviour among traders, another remarkable fact struck me during the dot.com years – that women were relatively immune to the frenzy surrounding internet and high-tech stocks. In fact, most of the women I knew, both on Wall Street and off, were quite cynical about the excitement, and as a result were often dismissed as ‘not getting it’, or worse, resented as perennial killjoys.

I have a special reason for relating these stories of Wall Street excess. I am not presenting them as items of front-line reportage, but rather as overlooked pieces of scientific data. Scientific research often begins with fieldwork. Fieldwork turns up curious phenomena or observations that prove to be anomalies for existing theory. The behaviour I am describing constitutes precisely this sort of field data for economics, yet it is rarely recognised as such. Indeed, out of all the research devoted to explaining financial market instability, very little has involved looking at what happens physiologically to traders when caught up in a bubble or a crash. This is an extraordinary omission, comparable to studying animal behaviour without looking at an animal in the wild, or practising medicine without ever looking at a patient. I am, however, convinced we should be looking at traders’ biology. I think we should take seriously the possibility that the extreme overconfidence and risk-taking displayed by traders during a bubble may be pathological behaviour calling for biological, even clinical, study.

The 1990s were a decade ripe for such research. They gave us the folly of the dot.com bubble as well as the phrase that best described it – ‘irrational exuberance’. This term, first used by Alan Greenspan in a speech delivered in Washington in 1996 and subsequently given wide currency by the Yale economist Robert Shiller, means much the same thing as an older one, ‘animal spirits’, coined in the 1930s by Keynes when he gestured towards some ill-defined and non-rational force animating entrepreneurial and investor risk-taking. But what are animal spirits? What is exuberance?

In the nineties, one or two people did suggest that irrational exuberance might be driven by a chemical. In 1999 Randolph Nesse, a psychiatrist at the University of Michigan, bravely speculated that the dot.com bubble differed from previous ones because the brains of many traders and investors had changed – they were under the influence of now widely prescribed antidepressant drugs, such as Prozac. ‘Human nature has always given rise to booms and bubbles followed by crashes and depressions,’ he argued. ‘But if investor caution is being inhibited by psychotropic drugs, bubbles could grow larger than usual before they pop, with potentially catastrophic economic and political consequences.’ Other observers of Wall Street, following a similar line of thought, pointed the finger at another culprit: the increasing use of cocaine among bankers.

These rumours of cocaine abuse, at least among traders and asset managers, were mostly exaggerated. (Members of the sales force, especially the salesmen responsible for taking clients out to lap-dancing bars till the wee hours of the morning, may have been another matter.) As for Nesse, his comments received some humorous coverage in the media, and when he spoke at a conference organised by the New York Academy of Sciences a year later he seemed to regret making them. But I thought he was on the right track; and to me his suggestion pointed to another possibility – that traders’ bodies were producing a chemical, apparently narcotic, that was causing their manic behaviour. What was this bull-market molecule?

I came across a likely suspect purely by chance. During the later years of the dot.com era I was fortunate enough to observe some fascinating research being conducted in a neuroscience lab at Rockefeller University, a research institution hidden on the Upper East Side of Manhattan, where a friend, Linda Wilbrecht, was doing a Ph.D. I was not at Rockefeller in any formal capacity, but when the markets were slow I would jump in a taxi and run up to the lab to observe the experiments taking place, or to listen to afternoon lectures in Caspary Auditorium, a geodesic dome set in the middle of that vine-clad campus. Scientists in Linda’s lab were working on what is called ‘neurogenesis’, the growth of new neurons. Understanding neurogenesis is in some ways the Holy Grail of the brain sciences, for if neurologists could figure out how to regenerate neurons they could perhaps cure or reverse the damage of neuro-degenerative diseases such as Alzheimer’s and Parkinson’s. Many of the breakthroughs in the study of neurogenesis have taken place at Rockefeller.

There was another area of the neurosciences where Rockefeller had made a historic contribution, and that was in research on hormones, and specifically their effects on the brain. Many of the breakthroughs in this field had been made by scientists addressing very specific issues in neuroscience, but today their results may help us understand irrational exuberance, for the bull-market molecule may in fact be a hormone. And if that is the case, then by a delightful coincidence, at the very moment in the late 1990s when Wall Street was asking the question ‘What is irrational exuberance?’, uptown at Rockefeller scientists were working on the answer.

So what exactly are hormones? Hormones are chemical messengers carried by the blood from one tissue in the body to another. We have dozens of them. We have hormones that stimulate hunger and ones that tell us when we are sated; hormones that stimulate thirst and ones that tell us when it is slaked. Hormones play a central role in what is called our body’s homeostasis, the maintenance of vital signs, like blood pressure, body temperature, glucose levels, etc., within the narrow bands needed for our continued comfort and health. Most of the physiological systems that maintain our internal chemical balance operate pre-consciously, in other words without our being aware of them. For instance, we are all blissfully unaware of the Swiss-watch-like workings of the system controlling the potassium levels in our blood.

But sometimes we cannot maintain our internal balance through these silent, purely chemical reactions. Sometimes we need behaviour; sometimes we have to engage in some sort of physical activity in order to re-establish homeostasis. When glucose levels in our blood fall, for example, our bodies silently liberate glucose deposits from the liver. Soon, however, the glucose reserves burn off, and the low blood sugar communicates itself to our consciousness by means of hunger, a hormonal signal that spurs us to search for food and then to eat. Hunger, thirst, pain, oxygen debt, sodium hunger and the sensations of heat and cold, for example, have accordingly been called ‘homeostatic emotions’. They are called emotions because they are signals from the body that convey more than mere information – they also carry a motivation to do something.

It is enlightening to see our behaviour as an elaborate mechanism designed to maintain homeostasis. However, before we go too far down the path of biological reductionism, I have to point out that hormones do not cause our behaviour. They act more like lobby groups, recommending and pressuring us into certain types of activity. Take the example of ghrelin, one of the hormones regulating hunger and feeding. Produced by cells in the lining of your stomach, ghrelin molecules carry a message to your brain saying in effect, ‘On behalf of your stomach we urge you to eat.’ But your brain does not have to comply. If you are on a diet, or a religious fast, or a hunger strike, you can choose to ignore the message. You can, in other words, choose your actions, and ultimately you take responsibility for them. Nonetheless, with the passing of time the message, at first whispered, becomes more like a foghorned bellow, and can be very hard to resist. So when we look at the effects of hormones on behaviour and on risk-taking – especially financial risk-taking – we will not be contemplating anything like biological determinism. We will be engaged rather in a frank discussion of the pressures, sometimes very powerful, these chemicals bring to bear on us during extreme moments in our lives.

One group of hormones has particularly potent effects on our behaviour – steroid hormones. This group includes testosterone, oestrogen and cortisol, the main hormone of the stress response. Steroids exert particularly widespread effects because they have receptors in almost every cell in our body and brain. Yet it was not until the 1990s that scientists began to understand just how these hormones influence our thinking and behaviour. Much of the work that led to this understanding was conducted in the lab of Bruce McEwen, a renowned professor at Rockefeller. He and his colleagues, including Donald Pfaff and Jay Weiss, were among the first scientists not only to map steroid receptors in the brain but also to study how steroids affect the structure of the brain and the way it works.

Before McEwen began his research, scientists widely believed that hormones and the brain worked in the following way: the hypothalamus, the region of the brain controlling hormones, sends a signal through the blood to the glands producing steroid hormones, be they testes, ovaries or adrenal glands, telling them to increase hormone production. The hormones are then injected into the blood, fan out across the body, and exert their intended effects on tissues such as heart, kidneys, lungs, muscles, etc. They also make their way back to the hypothalamus itself, which senses the higher hormone levels and in response tells the glands to stop producing the hormone. The feedback between hypothalamus and hormone-producing gland works much like a thermostat in a house, which senses cold and turns on the heating, and then senses the warmth and turns it off.

McEwen and his lab found something far more intriguing. Feedback between glands and the hypothalamus does indeed exist, is one of our most important homeostatic mechanisms, but McEwen discovered that there are steroid receptors in brain regions other than the hypothalamus. McEwen’s model of hormones and the brain works in the following way: the hypothalamus sends a message to a gland instructing it to produce a hormone; the hormone fans out across the body, having its physical effects, but it also returns to the brain, changing the very way we think and behave. Now, that is one potent chemical. Indeed, subsequent research by McEwen and others showed that a steroid hormone, because of its widespread receptors, can alter almost every function of our body (its growth, shape, metabolism, immune function) and of our brain (its mood and memory) and of our behaviour.

McEwen’s research was a landmark achievement because it showed how a signal from our body can change the very thoughts we think. And it raised a series of questions that today lie at the heart of our understanding of body and brain. Why does the brain send a signal to the body telling it to produce a chemical which in turn changes the way the brain works? What a strange thing to do. If the brain wants to change the way it thinks, why not keep all the signalling within the brain? Why take such a roundabout route through the body?

And why would a single molecule, like a steroid, be entrusted with such a broad mandate, simultaneously changing both body and brain? I think the answer to these questions goes something like this: steroid hormones evolved to coordinate body, brain and behaviour during archetypal situations, such as fighting, fleeing, feeding, hunting, mating and struggling for status. At important moments like these you need all your tissues cooperating on the task at hand; you do not want to be multi-tasking. It would make little sense to have, say, a cardiovascular system geared up for a fight, a digestive system primed for ingesting a turkey dinner, and a brain in the mood for wandering through fields of daffodils. Steroids, like a drill sergeant, ensure that body and brain fall into line as a single functioning unit.

The ancient Greeks believed that at archetypal moments in our lives we are visited by the gods, that we can feel their presence because these moments – of battle, of love, of childbearing – are especially vivid, are remembered as defining moments in our lives, and during them we seem to enjoy special powers. But alas, it is not one of the Olympian gods, poor creatures of abandoned belief that they are, who touches us at these moments: it is one of our hormones.

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. At Rockefeller University I came across a model of testosterone-fuelled behaviour that offered a tantalising explanation of trader behaviour during market bubbles, a model taken from animal behaviour called ‘the winner effect’.

In this model, 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 replicated these experiments with athletes, and believe the testosterone feedback loop may explain winning and losing streaks in sports. However, at some point in this winning streak the elevated steroids begin to have the opposite effect on success and survival. 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 behaviour.

Could this upward surge of testosterone, cockiness and risky behaviour also occur in the financial markets? This model seemed to describe perfectly how traders behaved as the bull market of the nineties morphed into the tech bubble. When traders, most of whom are young males, make money, their testosterone levels rise, increasing their confidence and appetite for risk, until the extended winning streak of a bull market causes them to become every bit as delusional, overconfident and risk-seeking as those animals venturing into the open, oblivious to all danger. The winner effect seemed to me a plausible explanation for the chemical hit traders receive, one that exaggerates a bull market and turns it into a bubble. The role of testosterone could also explain why women seemed relatively unaffected by the bubble, for they have about 10 to 20 per cent of the testosterone levels of men.

During the dot.com bubble, when considering this possibility, I was particularly swayed by descriptions of the mood-enhancing effects of testosterone voiced by people who had been prescribed it. Patients with cancer, for example, are often given testosterone because, as an anabolic steroid – one that builds up energy stores such as muscle – it helps them put on weight. One brilliant and particularly influential description of its effects was written by Andrew Sullivan and published in the New York Times Magazine in April 2000. He vividly described injecting a golden, oily substance about three inches into his hip, every two weeks: ‘I can actually feel its power on almost a daily basis,’ he reported. ‘Within hours, and at most a day, I feel a deep surge of energy. It is less edgy than a double espresso, but just as powerful. My attention span shortens. In the two or three days after my shot, I find it harder to concentrate on writing and feel the need to exercise more. My wit is quicker, my mind faster, but my judgment is more impulsive. It is not unlike the kind of rush I get before talking in front of a large audience, or going on a first date, or getting on an airplane, but it suffuses me in a less abrupt and more consistent way. In a word, I feel braced. For what? It scarcely seems to matter.’ Sullivan could just as easily have been describing what it feels like to be a trader on a roll.

