Wall Street’s Next Frontier Is Hacking Into Emotions of Traders
The trader was in deep trouble. A millennial who had only recently been allowed to set foot on a Wall Street floor, he made bad bets, and in a panic to recoup his losses, he’d blown through risk limits, losing $4.9 million in a single afternoon.
It wasn’t a career-ending day. The trader was taking part in a simulation run by Andrew Lo, an MIT finance professor. The goal: find out if top performers can be identified based on how they respond to market volatility. Lo had been invited into the New York-based global investment bank—he wouldn’t say which one—after giving a talk to its executives. So in 2014, unknown to the outside world, he rigged a conference room with monitors to create a lab where 57 stock and bond traders lent their bodies to science.
Banks have already set up big-data teams to harvest insights from the terabytes of customer information they possess. Now they’re looking inward to see whether they can improve operations and limit losses in their biggest cost center: employees. Companies including JPMorgan Chase and Bank of America have had discussions with tech companies about systems that monitor worker emotions to boost performance and compliance, according to executives at the banks who didn’t want to be identified speaking about the matter.
As machines encroach on humans’ role in the markets, technology offers a way to even the fight. The devices Lo used—wristwatch sensors that measure pulse and perspiration—could warn traders to step away from their desks when their emotions run wild. They could also be used to screen hires to find those whose physiology is best suited to risk-taking—what interested the bank that allowed the MIT study.
The most promising application, and the one with the most profound privacy issues, would be for keeping tabs on employees, Lo says. Risk managers could use it to spot problems brewing on a specific desk, such as unauthorized trading, before too much damage is done. “Imagine if all your traders were required to wear wristwatches that monitor their physiology, and you had a dashboard that tells you in real time who is freaking out,” Lo says. “The technology exists, as does the motivation—one bad trade can cost $100 million—but you’re talking about a significant privacy intrusion.”
Emotional surveillance has an undeniably dystopian vibe, like a finance version of George Orwell’s 1984, but it’s not science fiction. Banks are already signing up for services that incorporate it into their analysis of behavior. A startup founded by MIT graduates called Humanyze has created a sensor-laden badge that transmits data on speech, activity, and stress patterns.
Microphones and proximity sensors on the gadgets help employers understand what high-performing teams are doing differently from laggards. The Boston-based company is close to announcing a deal with a bank that’s moving some employees to new offices, according to Chief Executive Officer Ben Waber. The bank wants to use Humanyze badges to determine seating locations for traders, asset managers, and support staff to improve productivity, he says.
Another startup, Behavox, uses machine-learning programs to scan employee communications and trading records. Emotional analysis of telephone conversations is a part of a worker’s overall behavioral picture, according to founder Erkin Adylov, a former Goldman Sachs research analyst. When a worker deviates from established patterns—shouting at someone he’s trading with when previous conversations were calm—it could be a sign further scrutiny is warranted. “Emotion recognition and mapping in phone calls is increasingly something that banks really want from us,” says Adylov, whose company is based in London. “All the things you do as a human are driven by emotions.”
Emotions are reflexes that developed to drive behavior, scientists say, improving our prospects of seizing opportunity and surviving risk. They’re accompanied by measurable physiological changes such as increased blood pressure, sweating, and a pounding heart. Their role in investing has been established since at least the time of economist Benjamin Graham, the father of value investing. More recently, John Coates, a University of Cambridge neuroscientist and former derivatives trader, has studied how financial risk takers’ decisions are influenced by biology. His experiments, chronicled in a 2012 book, The Hour Between Dog and Wolf, show that hormones such as testosterone and cortisol play a part in exacerbating booms and busts.
The volunteers in Lo’s study were given a $3 million risk limit and told to make money in markets including oil, gold, stocks, currencies, and Treasuries. They came from across the bank’s fixed-income and equity desks and ranged from junior employees to veterans with 15 years of experience. Top traders have a signature response to volatility, says Lo, who plans to publish his findings by next year. Rather than being devoid of feeling, they are emotional athletes. Their bodies swiftly respond to stressful situations and relax when calm returns, leaving them primed for the next challenge. The top performer made $1.1 million in a couple of hours of trading.
Those who fared less well, like the trader who lost almost $5 million, were hounded by their mistakes and remained emotionally charged, as measured by their heart rate and other markers such as cortisol levels, even after the volatility subsided. Lo’s findings suggest there’s a sweet spot for emotional engagement: too much, and you’re overly aggressive or fearful; too little, and you aren’t involved enough to care. Veteran traders had more controlled responses, suggesting that training and experience count.
There are other ways to infer emotional states. Researchers led by Kellogg School of Management professor Brian Uzzi pored over 1.2 million instant messages sent by day traders over a two-year period. They found that, as in Lo’s study, having too much or too little emotion made for poor trades. Uzzi, whose study was published this year, says he’s working with two hedge funds to design a product based on the research.
As younger traders accustomed to biometric devices like the Fitbit enter the industry, applications designed to boost performance and monitor employees will become commonplace, says Lo, who expects it to be widespread in less than 10 years. “The more data we have, the more we’re able to characterize the emotional state of the individual,” he says. “Everybody will have to have these kinds of analytics.”
—With Laura J. Keller
The bottom line: Banks are exploring the use of data gleaned from body sensors, e-mail, and phone calls to identify top traders and limit losses.