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What happens to your body when you take risks?

A lot, argues Canadian-born former trader John Coates in his new book, The Hour Between Dog and Wolf. And the more you understand the biology of risk-taking, he says, the better prepared you’ll be to make sound investment decisions.

What intrigued you about the study of biology in relation to trading?

I worked on Wall Street during the dot-com bubble and I watched a lot of traders lose hold of reality. They became euphoric and delusional; they slept less; and they felt like they couldn’t do anything wrong. People were taking greater risks, even though the trade-offs were terrible. I started to wonder why no one had looked at it clinically.

How do the body and mind interact when we’re making high-stakes decisions?

People used to assume decision-making was purely cognitive, but we’ve since found that’s not true.

We did a series of experiments on City of London traders, in which we tracked their performance levels—how much they traded and how often—as well as their biological responses, including hormone levels, nervous system activation, and the pathways carrying gut feelings.

We found the same physiological patterns that support us in war and sport emerge when we take financial risk.

Rising levels of anabolic hormones, like testosterone, and catabolic hormones, like cortisol, can improve an athlete’s performance just before a race. Anabolic hormones are great during downtime, and rejuvenate the body’s cells.

Catabolic hormones give us surges in energy by rapidly breaking down energy stores, so they can help if we have something stressful to do over a short period of time. But if levels remain too high for too long, the hormones can have the opposite effect: the athlete becomes stressed out and loses judgment.

In the same way, we found a trader on a winning streak is prone to risk-taking pathologies. So, traders who can overcome their physical responses to the hormones will make more measured and rational decisions.

It’s the same for investors. A lot of the blow-ups that occurred in the markets have been at the hands of a trader on the tail end of a winning streak. So advisors should encourage clients who are doing well to reduce or maintain risk levels.

What’s the physiological significance of gut feelings?

There is a constant dialogue taking place between the body and the preconscious parts of our brain. Normally we don’t need to be aware of it, but occasionally these physical signals emerge into our consciousness as a feeling of dread. We call these gut feelings.

The more experience we have—in trading, for example—the more we can learn to trust these gut feelings, which can act as warnings that we’re about to make a bad decision.

Everyone can benefit from having a partner—or an advisor—monitor them when they’re making investment decisions. Often people can spot physiological changes in you better than you can recognize them yourself.

Another strategy: People are starting to monitor their heart rates, glucose levels, and so forth, during times of stress and calm. Advisors can assess how their bodies react when they’ve made good investment decisions, and choose to base future decisions in part on how their guts respond.

THE HOUR BETWEEN DOG AND WOLF has been shortlisted for both the 2012 Financial Times and Goldman Sachs Business Book of the Year Prize, and the 2012 Wellcome Trust Book Prize, which celebrates medicine in literature.

Originally published in Advisor's Edge