IRRATIONAL PESSIMISM

If testosterone seemed a likely candidate for the molecule of irrational exuberance, another steroid seemed a likely one for the molecule of irrational pessimism – cortisol.

Cortisol is the main hormone of the stress response, a bodywide response to injury or threat. Cortisol works in tandem with adrenalin, but while adrenalin is a fast-acting hormone, taking effect in seconds and having a half-life in the blood of only two to three minutes, cortisol kicks in to support us during a long siege. If you are hiking in the woods and hear a rustle in the bushes, you may suspect the presence of a grizzly bear, so the shot of adrenalin you receive is designed to carry you clear of danger. If the noise turns out to be nothing but wind in the leaves you settle down, and the adrenalin quickly dissipates. But if you are in fact being stalked by a predator and the chase lasts several hours, then cortisol takes over the management of your body. It orders all long-term and metabolically expensive functions of the body, such as digestion, reproduction, growth, storage of energy, and after a while even immune function, to stop. At the same time, it begins to break down energy stores and flush the liberated glucose into your blood. In short, cortisol has one main and far-reaching command: glucose now! At this crucial moment in your life, cortisol has in effect ordered a complete retooling of your body’s factories, away from leisure and consumption goods to war matériel.

In the brain, cortisol, like testosterone, initially has the beneficial effects of increasing arousal and sharpening attention, even promoting a slight thrill from the challenge, but as levels of the hormone rise and stay elevated, it comes to have opposite effects – the difference between short-term and long-term exposure to a hormone is an important distinction we will look at in this book – promoting feelings of anxiety, a selective recall of disturbing memories, and a tendency to find danger where none exists. Chronic stress and highly elevated stress hormones among traders and asset managers may thus foster a thorough and perhaps irrational risk-aversion.

The research I encountered on steroid hormones thus suggested to me the following hypothesis: testosterone, as predicted by the winner effect, is likely to rise in a bull market, increase risk-taking, and exaggerate the rally, morphing it into a bubble. Cortisol, on the other hand, is likely to rise in a bear market, make traders dramatically and perhaps irrationally risk-averse, and exaggerate the sell-off, morphing it into a crash. Steroid hormones building up in the bodies of traders and investors may thus shift risk preferences systematically across the business cycle, destabilising it.

If this hypothesis of steroid feedback loops is correct, then to understand how financial markets function we need to draw on more than economics and psychology; we need to draw as well on medical research. We need to take seriously the possibility that during bubbles and crashes the financial community, suffering from chronically elevated steroid levels, may develop into a clinical population. And that possibility profoundly changes the way we see the markets, and the way we think about curing their pathologies.

In time, and with the encouragement of several colleagues, I concluded that this hypothesis should be tested. So I retired from Wall Street and returned to the University of Cambridge, where I had previously completed a Ph.D in economics. I spent the next four years retraining in neuroscience and endocrinology, and began designing an experimental protocol to test the hypothesis that the winner effect exists in the financial markets. I then set up a series of studies on a trading floor in the City of London. The results from these experiments provided solid preliminary data supporting the hypothesis that hormones, and signals from the body more generally, influence the risk-taking of traders. We will look at these results later in the book.

MIND AND BODY IN THE FINANCIAL MARKETS

Research on body–brain feedback, even within physiology and neuroscience, is relatively new, and has made only limited inroads into economics. Why is this? Why have we for so long ignored the fact that we have bodies, and that our bodies affect the way we think?

The most likely reason is that our thinking about the mind, the brain and behaviour has been moulded by a powerful philosophical idea we inherited from our culture – that of a categorical divide between mind and body. This ancient notion runs deep in the Western tradition, channelling the riverbed along which all discussion of mind and body has flowed for almost 2,500 years. It originated with the philosopher Pythagoras, who needed the idea of an immortal soul for his doctrine of reincarnation, but the idea of a mind–body split was cast in its most durable form by Plato, who claimed that within our decaying flesh there flickers a spark of divinity, this being an eternal and rational soul. The idea was subsequently taken up by St Paul and enthroned as Christian dogma. It was by that very edict also enthroned as a philosophical conundrum later known as the mind–body problem; and later physicists such as René Descartes, a devout Catholic and committed scientist, wrestled with the problem of how this disembodied mind could interact with a physical body, eventually coming up with the memorable image of a ghost in the machine, watching and giving orders.

Today Platonic dualism, as the doctrine is called, is widely disputed within philosophy and mostly ignored in neuroscience. But there is one unlikely place where a vision of the rational mind as pure as anything contemplated by Plato or Descartes still lingers – and that is in economics.

Many economists, or at any rate those adhering to a widely adopted approach known as neo-classical economics, assume our behaviour is volitional – in other words, we choose our course of behaviour after thinking it through – and guided by a rational mind. According to this school of thought, we are walking computers who can calculate the rewards of each course of action open to us at any given moment, and weight these rewards by the probability of their occurrence. Behind every decision to eat sushi or pasta, to work in aeronautics or banking, to invest in General Electric or Treasury bonds, there purr the optimising calculations of a mainframe computer.

The economists making these claims recognise that most people regularly fall short of this ideal, but justify their austere assumption of rationality by claiming that people behave, on average, ‘as if’ they had performed the actual calculations. These economists also claim that any irrationality we display in our personal lives tends to fall away when we have to deal with something as important as money; for then we are at our most cunning, and come pretty close to behaving as predicted by their models. Besides, they add, if we do not act rationally with our money we will be driven to bankruptcy, leaving the market in the hands of the truly rational. That means economists can continue studying the market with an underlying assumption of rationality.

This economic model is ingenious, at moments quite beautiful, and for good reason has wielded enormous influence on generations of economists, central bankers and policy-makers. Yet despite its elegance, neo-classical economics has come under increasing criticism from experimentally-minded social scientists who have patiently catalogued the myriad ways in which decisions and behaviours of both amateur and professional investors stray from the axioms of rational choice. One reason for its lack of realism is, I believe, that neo-classical economics shares a fundamental assumption with Platonism – that economics should focus on the mind and the thoughts of a purely rational person. Consequently, neo-classical economics has largely ignored the body. It is economics from the neck up.

What I am saying is that something very like the Platonic mind–body split lingers in economics, that it has impaired our ability to understand the financial markets. If we want to understand how people make financial decisions, how traders and investors react to volatile markets, even how markets tend to overshoot sensible levels, we need to recognise that our bodies have a say in our risk-taking. Many economists might reiterate that the importance of money ensures that we act rationally where it is concerned; but perhaps it is this very importance which guarantees a powerful bodily response. Money may be the last thing about which we can remain cool.

Economics is a powerful theoretical science, with a growing body of experimental results. In fact many economists have come to question the assumption of a Spock-like rationality, even as a simplifying assumption, and a noteworthy group among them, beginning with the Chicago economist Richard Thaler and two psychologists, Daniel Kahneman and Amos Tversky, have started a rival school known as behavioural economics. Behavioural economists have succeeded in building up a more realistic picture of how we behave when dealing with money. But their important experimental work could today easily extend to the physiology underlying economic behaviour. And signs are some economists are heading that way. Daniel Kahneman, for one, has conducted research in the physiology of attention and arousal, and has recently pointed out that we think with our body.

He is right. We do. To understand just how our body affects our brain we should first recognise that they evolved together to help us physically pursue an opportunity or run away from a threat. When confronted by an opportunity for gain, such as food or territory or a bull market, or a threat to our well-being, such as a predator or a bear market, our brain sparks a storm of electrical activity in our skeletal muscles and visceral organs, and precipitates a flood of hormones throughout our bodies, altering metabolism and cardiovascular function in order to sustain a physical response. These somatic and visceral signals then feed back on the brain, biasing our thinking – our attention, mood, memory – so that it is in sync with the physical task at hand. In fact, it may be more scientifically accurate, although semantically difficult, to stop speaking in terms of brain and body at all, as if they were separable, and to speak instead of a whole-person response to events.

Were we to start viewing ourselves in this manner we would find economics and the natural sciences beginning to merge. Such a prospect may seem futuristic and strike some people as scary and a touch dehumanising. Scientific progress, admittedly, often heralds an ugly new world, divorced from traditional values, dragging us in a direction we do not want to go. But occasionally science does not do that; occasionally it merely reminds us of something we once knew, but have forgotten. That would be the case here. For the type of economics suggested by recent advances in neuroscience and physiology merely points us back to an ancient, commonsensical and reassuring tradition in Western thought, but one that has been buried under archaeological layers of later ideas – and that is the type of thinking begun by Aristotle. For Aristotle was the first and one of the greatest biologists, perhaps the closest and most encyclopaedic observer of the human condition, and for him, unlike Plato, there was no mind–body split.

In his ethical and political works Aristotle tried to bring thought down to earth, the catchphrase of the Aristotelians being ‘Think mortal thoughts’; and he based his political and ethical thinking on the behaviour of actual humans, not idealised ones. Rather than wagging a finger at us and making us feel shame for our desires and needs and the great gap existing between our actual behaviour and a life of pure reason, he accepted the way we are. His more humane approach to understanding behaviour is today in the process of being rediscovered. In Aristotle we have an ancient blueprint of how to merge nature and nurture, how to design institutions so that they accommodate our biology.

Fig. 1. Detail from Raphael’s School of Athens. Plato, on the left, holds a copy of his dialogue the Timaeus and points to the heavens. Aristotle holds a copy of his Ethics and gestures to the world around him, although with the palm of his hand facing down he also seems to be saying, ‘Plato, my friend, keep your feet on the ground.’

Economics in particular could benefit from this approach, for economics needs to put the body back into the economy. Rather than assuming rationality and an efficient market – the unfortunate upshot of which has been a trading community gone feral – we should study the behaviour of actual traders and investors, much as the behavioural economists do, only we should include in that study the influence of their biology. If it turns out that their biology does indeed exaggerate bull and bear markets then we have to think anew about how to alter training programmes, management practices, even government policies in order to counteract it.

At the moment, though, I fear we have the worst of both worlds – an unstable biology coupled with risk-management practices that increase risk limits during the bubble and decrease them during the crash, plus a bonus scheme that rewards high-variance trading. Today nature and nurture conspire in creating recurrent disasters. More effective policies will have to consider ways of managing the biology of the market. One way to do that may be to encourage a more even balance within the banks between men and women, young and old, for each has a very different biology.

WHAT UNITES US

To begin the story I want to tell, we need to get a better understanding of how brain and body cooperate in producing our thoughts and behaviour, and ultimately our risk-taking. The best way to do that is to look at what might be called the central operation of our brain. What might that be? We may be tempted to answer, given our heritage, that the central, most defining feature of our brain is its capacity for pure thought. But neuroscientists have discovered that conscious, rational thought is a bit player in the drama that is our mental life. Many of these scientists now believe that we are getting closer to the truth if we say that the basic operation of the brain is the organisation of movement.

