Apparently high-risk trading stimulates the brain just as effectively as cocaine.
But it’s a lot more expensive.
While I would never hand over my trading account to a robot, I also try not to let my own brain have free-reign on my trading. It’s just not that trustworthy.
It’s why traders tend to be most successful when they have strict rules to follow, so when their brains start getting carried away they can just switch them off and follow the rules.
But recognizing when you need to ‘switch off’ your trading brain takes a little self-knowledge.
American economist George Goodman once quipped: “If you don’t know who you are, the stockmarket is an expensive place to find out.”
Large corporations will send off their executives on weeks of training to help them make better decisions.
So, it’s naïve to think that just plonked in front of our screens, with a little technical know-how, we’re likely to make profitable decisions off the bat.
A while ago, I did some research into ‘neuroeconomics’. It turns out that our brains can be our worst enemies when it comes to trading.
As one leading expert puts it: “The mind is a charioteer driving twin horses of reason and emotion. Except reason is a smart pony, and emotion is an elephant.”
My advice would be: don’t let an elephant drive your trading decisions.
Here are some clues that your inner elephant might be gaining his head…
1. Is your mid-brain practicing extreme sports?
Human beings are attracted to ‘novelty’ – i.e. the thrill of trading. When we see an opportunity for trading in a new market or with larger than normal stakes, our mid-brain’s ‘wanting system’ kicks in, and our attention focuses on this target.
Know yourself – are you susceptible to ‘thrill trading’? Is trading becoming a sport for you? This is time to reduce risk and close in your horizons.
2. Is your brain making the connections it needs?
Trading is all about balancing risk and reward. This is a delicate process, and it isn’t helped by the fact that the risk and reward part of our brain are respectively distinct regions which are naturally disconnected.
The ‘risk’ region of the brain is (relatively) new in evolutionary terms, and is about measuring painful stimuli. Risk is something we feel – a type of pain –rather than a rational process.
Personally (there’s nothing scientific about this), I find it incredibly helpful to write down what the risk is on a position: seeing it in black-and-white seems to give my rational brain an edge. I’m ‘thinking’ about it, rather than ‘feeling’ it.
3. Can you delay gratification?
Let’s say someone gives you two options: either you can pick up a £10 note lying on the floor in front of you, or you could run down the road and pick up the £50 note that’s lying on the street.
Which do you choose?
Human beings are the only animals known that can delay gratification for more than a few minutes. However, we’re really not very good at it. Recent studies show that foregoing a current payoff to get a larger later return requires intense activity in the prefrontal cortex area of the brain.
We find waiting very hard to do.
With immediate rewards available, the midbrain ‘wanting’ system dominates. When markets are volatile, investors’ prefrontal cortices come under pressure. This is precisely when you are more likely to make decisions based on immediate gratification, with little consideration of the bigger pay-off.
It’s also worth noting that the pre-frontal cortex doesn’t mature until after the age of 30, and later in men than in women.
4. Have you been tricked onto the bandwagon?
Regular Maven readers will know that I’m a big advocate of trend trading. However, there’s a difference between trading in the direction of the market trend and jumping on board every bandwagon that passes you by.
Humans are social creatures, and when that social attachment occurs, the chemical ‘oxytocin’ is released in the brain. This makes us feel good – and is why we feel good when we’re following the herd. It’s this herd mentality that leads into investment bubbles.
5. Are you feeling sentimental?
The same chemical – oxytocin – also biologically stimulates us to form attachments to things that are familiar to us.
We therefore don’t view positions that we currently hold with the same impartiality as those we might potentially hold. We put a higher value on things that are familiar. In practical terms, this leaves us holding on to trades that we should have got out of long ago.
6. Are you a slave to your hormones?
If you’re a female trader, then you’ve got an automatic advantage. Scientific research shows, again and again, that women in general make smarter decisions regarding investment than men.
It is shown that women in couples are demonstrably better at evaluating risk than their partners, and single women are better still.
In a competitive situation, a man’s levels of testosterone rise, increasing his appetite for risk. If he wins, those testosterone levels stay high and are booster further in the next round. However, give a trader a winning streak and his testosterone levels rise way beyond helpful levels – their risk appetite has gone through the roof, and they start to do stupid things.
Watch out for feelings of euphoria while trading. If you’re on a winning run, there is no reason to increase your risk.
