Behavioural Finance turns to magic Pills in the search for the elusive alpha!

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Achieving abnormal profits, the so-called alpha in the stock market, is becoming ever more difficult and in the process, for many of the so called “hedge” funds (which do precisely the opposite and simply chase beta in a levered manner), justifying the fees that are charged to clients is also a hot topic.

While the traditional paradigm in finance would have you believe that traders make rational and unbiased decisions (part of the so called “efficient markets hypothesis that is, incidentally, complete bunkum!), the human brain is a far more complex structure than that with psychology, emotions and human sentiment all playing an important role in determining the final outcome. Understanding the human brain is therefore one way to try and gain an edge over your peers and competitors in the world finance. In fact the realm of what is termed “behavioural finance” is a hot and growing area of the marketplace. Can it really deliver higher profits though?

Only a few days ago traders at a firm known as Sang Lucci Capital Partners participated in a unique study that analyses the interactions between the human brain and trading. The experience involved a simulated trading environment where the traders conduct their normal day-to-day trading activities but after taking a special pill – TruBrain – and being monitored by electroencephalography electrodes (EEG). The pill developed by researchers from the University of California at LA and from the University of Geneva has as its main ingredient piracetam, a type of nootropic (“smart drug”) that’s purported to improve mental awareness. Traders were administered with the pill for one session and with a placebo for another session in order to try understand the differences between the two.

Bathgate, a partner at the firm commented about the traders under the experiment: “if you could see their faces when they were sitting down, you would’ve thought they were all trading with a million bucks”, such was the pressure on them. The final results will take time to be analysed and while using the pill may in fact show changes to the brain, it will be interesting to see if it really does add an edge.

 TruBrain claims to help stimulate brain activity without the need for traditional stimulants such as caffeine (and some “under the counter” one’s that the industry is known for, namely cocaine!). Interestingly, it has been also shown in the past that other measures such as meditating also help in trading activity. So should we stimulate the brain or relax it? With clinical tests near impossible to be conducted on supplements, the jury is out on the future of pills like TruBrain but it does reflect the recognition that finance is in need of a greater understanding of the obscure psychological factors that determine trading activity, precisely because they play an important role in markets.

Perhaps our old friend Steve Cohen should get himself involved with TruBrain development?! Even better, maybe he can offer a coffee plus the TruBrain pill every morning to his traders. We just don’t know whether it works or not but, if it really does work, then he has a new explanation for potential insider trading charges against his firm!

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