That statement may come as something of a shock – I know it did for me – even a disappointment. But had I learned its truth earlier than I did, I would have saved myself years of misunderstanding. You see, it is common when starting out in neuroscience to go looking for the computer in the brain, for our awesome reasoning capacities; but if you approach the brain with that goal you inevitably end up disappointed, for what you find is something a lot messier than expected. For the brain regions processing our reasoning skills are inextricably tangled up with motor circuits. You tend to get a bit annoyed at the lack of simplicity in this architecture, and frustrated at the inability to isolate pure thought. But that frustration comes from starting out with the wrong set of assumptions.

If, however, you view your brain and body and behaviour with a robust appreciation of the fact that you are built to move, and if you let that simple fact sink in, then I am willing to bet you will never see yourself in quite the same way again. You will come to understand why you feel so many of the things you do, why your reactions are often so fast as to leave conscious thought behind, why you rely on gut feelings, why it is that during the most powerful moments of your life – satisfying moments of flow, of insight, of love, of risk-taking, and traumatic moments of fear, anger and stress – you lose any awareness of a split between mind and body, and they merge as one. Seeing yourself as an inseparable unity of body and brain may involve a shift in your self-understanding, but it is, I believe, a truly liberating one.

Evolutionary biologists frequently look back over our past and try to spot the small advances here and there, the minor differences between us and our animal cousins, which might account for humans’ phenomenal ascent to the top of the food chain. They have found, not surprisingly, that many of these advances occurred in our body: the growth of vocal cords, for instance; or an opposable thumb, which gave us the manual dexterity to make and use tools; even an upright posture and a lack of fur – the former, it has been argued, minimising the body surface exposed to the midday sun, the latter making the cooling of our body so much easier, and both together permitting us to lope after swifter but fur-covered prey until it collapsed from heat exhaustion. On the African savannah we did not need to outrun or outfight our prey, so this theory claims, merely outcool it.

Many of the advances leading to our dominance over other animals did indeed take place in the body, which over time became taller, straighter, faster, cooler, more dextrous and much more talkative. Other advances of equal importance occurred in the brain. According to some evolutionary accounts, human prehistory was driven by the growth of our neo-cortex, the rational, conscious, newest and outermost layer of the brain. As this brain structure blossomed, we developed the ability to think ahead and choose our actions, and in so doing became liberated from automatic behaviours and an animal enslavement to immediate bodily needs. This story of the brain’s evolution and the increasingly abstract nature of human thinking is for the most part correct. But it is also the subplot of the evolutionary story that is most prone to misunderstanding. It can too easily imply that our bodies became ever less important to our success as a species. An extreme example of this view can be found in science fiction, where future humans are frequently portrayed as all head, a bulbous cranium sitting atop an atrophied body. Bodies, in sci-fi and to a certain extent in the popular imagination, are seen as relics of a bestial prehistory best forgotten.

The very existence of such a story, lurking in the popular imagination, is yet another testament to the staying power of the ancient notion of a mind–body split, according to which our bodies play a secondary and largely mischievous role in our lives, tempting us from the path of reason. Needless to say, such a story is simplistic. Body and brain evolved together, not separately. Some scientists have recently begun to study the ways in which the lines of communication between body and brain became more elaborate in humans compared to other animals, how over time the brain became more tightly bound to the body, not less. With the benefit of their research we can discern another story about our history that is at once more complete and far more intriguing – that the true miracle of human evolution was the development of advanced control systems for synchronising body and brain.

In modern humans the body and brain exchange a torrent of information. And the exchange takes place between equals. We tend to think it does not, that information from the body constitutes nothing more than mere data being input into the computer in our head, the brain then sending back orders on what to do. The brain as puppet master, the body as puppet, to change analogies. But this picture is all wrong. The information sent by the body registers as a lot more than mere data; it comes freighted with suggestions, sometimes merely whispered, at others forcefully shouted, on how your brain should use it. You experience the more insistent of these informational prods as desires and emotions, the more subtle and dimly discernible as gut feelings. Over the long years of our evolutionary prehistory, this bodily input to our thinking has proved essential for fast actions and good judgement. Indeed, if we take a closer look at the dialogue between body and brain we will come to appreciate just how crucially the body contributes to our decision-making, and especially to our risk-taking, even in the financial markets.

WHY ANIMALS CAN’T PLAY SPORTS

To free ourselves from the philosophical baggage that has impeded our understanding of body and brain, we should begin by asking a very basic question, perhaps the most basic in all the neurosciences: why do we have a brain? Why do some living creatures, like animals, have a brain, while others, like plants, do not?

Daniel Wolpert, an engineer and neuroscientist at the University of Cambridge, provides an intriguing answer to this question when he tells the tale of a distant cousin of humans, a sea squirt called the tunicate. The tunicate is born with a small brain, called a cerebral ganglion, complete with an eyespot for sensing light, and an otolith, a primitive organ which senses gravity and permits the tunicate to orient itself horizontally or vertically. In its larval stage the tunicate swims freely about the sea searching for rich feeding grounds. When it finds a promising spot it cements itself, head-first, to the sea floor. It then proceeds to ingest its brain, using the nutrients to build its siphons and tunic-like body. Swaying gently in the ocean currents, filtering nutrients from passing water, the tunicate lives out its days without the need or burden of a brain.

Fig. 2. The bluebell tunicate.

To Wolpert, and many like-minded scientists, the tunicate is sending us an important message from our evolutionary past, telling us that if you do not need to move, you do not need a brain. The tunicate, they say, informs us that the brain is fundamentally very practical, that its main role is not to engage in pure thought but to plan and execute physical movement. What is the point, they ask, of our sensations, our memories, our cognitive abilities, if these do not lead at some point to action, be it walking, or reaching, or swimming, or eating, or even writing? If we humans did not need to move then perhaps we too would prefer to ingest our brain, a metabolically expensive organ, consuming some 20 per cent of our daily energy. Scientists who believe the brain evolved primarily to control movement – Wolpert calls himself and his colleagues ‘motor chauvinists’ – argue that thought itself is best understood as planning; even higher forms of thought, such as philosophy, the epitome of disembodied speculation, proceed, they argue, by hijacking algorithms originally developed to help us plan movements. Our mental life, they argue, is inescapably embodied. Andy Clark, a philosopher from Edinburgh, has put this point nicely when he states that we have inherited ‘a mind on the hoof’.

To understand the brain, therefore, we need to understand movement. Yet that has turned out to be a lot harder than anyone imagined, harder in a sense than understanding the products of the intellect. We tend to believe that what belongs in the pantheon of human achievement are the books we have written, the theorems we have proved, the scientific discoveries we have made, and that our highest calling involves a turning away from the flesh, with its decay and temptation, and towards a life of the mind. But such an attitude often blinds us to the extraordinary beauty of human movement, and to its baffling mystery.

Such is the conclusion drawn by many engineers who have tried to model human movement or to replicate it with a robot. They have quickly come to a sobering realisation – that even the simplest of human movements involves a mind-boggling complexity. Steven Pinker, for example, points out that the human mind is capable of understanding quantum physics, decoding the genome and sending a rocket to the moon; but these accomplishments have turned out to be relatively simple compared to the task of reverse-engineering human movement. Take walking. A six-legged insect, even a four-legged animal, can always keep a tripod of three legs on the ground to balance itself while walking. But how does a two-legged creature like a human do it? We must support our weight, propel ourselves forward, and maintain our centre of gravity, all on the ball of a single foot. When we walk, Pinker explains, ‘we repeatedly tip over and break our fall in the nick of time’. The seemingly simple act of taking a step is in truth a technical tour de force, and, he reports, ‘no one has yet figured out how we do it’. If we want to observe the true genius of the human nervous system, we should therefore look not so much to the works of Shakespeare or Mozart or Einstein, but to a child building a Lego castle, or a jogger running over an uneven surface, for their movements entail solving technical problems which for the moment lie beyond the ken of human understanding.

Wolpert has come to a similar conclusion. He points out that we have been able to program a computer to beat a chess grandmaster because the task is merely a large computational problem – work out all possible moves to the end of the game and choose the best one – and can be solved by throwing a lot of computing power at it. But we have not yet been able to build a robot with the speed and manual dexterity of an eight-year-old child.

Our physical abilities are awe-inspiring, and they remain so even when compared to those of the animals. We tend to think that as we evolved out of our bodies and into our larger brains we left physical prowess behind, with the brutes. We may have a larger prefrontal cortex relative to brain size than any animal, but animals outclass us in pretty well any measure of physical performance. We are not as large as an elephant, not as strong as a gorilla, nor as fast as a cheetah. Our nose is not nearly as sensitive as a dog’s, nor our eyes those of an owl. We cannot fly like a bird, nor can we swim underwater for as long as a seal. We get lost easily in the forest and end up walking in circles, while bats have radar and monarch butterflies have GPS. The gold medals for physical achievement in all events therefore go to members of the animal kingdom.

But is this true? We need to look at the question from another angle. For what is truly extraordinary about humans is our ability to learn physical movements that do not in some sense come naturally, like dancing ballet, or playing the guitar, or performing gymnastics, or piloting a plane in an aerial dogfight, and to perfect them. Consider, for example, the skills displayed by a downhill skier who, in addition to descending a mountain at over 90 miles an hour, must carve turns, sometimes on sheer ice, at just the right time, a few milliseconds separating a winning performance from a deadly accident. This is a remarkable achievement for a species that took to the slopes only recently. No animal can do anything like this. Little wonder that Olympic events draw such large crowds – we are witnessing a physical perfection unequalled in the animal world.

Remarkable feats of physical prowess can also be viewed in the concert hall. The fingers of a master pianist can disappear in a blur of movement when engaged in a challenging piece. All ten fingers work simultaneously, striking keys so rapidly that the eye cannot follow, yet each one can be hitting a key with varying force and frequency, some lingering to hold the note, others pulling back almost instantly, the whole performance modulated so as to communicate an emotional tone or conjure up a certain image. The physical feat by itself is extraordinary, but to think that this frenzied activity is so closely controlled that it can produce artistic meaning almost beggars belief. A piano concert is an extraordinary thing to watch and hear.

Humans have always dreamed of breaking the bonds of terrestrial enslavement, and in sport, as in music and dance, we have come close to succeeding. Our incomparable prowess led Shakespeare to sing of our bodies, ‘In form and moving how express and admirable! In action how like an Angel!’ We have to wonder, how did we develop this physical genius? How did we learn to move like the gods? We did so because we grew a larger brain. And with that larger brain came ever more subtle physical movements, and ever more dense connections with the body.

The brain region that experienced the most explosive growth in humans was, of course, the neo-cortex, home to choice and planning. The expanded neo-cortex led to the glories of higher thought; but it should be pointed out that the neo-cortex evolved together with an expanded cortico-spinal tract, the bundle of nerve fibres controlling the body’s musculature. And the larger neo-cortex and related nerves permitted a new and revolutionary type of movement – the voluntary control of muscles and the learning of new behaviour. The neo-cortex did indeed give us reading, writing, philosophy and mathematics, but first it gave us the ability to learn movements we had never performed before, like making tools, throwing a spear, or riding a horse.

There was, however, another brain region which actually outgrew the neo-cortex and contributed to our physical prowess – the cerebellum (see fig. 3). The cerebellum occupies the lower part of the bulge that sticks out of the back of your head. It stores memories of how to do things, like ride a bike or play the flute, as well as programmes for rapid, automatic movements. But the cerebellum is an odd part of the brain, because it seems tacked on, almost like a small, separate brain. And in some sense it is, because the cerebellum acts like an operating system for the rest of the nervous system. It makes neural operations faster and more efficient, its contribution to the brain being much like that of an extra RAM chip added to a computer. The cerebellum plays this role most notably in the motor circuits of our nervous system, for it coordinates our physical actions, gives them precision and split-second timing. When the cerebellum is impaired, as it is when we are drunk, we can still move, but our actions become slow and uncoordinated. Intriguingly, the cerebellum also streamlines the performance of the neo-cortex itself. In fact, there is archaeological evidence indicating that modern humans may actually have had a smaller neo-cortex than the troll-like Neanderthals; but we had a larger cerebellum, and it provided us with what was effectively a more efficient operating system, and hence more brainpower.

