Written by Michael Bigger. Follow me on Twitter.
The folks at Dynamic Hedge have a fabulous blog post titled What Science Can’t Explain About Testosterone, Cortisol, and Compounding Trading Losses. The post discusses the role of testosterone and cortisol in trading. The big lessons for traders are “learn to harness these chemicals” and don’t overleverage.
Here is how we go about this in our investment and trading activities:
The following excerpts from our e-book, In Praise of Speculation! demonstrate how the above trading methodology limit the negative effects of hormones:
On May 6, 2010 at about 2:45 pm, the stock market experienced a stunning 9 percent drop followed by a partial recovery. The frantic action was over by 3 pm…
Our algorithm made 70 basis points on that day. This was a pretty good result considering the SPYs were down about 3.50 percent. More importantly, we had the opportunity to see how the algorithm behaves during a sharp drop. This was a dream come true as the algorithm stayed positive throughout the episode.
The algorithm did very well because during the fall, it unwound the stocks in the portfolio that did not move very much, according to our metrics, and it bought stocks that were decimated. When the gap between each group of stocks narrowed after 3 pm we generated profits. We doubt we could have taken advantage of this discrepancy without the help of computers.
In the above example, the algorithm made decisions that we might not have had the fortitude to make on our own. Or as the author of the Dynamic Hedge blog would see it, excessive cortisol levels would have prevented us from having a very profitable day. Did that ever happen to you?