Recent studies have shown a direct positive correlation between testosterone levels and financial risk taking, and a direct negative correlation between cortisol levels and risk. This would probably not be a surprise to most people. A study published in PNAS (Proceedings of the National Academy of Sciences) monitored 17 male
Testosterone is a steroid hormone that plays a role in maintaining muscle mass & strength and maintaining mental strength & energy. The study showed that each trader’s testosterone levels were higher on higher than average profitable days than on other days, indicating increased testosterone levels may cause traders to be more confident and have a bigger risk-taking appetite. In addition, the study showed that too much testosterone and prolonged elevation could lead to impulsive decision and extreme risk-taking, turning potential profits to losses.
Cortisol is another hormone that regulates immune response and has a direct correlation to stress levels. An increase in cortisol often leads to a decrease in testosterone. The researchers found that while both rising levels of testosterone and cortisol allowed traders to take risks, if testosterone reaches upper psychological limits (i.e. during market bubbles), it can turn risk taking into a form of addiction, while extreme cortisol (i.e. during a market crash), can make traders shun risk altogether. Either situation likely results in traders making stupid decisions.
This is an additional piece of evidence to support the notion that people are often caught in bubbles, causing them to make irrational decisions in market crashes. It can be also linked to the theme of my previous article about why it is difficult to let go of a sagging stock.
Another interesting piece of research worth looking at is by Dr. Nielson Knutson at Stanford, who shows that increased dopamine levels through looking at sexy photos of women, increases financial risk taking as well. Link: http://www-psych.stanford.edu/~span/Publications/bk08nr.pdf