Many people get paid to talk about why stock prices go up and down. I was one of them. All too often, we are wrong.
After the 2008 financial crisis, even Alan Greenspan said that we need to reassess how we forecast. But seven years after the crisis, little has changed. We still use the same financial forecasting methodology. If we want to get better at forecasting, we need a different approach. We need the assistance of someone who can show us how we make financial decisions. We need a neuroscientist.
Brian Knutson isn’t the type of guy who you typically find on Wall Street. He is deliberative and rarely wears suits. However, he is a leading neuroeconomist, a neuroscientist who studies how we make financial decisions. I grew intrigued with his research, as I was writing my book Coined: The Rich Life of Money And How Its History Has Shaped Us, so I invited him to dinner. In one meeting with Knutson, I learned more about how the brain processes money and how we make financial decisions than in my entire Wall Street career. There were four main takeaways from our conversation:
1. Money is like cocaine
Blackjack is my favorite casino game. No, I’m not a gambling addict. But if you were to scan my brain during a game, it’s likely that a reward region of the brain, the nucleus accumbens, would activate. Indeed, the thought of winning money stimulates our brain in a manner similar to gambling addicts and even cocaine junkies. In one study, twelve people played a game in which they could win or lose money. Their brains were scanned, and these images were then compared to those of cocaine addicts. Remarkably, the scans were nearly identical.
2. Brain scans can predict financial decisions
I ordered the profiteroles at dinner. They looked delicious. But upon further reflection, I didn’t order them based on how they looked. Two weeks prior, I was at another restaurant and they had run out of the delectable desert. I was dissatisfied, so the next chance I had, I made sure to order them.
Of course, Knutson could have told me what I was going to order before I was fully aware, if he had scanned my brain. In one of his studies, he asked participants to choose between a risky investment (a stock) and a conservative one (a bond), while their brains were scanned. Before a person chose a stock, the nucleus accumbens was stimulated. However, before someone chose a bond, a “fear region” known as the insula fired. The researchers accurately forecasted what security someone would buy based on brain scans.
3. Brain scans can forecast simulated market decisions
Can neuroeconomic research be applied to the broader market? It’s getting there. Researchers at Caltech found that brain scans reveal how people buy or sell in group settings similar to a securities market. They designed an experiment in which as many as 23 participants decided whether to buy or sell a security. At the same time, three of these participants had their brains scanned. They found that high-earners sell at the top of the market, as they experience more activation in the insula than the low-earners. In other words, the decision to buy or sell is regulated by neurological mechanisms.
It’s complex to predict a stock price because millions of people and computer programs are participants in the market. But we don’t need to scan the brains of every Wall Street trader. We already make forecasts without the full population being represented. Perhaps the brain scans of participants in a focus group become another input in a fund manager’s financial model.
4. Fund managers do care
Joining us for dinner that evening were a few of my friends who are fund managers. They were intrigued with Knutson’s findings, but not in the way you might expect. It will take years for neuroeconomic findings to be incorporated into their research process, yet many wanted to know: Could brain scans reveal which job candidates were more predisposed to risk-taking and risk-aversion?
It looks that way: In one of Knutson’s studies, he was able to isolate which genes may make us more or less likely to make riskier financial decisions.
Already neuroscientists have used brain scans to accurately predict whether a song or movie will be hit. So why not a stock? Neuroscientist Paul Glimcher believes that brain scans may hold the key to more accurate financial forecasting. “If we had access to that data, when people pick stocks, can these models predict macro-level changes in stock prices from individual-level models of angels picking stocks? There’s reason to believe it might work.”
Kabir Sehgal is the author of Coined: The Rich Life of Money And How Its History Has Shaped Us (Grand Central Publishing), and was a vice president at a global investment bank.