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. (more…)