For many, playing the stock market feels like wild speculation and guesswork. Today, more and more trading is handled by computers, but there are a few who still fall back on an age old constant– human intuition. “Nobody can predict the market, but traders are expected to,” says Richard Taffler, professor of finance at the University of Warwick. “This creates anxiety.” Anxiety, however, is just one of many emotions that holds an important role in driving financial markets; now, researchers speculate that knowing what’s happening in the brains of traders as prices fluctuate could shed light on the market’s future developments.
Take, for example, a study published in the Proceedings of the National Academy of Sciences, conducted by Alec Smith at the California Institute of Technology. Smith and his colleagues performed group-behavior experiments: for each of 16 rounds, they had from 11 to 23 students play a game that simulated a market situation. During each round, Smith monitored the brain activity of three of the participants with functional magnetic resonance imaging (fMRI), highlighting parts of the brain based upon levels of activity in that region. The game starts by assigning an asset an arbitrary value. As the market develops over time, the asset price increases– but not for long. The game is rigged so that a market bubble always forms, then inevitably bursts, bringing the asset back down to its initial value in short order.
The researchers found that a region called the nucleus accumbens (NA) showed activity correlating with the changing market prices– meaning as prices increased, activity in this region increased. Smith states it “makes sense we find this region active,” as the NA “was previously associated with emotions, fear, and pleasure.” Next, researchers compared the participants who came out as high or low earners, in an attempt to relate brain activity to a specific trading outcome. Low earners were those who bought shares around peak price– around when high earners were selling theirs. Smith suspected the cause for this behavior lay in the anterior insular cortex, the area of the brain responsible for feelings of bodily discomfort and also for financial risk.
Smith found that around the time prices were about to peak, insular activity increased in high earners, but showed no change in low earners. So, if you could measure the underlying brain activity of a successful trader in a critical market situation, you could possibly predict how prices may change. Taffler doesn’t believe that such predictions are possible. “It is not clear how we get from undergraduate students, in a confined laboratory environment, without a real potential of loss, to a real world market situation,” he said.
On the other hand, Smith insists the behavioral game is not too much of an abstraction from reality and we can use it learn about the principles of price bubbles. Still, Taffler proposes that we should instead observe and learn from behavior and price development in real-world market bubbles, should we seek to grasp the complexity of the market. Either way, the experimental setup at least provides for the possibility to learn about other cases where human groups badly judge the value of actions or events. Despite the intrigue of the research, the next step is probably not to connect every Wall Street trader to an fMRI.