Your Money, Your Brain Part 2

If you can understand what's going on in your brain you can improve your stock trading acumen

Photo by Jason Rogers. (License: Creative Commons Attribution)

If you missed part 1

In your book you give the example of a renowned fund manager who senses a stock will perform well if "it makes him feel like he wants to throw up." Do you condone individual investors attempting to use their own feelings as reverse indicators?

As I said before there is a lot of information in your own emotion and of course others people as well. But your own emotions are the easiest to verify. You are least likely to doubt what you yourself are feeling. I think it is a very good plan. The key is that you have to learn from your own experience. The problem you get into is that you can't simply turn your own feelings inside out and your certainly can't turn them off. Nobody can turn them off, unless you're a psychopath.

If you realize that you are feeling overconfident should you second-guess yourself?

You absolutely should but most likely you won't be able to do that unless you've tracked your feelings over time. It's only by keeping records of your own emotions that you can persuade yourself that your emotions are a reverse indicator. Otherwise when you're feeling afraid the signal your emotions are sending you is that you should be afraid, there is something to be afraid of. It's only by learning and remembering that the last time you felt like this was a great buying opportunity and the time before was as well. It's only by having that historical record of your own feelings at hand that you can get that feeling under control. It works both ways—you want to control not only your fear but your euphoria as well.

Can the neural shortcomings of the human brain explain why so many prospective homeowners accepted no money down subprime mortgages to buy houses they couldn't afford?

Absolutely. One of the oddities of the way the brain works in respect to money is that borrowing is treated as a form of reward. Why? Because when you borrow money you get money. You go to the bank or the mortgage lender, you sign your loan agreement and in exchange you get a cheque. Of course you also get an enormous interest bill but that doesn't come right away, that comes down the road spread out over time and that's not what you think about a the moment your doing the transaction. What you actually think about is that enormous lump sum of money that will be conveyed to you through that cheque and that is a very profound reward to the brain. The brain thinks very different about short term and long-term consequences. Short-term consequences are very emotional and long term consequences are very abstract.

How does the euphoria of seeing a stock in our portfolio surge demonstrate itself in our brain?

It depends quite a bit on the circumstances surrounding the rise of the stock. If it's something you just discovered it's going to be processed differently in the brain then if it's something you've been watching develop for a while. If there's a streak and it goes up and up and up and you are riding it like a rocket that stimulates a part of the brain called the subgenual cingulate. This is the same part of the brain that is implicated in mania, the upside of manic depression. Mania is characterized by delusions of grandeur, restless energy, inability to sleep and thinking at a mile a minute. People who are on a roll with a stock demonstrate a lot of those characteristics. That's important to realize because if you buy a stock, it gets hot, and it stays on a roll for a little while it can become almost impossible for you to detach the performance of the stock from your own beliefs about yourself. It's like the old saying—it's easy to confuse brilliance with a bull market. Easy for the person who came up with the cliché but it's harder for someone who has just made a successful stock pick to believe. If you have a portfolio that is going up but it was given to you lets say you inherited it, it's likely to feel quite different to you then how it would feel if you picked it one stock at a time even if it performs equally well. The sensation that you are in charge of your results activates a part of the brain called the caudate which is involved in very intense emotions like trust and romantic love. You can argue that feeling in control of how your portfolio does is quite similar to feeling to warm positive emotions like loving your spouse.

This Article originally ran in the Fall 07 issue of The Baystreet Bull

Copyright © Mike Dojc 2007

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Your Money and Your Brain

Mike Dojc

Thu Nov 15

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