The expanded cerebellum led to our unparalleled artistic and sporting achievements. It contributed as well to the expertise we rely on when we entrust ourselves to the hands of a surgeon. Today, when our body and brain embrace, when we apply our formidable intelligence to physical action, we produce movements that are like nothing else ever seen on earth. This is a uniquely human form of excellence, and it deserves as much highbrow recognition as the works of philosophy, literature and science that occupy our pantheons.

REVVING THE BRAIN

Movement needs energy, and that means the brain has to organise not only the movement itself, but also the support operations for the muscles. What are these operations? It turns out that they are not all that different from those of an internal combustion engine. The brain must organise the finding and ingesting of fuel, in our case food; it must mix the fuel with oxygen in order to burn it; it must regulate the flow of blood in order to deliver this fuel and oxygen to cells throughout the body; it must cool this engine before combustion causes it to overheat; and it must vent the carbon dioxide waste once the fuel is burned.

These simple facts of engineering mean that our thoughts are intimately tied to our physiology. Decisions are decisions to do something, so our thoughts come freighted with physical implications. They are accompanied by a rapid shift in our motor, metabolic and cardiovascular systems as these prepare for the movements that may ensue. Thinking about the options open to us at any given moment, scrolling through the possibilities, triggers a rapid series of somatic shifts. You can often see this in a person’s face as they think – eyes widening or squinting, pupils dilating, skin flushing or blanching, facial expressions as labile and fleeting as the weather. All thoughts involving choice of action involve a kaleidoscopic shift from one bodily state to another. Choice is a whole-body experience.

We are forcefully reminded of this fact whenever we contemplate the taking of risks, especially in the financial markets. When reading of the outbreak of war, for example, or watching stock prices crash, the information provokes a strong bodily response: you inhale a quick lungful of air, your stomach knots and muscles tense, your face flushes, you feel the thump, thump of a heart gearing up for action, and a thin sheen of sweat creeps across your skin. We are all so familiar with these physical effects that we take them for granted and lose sight of their significance. For the fact that information, mere letters on a page or prices on a screen, can provoke a strong bodily reaction, can even, should it create uncertainty and stress, make us physically ill, tells us something important about the way we are built. We do not regard information as a computer would, dispassionately; we react to it physically. Our body and brain rev up and down together. Indeed, it is upon this very simple piece of physiology that much of the entertainment industry is built: would we read novels or go to the movies if they did not take our bodies on a rollercoaster ride?

The point is this, and I cannot emphasise it enough: when faced by situations of novelty, uncertainty, opportunity or threat, you feel the things you do because of changes taking place in your body as it prepares for movement. Stress is a perfect illustration of this point. We tend to think that stress consists primarily of troubling thoughts, of being upset because something bad has happened or is going to happen to us, that it is a purely psychological state. But in fact the unpleasant and dangerous aspects of the stress response – the nervous stomach, the high blood pressure, the elevated glucose levels, the anxiety – should be understood as the gastro-intestinal, cardiovascular, metabolic and attentional preparation for impending physical effort. Even the gut feelings upon which traders and investors rely should be seen in this light: these are a lot more than mere hunches about what will happen next; they are changes taking place in the bodies of traders and investors as they prepare an appropriate physical response, be it fighting, running away, celebrating, or whimpering for relief. And because movement in times of emergency has to be lightning fast, these gut feelings are generated quickly, often faster than consciousness can keep up with, and are transmitted to parts of the brain of which we have only a dim and diffuse awareness.

CONTROLLING OUR INTERNAL WEATHER

For body and brain to be unified in this way, they must conduct a non-stop dialogue, a process, mentioned above, called homeostasis. Oxygen levels in the blood must be maintained within tight bands, and are kept so by a largely unconscious modulation of our breathing, as must heart rate and blood pressure. Body temperature too must be maintained within a degree or two of 37 degrees Celsius. Should it drop, say, below this band, the brain instructs our muscles to shiver and adrenal glands to raise our core temperature. Blood sugar levels too must be reported and then maintained within narrow bands, and should they fall, bringing on symptoms of low blood sugar, the brain promptly responds with a number of hormones, including adrenalin and glucagon, which liberate glucose stores for release into the blood. The amount of bodily signals being processed by the brain, coming as they do from almost every tissue, every muscle and organ, is voluminous.

Much of this bodily regulation is a job allotted to the oldest part of the brain, known appropriately as the reptile brain, and specifically to a part of it called the brain stem (see fig. 3). Sitting on top of the spine and looking like a small, gnarled fist, the brain stem controls many of the automatic reflexes of the body – breathing, blood pressure, heart rate, sweating, blinking, startle – plus the pattern generators that produce unthinking repetitive movements like chewing, swallowing, walking, etc. The brain stem acts as the life-support system of the body; other, more developed parts of the brain, ones responsible for, say, consciousness, can be damaged, leaving us ‘brain dead’, as they say, yet we can live on in a coma as along as the brain stem continues to operate. However, as animals evolved, the nervous circuitry linking their visceral organs such as the gut and the heart to the brain became more sophisticated. From amphibians and reptiles through mammals, primates and humans, the brain grew more complex, and with it came an expanded capacity for regulating the body.

An amphibian such as a frog cannot prevent the uncontrolled evaporation of water from its skin, so it must remain in or close to water at all times. Reptiles can retain water, and therefore can live in both water and desert. But they, like amphibians, are cold-blooded, and that means they depend on the sun and warm rocks for their heat, and become all but immobile in cool weather. Because they do not take responsibility for controlling their body temperature, amphibians and reptiles have relatively simple brains.

Mammals, on the other hand, took on far greater control of their bodies, and therefore needed more brainpower. Most notably, they began to control their internal temperature, a process called thermoregulation. Thermoregulation is metabolically expensive, requiring mammals to burn a lot of fuel to generate body heat, to shiver when cold and sweat when hot, and to grow fur in autumn and moult in the spring. An idling mammal burns about five to ten times the energy of an idling reptile, so it needs to store a lot more fuel. As a result mammals had to develop greatly increased metabolic reserves; but once equipped with them they were free to hunt far and wide. The advent of mammals revolutionised life in the wild, and could be likened to the terrifying invention of mechanised warfare. Mammals, like tanks, could move a lot farther and a lot faster than their more primitive foes, so they proved unstoppable. But their mobility required more carefully managed supply lines, something that was accomplished by more advanced homeostatic circuitry.

Humans in turn took on even more control over their bodies than lower mammals. This development is reflected in a more advanced nervous system and a more extensive and animated dialogue between body and brain. We find some evidence for this process in studies comparing the brain structures among animals and humans. In one noteworthy study of comparative brain anatomy, a group of scientists looked at differences in the size of various brain regions (size is measured as a percentage of total brain weight) among existing primates to see which regions correlated with life span, a measure they took as a proxy for survivability. Their study showed that in addition to the neo-cortex and cerebellum, two other brain regions grew relatively larger in humans, most notably two regions playing a role in the homeostatic control of the body – the hypothalamus and the amygdala (fig. 3).

The hypothalamus, a brain region found by projecting lines in from the bridge of your nose and sideways from the front of your ears, regulates our hormones, and through them our eating, sleeping, sodium levels, water retention, reproduction, aggression and so on. It acts as the main integration site for emotional behaviour; in other words it coordinates the hormones and the brain stem and the emotional behaviours into a coherent bodily response. When, for example, an angry cat hisses, and arches its back, and fluffs its fur, and secretes adrenalin, it is the hypothalamus that has assembled these separate displays of anger and orchestrated them into a single coherent emotional act.

Fig. 3. Basic brain anatomy. The brain stem, often called the reptile brain, controls automatic processes such as breathing, heart rate, blood pressure, etc. The cerebellum stores physical skills and fast behavioural reactions; it also contributes to dexterity, balance and coordination. The hypothalamus controls hormones and coordinates electrical and chemical elements of homeostasis. The amygdala processes information for emotional meaning. The neo-cortex, the latest evolved layer of the brain, processes discursive thought, planning and voluntary movement. The insula (located on the far side and near the top of the illuminated brain) gathers information from the body and assembles it into a sense of our embodied existence.

The amygdala assigns emotional significance to events. Without the amygdala, we would view the world as a collection of uninteresting objects. A charging grizzly bear would impress us as nothing more threatening than a large, moving object. Bring the amygdala online, and miraculously the grizzly morphs into a terrifying and deadly predator and we scramble up the nearest tree. The amygdala is the key brain region registering danger in the outside world and initiating the suite of physical changes known as the ‘stress response’. It also registers signs of danger inside the body, such as rapid breathing and heart rate, increased blood pressure, etc., and these too can trigger an emotional reaction. The amygdala senses danger and rouses the body to high alert, and is in turn alarmed by our body’s arousal, this reciprocal influence of body on amygdala, amygdala on body, occasionally feeding on itself to produce runaway anxiety and panic attacks.

Some of the most important research showing that connections between brain and body became more elaborate in humans is that conducted by Bud Craig, a physiologist at the University of Arizona. He has mapped out the nervous circuitry responsible for a remarkable phenomenon known as interoception, the perception of our inner world. We have senses like vision, hearing and smell that point outwards, to the external world; but it turns out we also have something very like sense organs that point inwards, perceiving internal organs such as the heart, lungs, liver, etc. The brain, being incurably nosey, has these listening devices – receptors that sense pain, temperature, chemical gradients, stretching tissue, immune-system activation – throughout the body, and like agents in the field they report back every detail of our viscera. This internal sensation can be brought to consciousness, as it is with hunger, pain, stomach and bowel distension, but most of it, like sodium levels or immune-system activation, remains largely unconscious, or inhabits the fringes of our awareness. But it is this diffuse information, flowing in from all regions of the body, that gives us the sense of how we feel.

Interoceptive information is collected by a forest of nerves that flow back from every tissue in the body to the brain, travelling along nerves that feed into the spinal cord or along a superhighway of a nerve, called the vagus nerve, that travels up from the abdomen to the brain, collecting information from the gut, pancreas, heart and lungs. All this information is then channelled through various integration sites – regions of the brain that collect disparate individual sensations and assemble them into a unified experience – ending up in a region of the cortex called the insula, where something like an image of the overall state of the body is formed. Craig has looked at the nerves connecting body and brain in various animals, and has concluded that the pathways leading to the insula are present only in primates, and further that an awareness of the overall state of our body may be found uniquely in humans.

Lastly and most controversially, Craig, along with other scientists such as Antonio Damasio and Antoine Bechara, has suggested that gut feelings and emotions, rationality and even self-consciousness itself, should be seen as more advanced tools that emerged over the course of evolution to help us regulate our body.

As evolution progressed, body and brain entwined in an ever more intimate embrace. The brain sent out fibres to touch every tissue in the body, asserting control over heart, lungs, gut, arteries and glands, cooling us when hot, warming us when cold; and the body in turn pumped message after message back into the brain, telling of its wants and needs, and making suggestions as to how the brain should behave. In this manner, feedback between body and brain became more complex and extensive, not less so. We did not grow a larger brain just to fit it inside a withering body of the kind seen in sci-fi movies. The brain grew in order to control a more sophisticated body – a body that can handle a sword like Alexander, play the piano like Glenn Gould, control a tennis racket like John McEnroe, or perform open-brain surgery like Wilder Penfield.

