by David Edwards

While mainstream financial theory remains dominated by the efficient markets proponents, some famous—such as Warren Buffet--and some not so famous--such as John Hussman--money managers have been making money based on market inefficiencies. Hussman, who manages the Hussman Family of Funds, uses an investment style that is based on capturing these inefficiencies, and he has a remarkable track record from 2000-2004 of consistently beating the market with low volatility of returns. There are also mutual funds based on behavioral finance principals. How then does neurofinancial theory relate to these market inefficiencies and what possible money making applications arise from it?

While we know markets are comprised of individual traders and that their actions as a group help create price discovery, it is a bit of a leap to assert that an individual trader's physiological make up affects the overall behavior and pricing of financial markets.

Neurofinance research will help make this case by examining how individual make up impacts the decisions that traders make. It is interesting to note that many traders are not trained per se, at least in the formal sense that business executives, musicians, athletes, and other professionals are, but rather are thrown into a Darwinian competition where survival entails not being wiped out. Apart from the problems with this method indicated by survivorship bias, which asserts that a certain percentage of traders survive and thrive by sheer luck or chance, and about which Nasim Taleb has written extensively in "Fooled By Randomness", we should consider why we do not take a more scientific approach to the training and assessment of traders.

Why it may seem strange or even unethical to envision screening and testing potential traders by scanning their brain and testing their blood chemistry, it was not long ago that testing lactate threshold and VO2 max, which is now routine for swimmers, runners, and other endurance athletes, was considered avant garde. This type of testing, not only offers insight into a person's natural ability based on heart size, aerobic capacity and other biological characteristics, but also provides critical biofeedback before, during and after performance. This is the basis upon which Sandia Labs is developing its anthroscope project, i.e. that biofeedback can offer real time information to teams in learning situations that allows them to alter their behavior in midstream and improve outcomes. A logical next phase is to apply these technologies and knowledge to traders and trading.