Brainwaves

"The brain is wider than the sky for, put them side by side, the one the other will contain, with ease, and you, beside." - A Poem by Emily Dickinson

Over years of study, three chemical messengers have been found to influence a human's attraction to or avoidance of risky investments.  Altering these chemicals in the body has profound impacts on an investor and their beliefs.  I have mentioned one of them in a previous blog and that is testosterone.  As traders win their testosterone levels rise and this then drives them into ever more risky investments.  Lower the testosterone level and the risk of the trade is reduced.  The relationship therefore is not that men are better traders than women, on the contrary often times the elevated testosterone levels are what gets a male trader in over his head while his female counterpart reduces risk and avoids a blow up.  This is a very wide brush I am using as I am not suggesting that females never get crushed, but it does show why often times it is better to avoid the trader that is on a "hot" streak as they are running higher than normal levels of testosterone and could be about to blow up.

The next chemical is oxytocin which predominantly affects females.  This is the chemical that elevates itself at the time of giving birth, deadening the pain of the birthing process, allowing the female to bond with the child.  This bond is highlighted using a life or death scenario where a runaway train can be sent down one of two tracks.  Track One has 5 people that would die should the train be sent down that track while Track Two has only one person in peril.  Pretty much everyone chooses Track Two until you are told that the one person is someone that you know.  At this point most people switch the train to Track One.  Oxytocin is the reason for this change and it can affect your investment decisions.  This herd mentality can link people to groups and can sway a rational analysis to an irrational one when "everyone" is buying a stock.

Take Apple for example, it was hard to sit on the sidelines when it carried on climbing above $600 but with the recent bloodletting that it has done, falling below $450 from over $700 it is clear that it was the correct decision.  It would have been doubly hard to sit on the sidelines if I worked at a large corporation where the cheer leading reached a fever pitch.  For this reason the most successful investor of all time Warren Buffet lives away from the crowd in Omaha.  Another great investor, Nassim Taleb prefers to spend his time reading books on philosophy and sitting in coffee shops that do not have a television.  Nassim bets on the only sure thing in the market - it will crash again.  The problem is that as humans we are wired to win regularly and his investment strategy loses often but wins big every now and then.  Listening to the cheer leading section of CNBC disrupts his trading discipline so he does his best to avoid being sucked in by the crowd.

The final chemical is serotonin which regulates levels of anxiety.  Changing the serotonin levels can dramatically affect investment decisions.  In a study players were given a sum of money and were told to split it with another player.  With normal levels of serotonin about half rejected an offer of less than 30% of the money even though to refuse the offer was to receive nothing.  Reducing the serotonin levels increased the levels of non-cooperation enormously as now more than 80% of players refused to accept less than 30% of the money.  Taking this a step further shows that there is a direct link between the serotonin levels and risk aversion.  The lower the level the higher the risk aversion and vice versa.  For the low level serotonin people risk averse investments trump high return but risky investments and the opposite is true.

The take away of all of these studies to me is that we have to ensure that whatever investment decisions we make are made based on rational analysis rather than an emotional response.  This flies in the face of going with your gut instinct which as we all know can serve us well on many occasions.  Outside of gut instinct however we are far better served by investing based on our own sound investment analysis rather than those of others.  Switching off the TV and doing your own investment analysis will serve you well.  In addition be aware that when you are on a roll that it may be time to pare back rather than press the accelerator harder.  And finally while you may not want to risk your investment dollars too much sometimes stretching the band a little will serve you well as long as you have performed sound investment analysis.  So while the world of investments tests us at the best of times we need to understand that we can be our own worst enemy.  This is why often times it is best to sleep on a problem rather than jump right in; particularly when the investment decision would be made based on an anonymous tip!