Through the research surveyed here, from anatomy, physiology and neuroscience, we have today come to see the body as an éminence grise, standing behind the brain, effectively applying pressure at just the right point, at just the right time, to help us prepare for movement. Scientists, by small steps, are thus patiently stitching closed an ancient wound opened up between mind and body. By doing so they have helped us understand how body and brain cooperate at crucial moments in our lives, like the taking of risks, including, most certainly, financial risks.

A WAKE-UP CALL ON THE TREASURY DESK

The trading floor we will be observing belongs to a large Wall Street investment bank, located a short walk from the Stock Exchange and the Federal Reserve. We begin our visit early on a crisp morning in March. It is just past 7 a.m., darkness still shrouds the city, street lamps burn, but already bankers trickle from subway stations at Broadway, Broad Street and Bowling Green, or step from taxis and limos in front of our bank. Women in Anne Taylor and trainers grip coffees; men in Brooks Brothers look freshly scrubbed and combed, their eyes fixed, like an athlete’s, on the day ahead.

Up on the 31st floor the elevator doors open and bankers are drawn into a yawning trading room. Almost a thousand desks line its gridwork of aisles, each one cluttered with half a dozen computer screens that will soon monitor market prices, live news feeds and risk positions. Most screens are black now, but one by one they are switched on, and the floor begins to blink with neon green, orange and red. A rising hubbub absorbs individual voices. Out the front window, across the narrow street, looms another glass office tower, so close you can almost read the newspaper lying on a desk. Out the side window, lower down, climbs a listed 1920s building, its stepped-back rooftop an Art Deco masterpiece: pillars topped with hooded figures; friezes depicting sunbursts, winged creatures and mysterious symbols the meaning of which have long since been forgotten. During idle moments bankers gaze down on this lost civilisation and feel a momentary nostalgia for that more glamorous time, memories of the Jazz Age being just some of the ghosts haunting this storied street.

Settling in for the day, traders begin to call London and ask what has happened overnight. Once they have picked up the thread of the market they one by one take control of the trading books, transferring the risk to New York, where it will be monitored and traded until Tokyo comes in that evening. These traders work in three separate departments – bonds (the department is often called fixed income), currencies, and commodities, while downstairs a similar-sized trading floor houses the equity department. Each department in turn is split between traders and salespeople, the salespeople of a bank being responsible for convincing their clients – pension funds, insurance companies, mutual funds, in short, the institutions managing the savings of the world – to invest their money or execute their trades with the bank’s traders. Should one of these clients decide to do so, the salesperson takes an order from them to buy or sell a security, say a Treasury bond or a block of currencies, say dollar–yen, and the order is executed by the trader in charge of making markets in this instrument.

One of these clients, DuPont Pension Fund, livens up what is turning out to be an uneventful day by calling in the only big trade of the morning. DuPont has accumulated $750 million-worth of pension contributions from its employees, and needs to invest the funds. It chooses to do so in US Treasury bonds maturing in ten years, the interest payments from which will finance retiring employees’ pension benefits. It is still early in the day, only 9.30, and most markets are sleepy with inactivity, but the fund manager wants to execute this trade before the afternoon. That is when the Fed will announce its decision to raise or lower interest rates. Even though the financial community widely expects it to do nothing, the fund manager does not want to take unnecessary risks. Besides, for months now she has worried about what she considers an unsustainable bull market in stocks, and the very real possibility of a crash.

The fund manager scans her telephone keyboard for the four or five banks she prefers to deal with for Treasury bonds. Morgan Stanley sent her an insightful piece of research yesterday – maybe she should give them a shot. Goldman can be aggressive on price. Deutsche Bank entertains well, and last summer the salespeople covering her out of Europe took her to Henley Regatta. After a moment’s indecision she passes on these banks, and decides instead to give her pal Esmee a shot. Hitting the direct line, she says, without the usual chitchat, ‘Esmee, offer $750 million ten-year Treasuries, on the hop.’

Esmee, the salesperson, covers the speaker of her phone and yells to the trader on the Treasury desk, ‘Martin, offer 750 tens, DuPont!’

The trader shoots back, ‘Is this in competition?’ meaning is DuPont getting prices from a number of other banks. The advantage of doing a trade in competition is that DuPont ensures it gets an aggressive price; the disadvantage is that several banks would know there is a big buyer, and this may cause prices to spike before the fund gets its bonds. However, the Treasury market is now so competitive that price transparency is no longer an issue, so on balance it is probably in DuPont’s interest to keep this trade quiet. Esmee relays to Martin that the trade is ‘out of comp’, but adds, ‘Print this trade, big boy. It’s DuPont.’

Looking at his broker screens, Martin sees ten-year Treasuries quoted at 100.24–100.25, meaning that one bank, trying to buy them, is bidding a price of 100.24, while another, trying to sell, is offering them at 100.25. Traders post their prices on broker screens to avoid the tedious process of calling round all the other banks to find out which ones need to trade (in that regard a securities broker is no different from an estate agent), and also to maintain anonymity. The offer price posted right now on this broker screen is good for about $100 million only. If Martin offers $750 million to DuPont at the offered price of 100.25, he has no guarantee of buying the other $650 million at the price he sold them.

To decide on the right price, Martin must rely on his feel for the market – how deep it is, in other words how much he can buy without moving prices, and whether the market is going up or down. If the market feels strong and the offers are thinning out, he may need to offer the bonds higher than indicated on the screen, at say 100.26 or 100.27. If on the other hand the market feels weak, he may offer right at the offer side price of 100.25 and wait for the market to go down. Whatever his decision, it will involve taking a substantial risk. Nonetheless, all morning Martin has been unconsciously mapping the trading patterns on the screens – the highs and lows, the size traded, the speed of movement – and comparing them to ones stored in his memory. He now mentally scrolls through possible scenarios and the options open to him. With each one comes a minute and rapid shift in his body, maybe a slight tightening of his muscles, a shiver of dread, an almost imperceptible shot of excitement, until one option just feels right. Martin has a hunch, and with growing conviction believes the market will weaken.

‘Offer at 100.25.’

Esmee relays the information to DuPont, and immediately shouts back to Martin, ‘Done! Thanks, Martin; you’re the man.’

Martin doesn’t notice the stock compliment, just the ‘done’ part. He now finds himself in a risky position. He has sold $750 million-worth of bonds he does not own – selling a security you do not own is called ‘shorting’ – and needs to buy them. The market today may not seem much of a threat, languishing as it is, but this very lack of liquidity poses its own dangers: if the market is not trading actively, then a big trade can have a disproportionate effect on prices, and if he is not stealthy Martin could drive the market up. Besides, news by its very nature is unpredictable, so Martin cannot allow himself to be lulled into a sense of security. The ten-year Treasury bond, which is considered a safe haven in times of financial or political crisis, can increase in price by up to 3 per cent in a day, and if that happened now Martin would lose over $22 million.

He immediately broadcasts over the ‘squawk box’ – an intercom system linking all the bank’s offices around the world – that he is looking to buy ten-years at 100.24. After a few minutes a night salesman from Hong Kong comes back and says the Bank of China will sell him $150 million at 100.24. Salespeople from around the US and Canada come back with other sales, all different sizes, eventually amounting to $175 million. Martin is tempted to take the little profit he has already made and buy the rest of the bonds he needs, but now his hunch starts to pay off; the market is weakening, and more and more clients want to sell. The market starts to inch down: 100.23–24, 100.22–23, then 100.21–22. At this point he puts in the broker screen a bid of 100.215, a seemingly high bid considering the downward drift of the market. He immediately gets hit, buying $50 million from the first seller, then building up the ticket to $225 million as other sellers come in. Traders at other banks, seeing the size of the trade on the broker screen, realise there has been a large buyer and now reverse course, trying to buy bonds in front of Martin. Prices start to climb, and Martin scrambles to lift offers while he still has a profit, at higher and higher prices, first 100.23, then .24, finally buying the last of the bonds he needs at 100.26, slightly higher than where he sold them. But it is of no concern. He has bought back the bonds he shorted at 100.25 at an average price just under 100.23.

Martin has covered his bonds within 45 minutes, and made a tidy profit of $500,000. Esmee receives $250,000 in sales credit (her sales credit, a number that determines her year-end bonus, should represent that part of a trade’s profit which can be attributed to the relationship she has built with her client. You can imagine the frequent arguments between sales and trading. Like cats and dogs). The sales manager comes over and thanks Martin for helping build a better relationship with an important client. The client is happy to have bought bonds at lower levels than the current market price of 100.26. Everyone is happy. A few more days like today, and everyone can start hinting to management, even this early in the year, their high expectations come bonus time. Martin strolls to the coffee room feeling invincible, with whispered comments trailing behind him: ‘That guy’s got balls, selling $750 million tens right on the offer side.’

This scenario describes what happens on a trading floor when things go right. And in general things do not go badly wrong on a Treasury trading desk. There are certainly bad days, even months; but the really fatal events, like a financial crisis, strike at other desks. The reason is that Treasury bonds are considered to be less risky than other assets, such as stocks, corporate bonds or mortgage-backed securities. So when the financial markets are racked by one of their periodic crises, clients rush to sell these risky assets and to buy Treasuries. Trading volume in Treasuries balloons, the bid–offer spread widens, and volatility spikes. In periods like that Martin may price billion-dollar deals several times a day, and instead of making one or two cents, he may make half a point – $5 million at a crack. A Treasury desk usually makes so much money during a crisis it helps buffer the losses made on other trading desks, ones more exposed to credit risk.

There is a further reason the Treasury desk holds a privileged position on a trading floor, and that is the unrivalled liquidity of Treasury bonds. A bond is said to be liquid if a client can buy and sell large blocks of it without paying a lot in bid–offer spread and broker commissions. In normal conditions, clients can buy a ten-year Treasury at the offer side price of, say, 100.25, and sell it immediately, should they need to, a mere one cent lower. By way of comparison, corporate bonds, ones issued by companies, commonly trade with a bid–offer spread of 10–25 cents, with some trading as wide as $1 or $2. The Treasury market is the most liquid of all bond markets, and is thus perfectly tailored for large flows and fast execution, Treasury bonds being the thoroughbreds of trading instruments.

Such a market calls forth traders with a complementary set of skills. Traders like Martin must price client trades quickly, and cover their positions nimbly, before the market moves against them. This is especially true when the markets pick up speed, for then Martin has no time to think; if he is to avoid owning bonds in a falling market or being caught short in a rising one, he must price and execute his trades with split-second timing. In this his behaviour resembles not so much that of rational economic man, weighing utilities and calculating probabilities, but a tennis player at the net.

We are now going to look at Martin’s trade much as an athlete’s coach would, as a physical performance. We saw in the last chapter that our brain evolved to coordinate physical movements, and these, by the very nature of the world we lived in, had to be fast. If our actions had to be fast, so too did our thinking. As a result we came to rely on what are called pre-attentive processing, automatic motor responses and gut feelings. These processes travel a lot faster than conscious rationality, and help us coordinate thought and movement when time is short. We will look at some extraordinary research that demonstrates just how unaware we can be of what is really going on in our brains when we make decisions and take risks.

In this chapter we stray from the trading floor and visit other worlds where speed of reactions is crucial for survival, as it is in the wild and in war, and crucial for success, as it is in sports and trading. In the next chapter we look at gut feelings. These chapters provide the science we need, the background story, that will help us understand what we are seeing when, in later chapters, we head back onto the trading floor and watch Martin and his colleagues as they are swept up in a fast-moving market.

