Coates, The Hour Between Dog and Wolf

Traders should be unemotional. No, traders should tap into their emotions and use these emotions as trading inputs. The debate rages on, mostly at the level of pop psychology, rarely rising to a level that is even quasi-scientific.

John Coates, a senior research fellow in neuroscience and finance at the University of Cambridge who previously worked for Goldman Sachs and ran a trading desk for Deutsche Bank, changes all this—or so one would hope. The Hour Between Dog and Wolf: Risk Taking, Gut Feelings and the Biology of Boom and Bust (Penguin Press, 2012) is a compelling narrative of the links between biology and the trading floor. It’s one of the most intriguing books I’ve read in a long time.

Coates’s previously published research papers offer a glimpse into this book, but no more than a glimpse. Let’s start with the title, a French expression meaning literally dusk, when the light is so dim that you can’t distinguish a dog from a wolf. More subtly and aptly, according to the website Naked Translations, “it also expresses that limit between the familiar, the comfortable versus the unknown and the dangerous… It is an uncertain threshold between hope and fear.”

Traders live in the gloaming, and their bodies (and consequently their risk management skills) respond accordingly. They spend a good part of their day faced with novelty, uncertainty, and uncontrollability—“three types of situation [that] signal threat and elicit a massive physiological stress response.” (p. 217) If markets are more or less normal, traders can usually handle this stress because it is moderate and exists over a short period of time. If, however, stress goes on for an extended period of time, this chronic exposure can impair their cognitive and physical performance.

Coates explains in wonderfully clear prose the physiological mechanisms that affect traders’ behavior. He describes, for instance, how the brain of a skilled trader can separate signal from noise and how the trader can feel in his body “when the chaos on the screens can be safely ignored and when it cries a warning that should be heeded.” (p. 140)

He looks at the reactions of two traders to a rapidly dropping market, one of whom is invigorated while the other finds it impossible to think clearly. “[O]ddly, inappropriately,” the second trader’s body “has atavistically prepared him to fight with or run away from a bear. The stress response is prehistorically hamfisted in this regard. It does not distinguish very clearly between physical, psychological and social threats, and it triggers much the same bodily response to each one. In his way the stress response, so valuable in the woods, can prove archaic and dysfunctional when displaced onto the trading floor, or for that matter any workplace. We need to think, nor run.” (pp. 209-10) Coates writes that “some studies have even suggested that under conditions of extreme stress our prefrontal cortex is effectively taken offline, impairing analytic thought and leaving our brains to run on stored reactions, largely emotional and impulsive ones. … Shell-shocked traders, under the influence of an overly active amygdala, become prey to rumor and imaginary patterns.” (p. 227)

Coates contends that traders can be trained to be tough, to view novel events as challenges to embrace instead of crippling stressors. Although he admits that “it is too early in this research to recommend any particular toughening regime,” he suggests that since the new training programs will have to be able to access the primitive brain, not just the rational cortex, they “may turn out to involve a lot more physical exercises than they do at present.” (p. 254)

The Hour Between Dog and Wolf is a very rich book, one that every trader and risk manager should read. I recommend it unequivocally. (Just don’t send me to boot camp.)