The Stock Market: How Biology Plays A Role In Your Finances

There is a relatively new field that encompasses both finance and biology, it's called behavioral finance. Behavioral finance explores why people make irrational financial decisions. The idea of psychology influencing financial decisions was first suggested by a famous economist John Maynard Keynes in his book The General Theory of Employment, Interest and Money. Keynes used the term 'animal spirits' to describe the phenomenon. Keynes was rather appropriate when creating this term as some similar behaviors are found in other animals. 

Two hormones, testosterone and cortisol, have been determined to affect risk-taking financial decisions. The stock market has often been described as competitive and stressful especially in times of instability and turmoil. Winning a competition such as making large profits in the stock market has been associated with increasing testosterone levels. This creates a sense of overconfidence and causes  investors to take on more risky investments. This behavior can also work in the opposite way when someone loses money which is seen as a lost competition. This decreases testosterone levels and eliminates confidence causing investors to make safer, less risky investments. 

Cortisol, the other hormone is proven to negatively affect risk taking. Cortisol is released during times of stress. An example of this is a volatile stock market. Cortisol causes pessimism and pessimists are less likely to invest in risky investments. These risky investments can pay off and cause large gains or they can fail and cause losses.

percent changes in GME compared to the S&P 500 source

    Earlier, I mentioned 'animal spirits',  while the exact methods of why these phenomenon occur is unknown, I will explain the general behavioral patterns present. One of these 'animal spirits' is herd behavior. In finance, herd behavior is characterized by a group of investors making the same trades. A recent example of herd behavior in the stock market is GameStop (NYSE:GME). For those who don't know GameStop was a popular "meme stock" that was promoted by a group comprised of millions of amateur retail investors on Reddit. These investors and others bought the stock causing the stock price to rise thousands of percent in just a few days in late January 2021. Reddit allowed the initial investors to spread their view to others on their sub-reddit Wall Street Bets. Even today months after the stock remains significantly elevated. The drastic rise happened for almost no reason and caused a lot of gains and losses for those involved. The group also caused similar behavior in the stocks of AMC and BlackBerry (NYSE:BB). This behavior of following a group or acting as a group is found in other animals. Examples are fish forming a school to escape predators, dolphins traveling in pods and birds flocking together.

schooling blue jack mackerel source

Some of you might be asking where is the evidence for this. Various studies have been conducted. While I will not go into detail about the studies, they generally follow a group of investors in a trading simulation,  measuring hormone levels and in some cases injecting participants with hormones and measuring the risk of their trades. These studies showed elevated levels of testosterone in investors with riskier investments. They also showed that investors with elevated cortisol levels chose safer investments. If you would like to learn more about these studies, research other behaviors or learn more about behavioral finance go to some of the sources below. Hopefully, you now have a good understanding of how your psychology can affect your financial decisions and can avoid allowing these factors to influence your investments.

science direct

Investopedia-animal spirits

corporate Finance Institute

Investopedia-behavioral finance

science daily

nature.com