THE ENIGMA OF FAST REACTIONS

We evolved in a world where dangerous objects frequently hurtled at us at high speeds. A lion sprinting at 50 miles an hour from a hundred feet away will sink its teeth into our necks in just over one second, giving us very little time to run, climb a tree, string a bow, or even think about what to do. A spear launched in battle at 65 miles an hour from 30 feet away will pierce our chest in a little over 300 milliseconds (thousandths of a second), about a third of a second. As predator and projectile zero in, and our time to escape runs out, the speed of the reactions needed to survive shortens into a timeframe our conscious mind has difficulty imagining. Over millennia of prehistory, the difference between someone who lived and someone who died often came down to a few thousandths of a second in reaction time. Evolution, like qualifying heats at the Olympics, took place against the sustained ticking of a stopwatch.

Things are not that different today, in sport, for example, or war, or indeed in the financial markets. In sport we have sharpened the rules and honed the equipment to such an extent that once again, as in the jungle, we have pushed up against our biological speed limits. A cricket ball bowled at 90 miles an hour covers the 22 yards to the batsman’s wicket in about 500 milliseconds; a tennis ball served at 140 miles an hour will catch the service line in under 400 milliseconds; a penalty shot in football will cover the short 36 feet to the goal in about 290 milliseconds; and an ice hockey puck shot halfway in from the blue line will impact the goalie’s mask in less than 200 milliseconds. In each of these cases, the less than half a second travel time of the projectile gives the receiving athlete about half that time to make a decision whether or not to swing the bat, or return the serve, or jump to the left or right, or reach for the puck, for the remaining time must be spent initiating the muscle or motor response.

Even these short timeframes do not capture the truly miraculous speeds frequently demanded of the human body. In table tennis, which many of us consider a leisurely pursuit, the ball when smashed travels at 70 miles an hour, yet the distance between players may be only 14 to 16 feet, giving the returning player about 160 milliseconds to react. The difference between winning and losing has been shaved to a few thousandths of a second in reaction times. Similar reaction times are found in sprinters, who are so fast off the blocks, reacting to the starting gun in a little over 120 milliseconds, with some even approaching the 100-millisecond mark, that races increasingly feature what are called silent guns. These starting pistols produce a bang which is heard from electronic speakers placed behind each runner so that they all hear the starting signal at the same time. Without these speakers the runners in the outside lanes would hear the pistol with a fatal 30-millisecond delay, that being about the time it takes the sound of the shot to reach them.

Or consider one of the most dangerous positions in the sporting world, the close fielder in cricket. On a cricket field, this brave soul plants himself, crouched at the ready, a mere 14 to 17 feet from the batsman, with some coming in even closer than that. Here, without the benefit of gloves, he attempts either to catch the ball as it explodes off the bat, or to get out of the way. A cricket ball, slightly larger than a baseball and much harder, rebounds off a swinging bat at speeds of up to 100 miles an hour. The fielder facing this ball must first take care not to be hit by the bat itself, and then has as little as 90 milliseconds, less than a tenth of a second, to react to the incoming projectile. One of the closest of these positions is appropriately called silly point, and in here, this close to the batsman, death can occur. One Indian player, Raman Lamba, was killed by a ball to the temple while he was fielding at short leg, another position frighteningly close to the batsman.

Equally deadly projectiles, ones responsible for far more injuries, can be found in contact sports like karate and boxing, where punches have been clocked at terrifying speeds. Norman Mailer, reporting on the Rumble in the Jungle, when Muhammad Ali fought George Foreman in the Zairean capital Kinshasa in 1974, describes Ali warming up in the ring, ‘whirling away once in a while to throw a kaleidoscope-dozen of punches at the air in two seconds, no more – one-Mississippi, two-Mississippi – twelve punches had gone by. Screams from the crowd at the blur of the gloves.’ If Mailer’s numbers are right, one of Ali’s punches would run its course from beginning to end in about 166 milliseconds, although Foreman would only have had half that time to avoid it. In fact, later, more scientific measurement timed Ali’s left jab at little more than 40 milliseconds.

Fig. 4. Speed of reactions. Jo-Wilfried Tsonga reaching for a volley at Wimbledon, 2011. If we assume his opponent, Novak Djokovic, hit a backhand from the baseline at about 90 mph, then Tsonga had a little over 300 milliseconds to respond.

It should come as no surprise that athletes facing fast-moving objects like cricket balls or ice hockey pucks frequently fail to intercept them (or in boxing to avoid them). But if an athlete succeeds, say, one time out of three, as a good baseball player does when at bat, his success rate approaches that of many predators in the wild. A lion, for example, closing in on an antelope, or a wolf on a deer, catches its prey on average one time out of three. In sport, as in nature, competition has pushed reaction times right to the frontier of the biologically possible.

Unfortunately, those of us not gifted with the reaction times of an Olympic athlete are nonetheless often called upon to respond with something like their speed, especially while on the road. A driver speeding at 70 miles an hour has as little as 370 milliseconds to avoid a car 75 feet in front that has mistakenly swerved into the oncoming lane. Here a success rate of one out of three still leaves a lot of car crashes.

The speed demanded of our physical reactions, in the wild, in sports, on the road, even in the financial markets, raises troubling questions when lined up against certain findings in neuroscience. Take this curious fact, for instance: once an image hits the retina, it takes approximately 100 milliseconds – that is a full tenth of a second – before it consciously registers in the brain. Pause for a moment and contemplate that fact. You will soon find it profoundly disturbing. We tend to think, as we survey the world around us or sit in the stands of a sporting match, that we are watching a live event. But it turns out that we are not – we are watching news footage. By the time we see something, the world has already moved on.

The trouble stems from the fact that our visual system is surprisingly slow. When light hits our retina, the photons must be translated into a chemical signal, and then into an electrical signal that can be carried along nerve fibres. The electrical signal must then travel to the very back of the brain, to an area called the visual cortex, and then project forward again, along two separate pathways, one processing the identity of the objects we see, the ‘what’ stream, as some researchers call it, and the other processing the location and motion of the objects, the ‘where’ stream. These streams must then combine to form a unified image, and only then does this image emerge into conscious awareness. The whole process is a surprisingly slow one, taking, as mentioned, up to one tenth of a second. Such a delay, though brief, leaves us constantly one step behind events.

Neuroscientists have discovered another problem with the idea that we are watching the world live. An important part of this idea is the notion that our eyes objectively and continuously record the scene before us, much like a movie camera. But eyes do not operate like this. If we continuously recorded the visual information presented to us, we would waste a great deal of time (and probably suffer constant headaches) looking at blurred images as our eyes pan from one scene to another. More importantly, we would be swamped by the sheer amount of data, most of which is irrelevant to our needs. Live streaming takes up an enormous amount of bandwidth on the internet, and it does so as well in our brains. To avoid a needless drain on our attentional resources, our brain has hit upon the tactic of sampling from a visual scene, rather than filming it. Our eyes fix on a small section of our visual field, take a snapshot, then jump to another spot, take a snapshot, and quickly jump again, much like a hummingbird nervously flitting from flower to flower. We are largely unaware of this process, and do not see a blur when our eyes shift location because, remarkably, the visual system stops sending images up to consciousness while it jumps from scene to scene. Furthermore, we are unaware of these jumps and intervening blackouts because our brain weaves these images seamlessly into something that does appear much like a movie. We can perform up to five of these visual jumps per second, the minimum amount of time required for a shift in view being therefore one fifth of a second.

If we return to sports, we can see that some numbers do not add up. How can a cricketer at silly point catch (or duck) a ball in under a tenth of a second if he is not even aware of it yet? How can he direct his attention to the ball if it takes him twice as long just to move his eyes? And when dealing with these numbers we have not even begun to consider the additional 300–400 milliseconds required for an elementary cognitive decision or inference, and the 50 milliseconds or so it takes for a motor command to be communicated by nerves to our muscles. The picture conjured by these numbers is one of an infielder frozen in the readiness stance, eyes fixed like a waxwork model, while a projectile shudders past his immobile and fragile head.

The same questions we ask about athletes can be asked, and with more urgency, beyond the cricket pitch. How can we humans survive in a brutal and fast-moving world if our consciousness arrives on the scene just after an event is over? This is a baffling question. But asking it allows us to see what is wrong with the notion of the brain as a central processor, taking in objective information from the senses in the manner of a camera, processing this information rationally, consciously and discursively, deciding on the appropriate and desired action, and then issuing motor commands to our muscles, be they larynx or quadriceps. Each of these steps takes time, and if we were indeed programmed to behave this way, then life as we know it would be very different. If we had to think consciously about every action we took, sporting events would become odd, slow-motion spectacles that few people would have the patience to watch. Worse, in nature and in war we would have long ago fallen prey to some quicker beast.

I, CAMERA?

It turns out that there is something wrong with each step in this supposed chain of mental events. The eye takes snapshots rather than movies; but even these snapshots are not a photographic and objective record of the outside world. All sensory information comes to us tampered with. Like the news on TV, it is filtered, warped and pre-interpreted in a way designed to catch our attention, ease comprehension and speed our reactions.

Take for instance the ways in which the brain deals with the problem of the one-tenth-of-a-second delay between viewing a moving object and becoming consciously aware of it. Such a delay puts us in constant danger, so the brain’s visual circuits have devised an ingenious way of helping us. The brain anticipates the actual location of the object, and moves the visual image we end up seeing to this hypothetical new location. In other words, your visual system fast-forwards what you see.

An extraordinary idea, but how on earth could we ever prove it to be true? Neuroscientists are devilishly clever at tricking the brain into revealing its secrets, and in this case they have recorded the visual fast-forwarding by means of an experiment investigating what is called the ‘flash-lag effect’. In this experiment a person is shown an object, say a blue circle, with another circle inside it, a yellow one. The small yellow circle flashes on and off, so what you see is a blue circle with a yellow circle blinking inside it. Then the blue circle with the yellow one inside starts moving around your computer screen. What you should see is a moving blue circle with a blinking yellow one inside it. But you do not. Instead you see a blue circle moving around the screen with a blinking yellow circle trailing about a quarter of an inch behind it. What is going on is this: while the blue circle is moving, your brain advances the image to its anticipated actual location, given the one-tenth-of-a-second time lag between viewing it and being aware of it. But the yellow circle, blinking on and off, cannot be anticipated, so it is not advanced. It thus appears to be left behind by the fast-forwarded blue circle.

The eye and brain perform countless other such tricks in order to speed up our understanding of the world. Our retina tends to focus on the front edge of a moving object, to help us track it. We process more information in the lower half of our visual field, because there is normally more to see on the ground than in the sky. We group objects into units of three or four in order to perceive numbers rather than count them, a process, known as subitising, that comes in handy when assessing the number of opponents in battle. We rapidly and unconsciously assume an object is alive if it moves in certain ways, regularly changing direction say, or avoiding other objects, and then pay it closer attention than we would if it was inanimate.

Our reaction times can also be speeded up by relying more on hearing than vision. That may seem counter-intuitive. Light travels faster than sound, much faster, so visual images reach our senses before sounds. However, once the sensations reach our eyes and ears, the relative speeds of the processing circuits reverse. Hearing is faster and more acute than seeing, about 25 per cent so, and responding to an auditory cue rather than a visual one can save us up to 50 milliseconds. The reason is that sound receptors in the ear are much faster and more sensitive than anything in the eye. Many athletes, such as tennis and table-tennis players, rely on the sound a ball makes on a racket or bat as much as on the sight of its trajectory. A ball hit for speed broadcasts a different sound from one sliced or spun, and this information can save a player the precious few milliseconds that separate winners from losers.

