An unusual study of traders’ spit may offer a taste of the future in how we understand what drives markets ― and why they aren’t as stable and efficient as we might hope. 

Several years ago, two neuroscientists undertook an experiment on the trading floor of a major investment bank in London. Over eight consecutive business days, at both 11 a.m. and 4 p.m., John Coates and Joe Herbert took samples of saliva from the mouths of 17 traders. With these samples, taken before and after the bulk of the day’s trading activity, they measured the rising and falling levels of a number of steroid hormones, including testosterone, adrenaline and cortisol.

The data revealed physiological changes not evident to the eye. To begin with, Coates and Herbert found that when traders did well and made money, they didn’t do it solely through cleverness and cerebral dexterity. Guts also played a role, although “testicles” would actually be more accurate. Traders performed better on days in which they registered higher morning levels of the hormone testosterone, which is mostly produced in the testes.

This isn’t actually surprising. After all, testosterone increases the level of hemoglobin in the blood, enabling it to carry more oxygen. Experiments in both animals and humans show that it boosts searching persistence, fearlessness and appetite for risk, qualities that obviously help any trader exploit real opportunities in the market. Athletes preparing for a competition produce more testosterone, which helps bring them to an optimal state of readiness for intense action.

The London experiments, though, also showed something unexpected. Levels of the hormone cortisol ― often called the “stress hormone,” because its levels rise in people experiencing severe psychological or physical stress ― didn’t increase when traders suffered significant losses. Rather, they went up in direct proportion to the volatility of recent trading. The more wildly unpredictable the record of wins and losses, the more cortisol. In sufficient quantities, the hormone orchestrates a response to injury or threat by shutting down functions related to digestion and reproduction, even the immune system.

This simple fact should have big implications for how we think about markets. Market participants aren’t the rational automatons of most financial theory. They are biological organisms responding with a neural and physiological apparatus designed millions of years ago. If what happens in markets affects hormones, these in turn alter behavior and feed back into the markets. As Coates argues in a new book, our bodies may make us hard-wired for episodes of financial boom and bust.

Biologists studying animals in the wild have documented a testosterone-driven dynamic called the “winner effect.” If two male lions or bears fight over a potential mate, the level of testosterone in the winner skyrockets afterward, while that of the loser plummets. This makes evolutionary sense, as the loser needs to rest and put energy into recovery, while the winner often faces immediate challenges from other rivals.

Ultimately, the winner effect can lead to trouble. By boosting confidence and risk appetite, testosterone priming makes that winner more likely to win again, and successive winning can push testosterone to counterproductive levels. Indeed, researchers have observed a systematic tendency for animals to become so aggressive and overconfident after a period of serial winning that they take stupid risks ― standing in open ground, for example, where they can be seen and attacked by several rivals together.

In light of these findings, it’s natural to suspect that a good part of the giddy energy and aggressive excitement that spills over Wall Street during a long bull market must reflect a surge in general testosterone levels, and that basic physiological mechanisms can drive financial bubbles. The more markets rise, the more confident and risk-seeking traders and investors become. The ultimate outcome is a market of people largely convinced of their own invincibility and ready to take irrational risks confident in the outcome being yet another victory.

When the bubble bursts, Coates argues, another hormonal response amplifies the effects. The mental consequences of long-term exposure to heightened cortisol levels include anxiety, selective recall of disturbing memories and a sense of danger lurking everywhere. The market becomes irrationally risk-averse. The bear market persists as the financial industry, or much of it, becomes, in Coates’s term, a “clinical population” unable to make the most of the opportunities it finds.

Now at the University of Cambridge, Coates turned to neuroscience after working for a decade at Goldman Sachs Group Inc. and Deutsche Bank AG, where he ran a trading desk. Even before his experiments, his practical experience during the dot-com bubble convinced him that the markets were running on something deeper than dispassionate reason. Normally “a sober and prudent lot,” as he recalls, “traders were becoming by small steps euphoric and delusional.” They were “overconfident in their risk-taking, placing bets of ever-increasing size and ever worsening risk-reward trade-offs.” As much as traders and investors try to remain rational, will power is no match for steroids that work their effects in every single cell in the body.

It’s rather amazing that biology has until very recently been more or less excluded from economics. That error has deep roots in the rationalist tendency to split brain and body and attribute behavior to thinking, even when it has much broader origins. If the mechanisms of our bodies and brains might play a major causal role in the rhythm of financial boom and bust, it’s time for finance theory to become more physiological.

Coates makes a convincing case that physiology plays a central role in driving markets, one that is generally overlooked. This insight might well form the basis of new investment indexes, even funds, based on widespread real-time monitoring of the hormonal biochemistry of the investing population.

The moment for the testosterone index may have arrived. 

By Mark Buchanan

Mark Buchanan, a theoretical physicist and the author of “The Social Atom: Why the Rich Get Richer, Cheaters Get Caught and Your Neighbor Usually Looks Like You,” is a Bloomberg View columnist. The opinions expressed are his own. ― Ed.