If we now add up all the time delays between an event occurring in the outside world and our perceiving it, we discover the following lovely fact. For events occurring at a distance, we see them first and hear them with a delay, as we do, for example, when seeing lightning and hearing the thunder afterwards. But for events taking place close to us, we hear them, because of our rapid auditory system and relatively slow visual one, slightly in advance of seeing them. There is, though, a point at which sights and sounds are perceived as occurring simultaneously, and that point is located about ten to fifteen metres from us, a point known as the ‘horizon of simultaneity’.

Could our more rapid hearing provide traders with an edge over competitors? Right now, all price feeds onto a trading floor are visual images on a computer screen. But the technology does exist for supplying audio price feeds. These have already been supplied to blind people, and apparently they sound much like an audiocassette on fast forward. Such a feed could give traders a 40-millisecond edge. That is not much time. But who knows, it could prove decisive when hitting a bid or lifting an offer during a fast market.

Bringing a trader’s hearing into play may have a further advantage. Research in experimental psychology has found that perceptual acuity and general levels of attention increase as more senses are involved. In other words, vision becomes more acute when coupled with hearing, and both become more acute when coupled with touch. The explanation ventured for these findings is that information arriving from two or more senses instead of just one increases the probability that it is reporting a real event, so our brain takes it more seriously. Many older trading floors may have inadvertently capitalised on this phenomenon, because they came equipped with an intercom to the futures exchanges, with an announcer reporting bond futures prices: ‘One, two … one, two … three, four … fours gone, fives lifted, size coming in at six …’ and so on. With the advent of computerised pricing services, many companies felt this voice feed was antiquated and discontinued the service. Yet by bringing in a second sense it may have been an effective way of sharpening attention and reactions among the traders.

KNOWING BEFORE KNOWING

All these ad hoc adjustments to the information being transmitted to your conscious brain keep you from falling hopelessly behind the world. But the brain has an even more effective way of saving you from your fatally slow consciousness. When fast reactions are demanded it cuts out consciousness altogether and relies instead on reflexes, automatic behaviour and what is called ‘pre-attentive processing’. Pre-attentive processing is a type of perception, decision-making and movement initiation that occurs without any consultation with your conscious brain, and before it is even aware of what is going on.

This processing, and its importance to survival, has nowhere been better described than in the extraordinary book All Quiet on the Western Front, written by Erich Maria Remarque, a soldier who served in the trenches during the First World War. Remarque explains that to survive on the front soldiers had to learn very quickly to pick out from the general din the ‘malicious, hardly audible buzz’ of the small shells called daisy cutters, for these were the ones that killed infantry. Experienced soldiers could do this, and developed reactions that kept them alive even amid an artillery bombardment: ‘At the sound of the first droning of the shells,’ Remarque tells us, ‘we rush back, in one part of our being, a thousand years. By the animal instinct that is awakened in us we are led and protected. It is not conscious; it is far quicker, much more sure, less fallible, than consciousness. One cannot explain it. A man is walking along without thought or heed; – suddenly he throws himself down on the ground and a storm of fragments flies harmlessly over him; – yet he cannot remember either to have heard the shell coming or to have thought of flinging himself down. But had he not abandoned himself to the impulse he would now be a heap of mangled flesh. It is this other, this second sight in us, that has thrown us to the ground and saved us, without our knowing how.’

Neuroscientists have long known that most of what goes on in the brain is pre-conscious. Compelling evidence of this fact can be found in the work of scientists who have calculated the bandwidth of human consciousness. Researchers at the University of Pennsylvania, for example, have found that the human retina transmits to the brain approximately 10 million bits of information per second, roughly the capacity of an ethernet connection; and Manfred Zimmermann, a German physiologist, has calculated that our other senses record an additional one million bits of information per second. That gives our senses a total bandwidth of 11 million bits per second. Yet of this massive flow of information no more than about 40 bits per second actually reaches consciousness. We are, in other words, conscious of only a trivial slice of all the information coming into the brain for processing.

A fascinating example of this pre-conscious processing can be found in a phenomenon known as blindsight. It became a topic first of curiosity and then of medical concern during the First World War, when medics noticed that certain soldiers who had been blinded by a bullet or shell wound to the visual cortex (but whose eyes remained intact) were nonetheless ducking their heads when an object, such as a ball, was tossed over their heads. How could these blind soldiers ‘see’? They were seeing, it was later discovered, with a more primitive part of the brain. When light enters your eye its signal follows the pathways, described above, back to your visual cortex, a relatively new part of the brain. However, part of the signal also passes down through an area called the superior colliculus, which lies underneath the cortex, in the midbrain (fig. 5). The superior colliculus is an ancient nucleus (collection of cells) that was formerly used for tracking objects, like insects or fast-moving prey, so that our reptilian ancestors could, say, zap it with their tongues. Now largely layered over by evolutionarily more advanced systems, it nonetheless still works. It is not sophisticated: it cannot distinguish colour, discern shape or recognise objects, the world appearing to the superior colliculus much like an image seen through frosted glass. But it does track motion, capture attention and orient the head towards a moving object. And it is fast. Fast enough, according to some scientists, to account for a batsman or a close fielder’s rapid tracking of a cricket ball. Lastly, blindsight operates without us ever being aware of it.

Fig. 5. The visual system. Visual images travel by electrical impulses projected from the retina to the visual cortex at the back of the brain. They are then sent forward along the ‘what’ stream, which identifies the object, and the ‘where’ stream, which identifies its location and movement. An older, faster route for visual signals travels down to the superior colliculus where fast-moving objects can be tracked.

To what features of the world do we pre-attend? When a close fielder is crouched at the ready, frozen like a statue, his eyes fixed and unable to scan, what in his visual field captures the interest of his pre-conscious processor? We do not yet know a complete answer to this question, but we do know a few things. We attend pre-consciously, as in blindsight, to moving objects, especially animate ones. We attend to images of certain primitive threats, such as snakes and spiders. And we are strongly biased to aurally attend to human voices, and visually to faces, especially ones expressing negative emotions such as fear or anger. All these objects can be registered so rapidly, in as little as 15 milliseconds (this does not include a motor response, of course), that they can affect our thinking and moods without our even being aware of them. In fact we often know whether we like or dislike something or someone well before we even know what or who it is. The speed and power of pre-conscious images, especially sexual ones, were once used in subliminal advertising as a way of biasing our subsequent spending decisions. More usefully, this pre-conscious processing can affect motor commands for reflex actions and automatic behaviours.

One of these reflexes is our startle response, a quick and involuntary contraction of muscles designed to withdraw us, like an escaping octopus, from a sudden threat. It can be initiated by both sights and sounds. A loud bang will trigger the startle, as will a rapidly approaching object in our visual field. The way we visually detect an object on a collision course with us is ingenious: our startle is initiated by a symmetrical expansion of a shadow in our visual field. The expanding shadow indicates an incoming object, and its symmetry indicates that it is heading straight for us. Apparently this pre-conscious object tracking is so well calibrated that if the shadow is expanding asymmetrically our brain can tell within five degrees that the object will miss us, and as a result the startle response is not triggered. The startle, from sensory stimulus to muscle contraction, is exceptionally fast, your head reacting in as little as 70 milliseconds and your torso, since it is farther from your brain, in about 100 milliseconds. Coincidentally, that is roughly the time required for a fielder at silly point to catch a ball coming off a bat. It is entirely possible that close fielders rely on the startle response to achieve the almost inhuman response times they display. If so, then, conveniently, perhaps the fielder can catch or avoid a ball in the little time allowed him only if it is coming straight for his head.

Besides the startle response, how can we react fast enough to meet the challenges sports, and daily life, throw at us? As we saw in the previous chapter, humans have adopted a wide range of movements, like those found in sports and dance and modern warfare and even trading, for which evolution has not prepared us. How can these learned movements become so habitual that they approach the speeds needed for sporting success or survival in the wild? To answer this question we should recognise a basic principle at work in our reflexes and automatic behaviours: the higher we rise in the nervous system, moving from the spine to the brain stem to the cortex (where voluntary movement is processed), the more neurons are involved, the longer the distances covered by nervous signals, and the slower the response. To speed our reactions the brain tends therefore to pass control of the movement, once it has been learned, back to lower regions of the brain where programmes for unthinking, automatic and habitual actions are stored. Many of these learned and now-automatic behaviours can be activated in as little as 120 milliseconds.

A glimpse into this process has been provided by a brain-scanning study of people learning the computer game Tetris. At the beginning of the study, large swathes of the trainees’ brains lit up, showing a complex process of learning and voluntary movement; but once they had mastered the game their movements became habitual, and brain activity in the cortex died down. Their brains now drew much less glucose and oxygen, and their speed of reactions increased markedly. Once the players had the knack, they no longer thought about playing the game. This study, and others like it, supports the old saying that when learning begins we are unconscious of our incompetence, and proceed to a stage where we are conscious of our incompetence; then when training begins we move to conscious competence; and as we master our new skill we arrive at the end point of our training – unconscious competence. Thinking, one could say, is something we do only when we are no good at an activity.

One last point. As fast as these automatic reactions may be, they still do not seem quite fast enough for many of the high-speed challenges we face, and may therefore leave us slightly behind the ball, so to speak. The trouble with these reaction times is just that – they are reactions. But good athletes are not in the habit of waiting around for a ball or a fist to appear, or opponents to make their move. Good athletes anticipate. A baseball batter will study a pitcher and narrow down the likely range of his pitches; a cricket close fielder will have registered a hundred tiny details of a batsman’s stance and glance and grip even before the ball has left the bowler’s hand; and a boxer, while dancing and parrying jabs, will pre-consciously scan his opponent’s footwork and head movements, and look for the telltale setting of his stabiliser muscles as he plants himself for a knockout blow. Such information allows the receiving athlete to bring online well-rehearsed motor programmes and to prepare large muscle groups so that there is little to do while the ball or fist is in the air but make subtle adjustments based on its flightpath. Skilled anticipation is crucial to lowering reaction times throughout our physiology.

Let us finish by listening to Ken Dryden, a legendary goalie in ice hockey and one of the most articulate athletes ever, on the importance of anticipation and automatic behaviour: ‘When a game gets close to me, or threatens to get close, my conscious mind goes blank. I feel nothing. I hear nothing, my eyes watch the puck, my body moves – like a goalie moves, like I move; I don’t tell it to move or how to move or where, I don’t know it’s moving, I don’t feel it move – yet it moves. And when my eyes watch the puck, I see things I don’t know I’m seeing … I see something in the way a shooter holds his stick, in the way his body angles and turns, in the way he’s being checked, in what he’s done before that tells me what he’ll do – and my body moves. I let it move. I trust it and the unconscious mind that moves it.’

To sum up, we humans have been equipped over our long evolutionary training period with a large bag of tricks designed to increase our speed of reactions. In the foregoing discussion I have rummaged in this bag and pulled out only a few of our amazing gadgets. But demonstrating how they work should be enough, I hope, to show just how reliant we are on these quick responses for survival in the wild and in war, for success in sports, and for buying back a large block of bonds sold to DuPont.

WHAT LIES BENEATH

In fact, so fast are our reactions that consciousness is frequently left out of the loop. Given that sobering fact, we have to ask: what role does consciousness play in our lives? We experience our consciousness as something residing in our heads, peering out through our eyes much as a driver peers through a windscreen, so we tend to believe that our brain interacts with our body just as a person interacts with a car, choosing the direction and speed and issuing commands to a passive and mechanical device. But this belief does not stand up to scientific scrutiny. As George Loewenstein, an economist at Yale, points out, ‘There is little evidence beyond fallible introspection supporting the standard assumption of complete volitional control of behavior.’ And he is right, for the stats on reaction times tell us otherwise: we are for the most part on autopilot.

The news gets even worse for the Platonists among us. In the 1970s, Benjamin Libet, a physiologist at the University of California, conducted a famous series of experiments that has tormented many a scientist and philosopher. These experiments were simplicity itself. Libet wired up a group of participants with what are called EEG leads, small monitors attached to the scalp which record the electrical activity in the brain, and then asked them to make a decision to do something, like lift a finger. What he found was that the participants’ brains were preparing the action 300 milliseconds before they actually made the decision to lift their finger. In other words, their conscious decision to move came almost one third of a second after their brain had initiated the movement.

Consciousness, these experiments suggested, is merely a bystander observing a decision already taken, almost like watching ourselves on video. Scientists and philosophers have proposed many interpretations of these findings, one of which is that the role of consciousness may not be so much to choose and initiate actions, but rather to observe decisions made and veto them, if need be, before they are put into effect, much as we do when we practise self-control by stifling inappropriate emotional or instinctive urges. (We may be on autopilot for much of the day, but that does not mean we cannot take responsibility for our actions.) Libet’s experiments, suggesting as they do that consciousness is largely an override mechanism, led one particularly witty commentator, the Indian neuroscientist V.S. Ramachandran, to conclude that we do not in fact have free will; what we have is free won’t.

It seems that consciousness is a small tip of a large iceberg. But what exactly lies below it? What lurks beneath our rational, conscious selves? The eighteenth-century German philosopher Immanuel Kant proposed a particularly intriguing answer to this question: we do not know what is down there. Kant believed that our consciousness – that is, our experience of a unified and understandable world, and of a continuing person experiencing this world – is possible only because our mind constructs this unified experience. If our mind did not organise our sensations the world would be a whirling, blooming confusion. But the mind does: it provides organising constructs, such as space and time, so that we experience a continuing world, just as it does another construct, that of cause and effect, which ties succeeding events together into a coherent story. Kant thought all these unifying constructs applied only to the veil of sensations, and not to the entities creating or lying behind the sensations. These objects we can never know. Inaccessible to rational analysis, forever mysterious to science, these hidden beings can be groped at and suggestively discerned only through art and religion. And it is in this dark world that the soul belongs, putting it too beyond the ken of rationality and beyond the domain of cause and effect. It was upon this argument that Kant rested his belief in free will.

Kant’s philosophy left a deep imprint on German thought. Freud, inspired by Kant’s vision, argued that below the façade of our rational selves, deep in our subconscious, there boils a devil’s cauldron of envy and sexual perversion and patricidal tendencies which warps our judgement. Nietzsche too found beneath our delusions of rationality and morality a dark urge for power and dominance. Modern neuroscience, however, has lifted the lid off this hitherto mystifying brain and found something far more valuable than the entities proposed by nineteenth-century German philosophy – a meticulously engineered control mechanism. More valuable because it has been precisely calibrated over millennia to keep us alive in a brutal and fast-moving world. And we can thank our lucky stars for it, otherwise we would long ago have been battered to extinction. Lifting the lid of our brain does not reveal the nether world of Kant’s unsayable, nor the volcanic will of Nietzsche’s superman, nor yet the hellish subterranean den of Freud’s subconscious. It reveals something that is a lot closer to the inner workings of a BMW.

FAST TIMES ON THE TRADING FLOOR

Let us now return to the financial world, and consider the importance of fast reactions to the success and survival of risk-takers. Traders like Martin frequently face high-speed challenges which demand an equally fast response. The challenges may not demand quite the same speed of reactions as fielding at silly point, but traders nonetheless regularly face time constraints, and when they do their decision-making and trade execution must bypass conscious rationality and draw instead on automatic reactions. This is especially true when markets begin to move fast, as they might in a frantic bull market. Then Martin is obliged to sell bonds to clients or risk alienating the sales force, and must scramble to buy them on the broker screens or from other clients before losing money. At times like this trading is much like a game of snap, and the fastest person wins.

This simple point carries unexpected implications for economics. It is not often appreciated that financial decision-making is a lot more than a purely cognitive activity. It is also a physical activity, and demands certain physical traits. Traders with a high IQ and insight into the value of stocks and bonds may be worth listening to, but if they do not have an appetite for risk then they will not act on their views and will suffer the fate of Cassandra, who could predict the future but could not affect its course. And even if they have a good call on the market and a healthy appetite for risk, yet are shackled with slow reactions, they will remain one step behind the market, and will not survive on the trading desk – or anywhere else in the financial world, for that matter.

Treasury traders, like flow traders more generally (a flow trader is one who trades with clients, handles the flows coming off the sales desks), therefore require a battery of traits: they need a high enough IQ and sufficient education to understand basic economics; a hearty appetite for risk; and a driving ambition. But they also need the physical build. They must be able to engage in extended periods, hours at a time, of what is called visuo-motor scanning, i.e. scrutinising the screens for price anomalies between say the ten-year and the seven-year Treasury bond, or between the bond and currency markets. Such scanning requires concentration and stamina, and not everyone can do it, just as not everyone can run a four-minute mile. And once a price discrepancy has been identified, or a high bid spotted during a sell-off, a trader must move quickly to trade on these prices before anyone else. Not surprisingly, most flow-trading desks, be they ones trading Treasury or corporate or mortgage-backed bonds, usually employ one or two former athletes, a World Cup skier, say, or a college tennis star.

The physical nature of trading is even more apparent on other types of floors. On the floor of a stock exchange or the bond and commodity pits at the Chicago Board of Trade, a trader’s job can resemble a day spent in a wrestling ring. Hundreds of traders stand together, jostling each other and vying for attention when trying to trade with each other, something they do with an arcane system of hand signals. When markets are moving fast and a trader needs the attention of someone on the other side of the pit, then height, strength and speed are of paramount importance in executing a trade, as is the willingness to elbow a competitor in the face. Needless to say, there are not a lot of women in the financial mosh pits.

Another style of trading that makes punishing physical demands is what is called high-frequency trading. This activity involves buying or selling securities, say a bond or stock or futures contract, sometimes in sizes amounting to billions, but holding the positions for only a few minutes, sometimes mere seconds. High-frequency traders do not try to predict where the market is going in the next day or two, let alone the next year, as do asset managers who invest for the long term; they try to predict the small moves in the market, a few cents up or down. As a general rule, the shorter the holding period for a style of trading, the greater the need for its traders to have fast reactions.

Having said all this, there are good reasons for expecting the physical aspect of trading to decline in importance in the financial world. More and more activities are now carried out electronically. The first and most dramatic sign of such a change was the closing down of physical stock exchanges, such as the London Stock Exchange. In their place mainframe computers took over the task of matching buyers and sellers of securities. Today only a few physical exchanges, with tumultuous floors and face-to-face execution of trades, remain, the New York Stock Exchange and the Chicago Board of Trade being the most famous.

The same evolution has begun in bond and currency trading at banks. Many banks began to post the prices of the most liquid securities, beginning with Treasuries and mortgage-backed bonds, on computer screens, and then allowed their clients access to the screens. That way they could execute trades themselves, without the need of going through a salesperson like Esmee. Normally traders like Martin post prices on these screens for a limited size, say $25 to $50 million, and these will be executed electronically by clients; but for bigger trades, like DuPont’s, clients still prefer to call their salesperson. Nonetheless, many people within the banks think the flow traders are dinosaurs, and will eventually go extinct.

Perhaps the greatest threat facing the human trader, though, comes from computerised trading algorithms known as black boxes. Life for many traders has always been nasty, brutish and short, given the vicious competition between them. Survival has depended on their relative endowment of intelligence, information, capital and speed. But the advent and insidious spread of the black boxes has begun squeezing humans out of their ecological niche in the financial world. These computers, backed by teams of mathematicians, engineers and physicists (‘quants’, they are called) and billions in capital, operate on a time scale that even an elite athlete could not comprehend. A black box can take in a wide array of price data, analyse it for anomalies or statistical patterns, and select and execute a trade, all in under 10 milliseconds. Some boxes have shaved this time down to two or three milliseconds, and the next generation will operate on the order of microseconds, millionths of a second. The speeds now dealt with in the markets are so fast that the physical location of a computer affects its success in executing a trade. A hedge fund in London, for example, trading the Chicago Board of Trade, lags at least 40 milliseconds behind the market, because that is the time it takes for a signal, travelling at close to the speed of light, to travel back and forth between the two cities while a price is communicated and a trade executed, and the delays added by routers along the way mean the actual time is considerably longer. Most companies running boxes therefore co-locate their servers to the exchange they trade, to minimise the travel time for an electronic signal.

Many of these boxes are what are called ‘execution-only’ boxes. This type of box does not look for trades, it merely mechanises their execution. At this task, boxes excel. They can take a large block of equities, for example, and sell it in pieces here and there, minimising the effect on prices. They test the waters, looking for deep pools of liquidity, a practice known as pinging, just like a sonar searching the depths. When they find large bids hidden just below the surface of existing prices they execute a block of the trade. In this way they can move enormous blocks of stock without rippling the market. At this trading exercise, boxes are more efficient than humans, faster and nimbler. They do what Martin did when he pieced out of the DuPont trade, only they do it better. Many managers have started to ask why traders spend so much time and effort executing client trades when a box could do it just as well, and never argue over its bonus.

Other boxes do more than execution: they think for themselves. Employing cutting-edge mathematical tools such as genetic algorithms, boxes can now learn. Funds running them regularly employ the best programmers, code-breakers, even linguists, so the boxes can parse news stories, download economic releases, interpret them and trade on them, all before a human can finish reading even a single line of text. Their success has led to an exponential growth in the capital backing them, and boxes already make up the majority of trading by volume on many of the largest stock exchanges; and they are now spreading into the currency and bond markets. Their growing dominance in the markets is one of the most significant changes ever to take place in the markets. I, like many others, find the markets increasingly inhuman, and when I trade now I often have difficulty catching the scent of the market’s trail.

Human traders such as Martin are therefore in a fight for their lives. Unbeknownst to outsiders, every day a battle rages up and down Wall Street between man and machine. Some informed observers believe human traders have had their day, and will meet the same fate as John Henry, the legendary nineteenth-century railway worker who challenged a steam drill to a competition and ended up rupturing his heart.

Others, however, note with optimism that human traders are more flexible than a black box, are better at learning, especially at forming long-term views on the market, and thus in many circumstances remain faster. Evidence of their greater flexibility is found when market volatility picks up after some catastrophic event, like a credit crisis. Then managers at the banks and hedge funds are forced to unplug many of their boxes, especially those engaged in medium- and long-term price prediction, as the algorithms fail to comprehend the new data and begin to lose ever increasing amounts of money. Humans quickly step into the breach.

Something much like this occurred during the credit crisis of 2007–08. Anecdotal evidence and published fund performance statistics give us something like the following scorecard: in high-frequency trading, humans and machines fought to a draw, both making historic amounts of money; in medium-term price prediction, in other words seconds to minutes, humans pulled slightly ahead of the boxes, as flow traders made record amounts of money; but in medium- to long-term price prediction, minutes to hours or days – the boxes engaged in these time horizons are known as statistical arbitrage and quantitative equity – humans outperformed the boxes, because only they understood the implications of the political decisions being made by central bankers and Treasury officials. Thus, in what may have been the first major test of human versus machine trading, humans won, but only just. And so it is that this futuristic battle ebbs and flows.

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