Look out over the choppy landscape of the financial markets: they’re up, they’re down. We see pullbacks, we see stocks soar, we see devaluation, inflation, and other seismic events happen all the time. It can be scary. There is one word that can sum up the state of today’s economy: volatile.
But please, keep calm. Volatility in the market is actually a good thing.
When we think of something as volatile – especially when it comes to something that can affect our bank accounts – we automatically assume the worse. We think of something volatile and we imagine a canister of some neon green chemical that will blow up if it’s shaken too much. We think of doom.
But you should think the opposite…
It doesn’t matter if you’ve always considered yourself an optimistic, “glass half-full” kind of person either; this reaction to volatility is actually hardwired into our brains.
In a major study conducted by two Stanford scientists, Camelia Kuhnen and Brian Knutson, it has actually been mapped out on MRI images how our brains react when we’re presented with different decision-making situations.
When we’re presented with a decision that will result in a loss or a gain, the portion of the brain called the Nucleus Accumbens is activated.
This is different from a scenario where the decision we’re presented with will have a relative value outcome, or a long term outcome. When we’re presented with these types of decisions, the Anterior Insula portion of the brain is activated.
Using this information and applying it to trading, it’s plain to see why some investors lose their cool when they see a drop in the markets. The Nucleus Accumbens is all about rewards: good money, good food, good drink. When things take a dip in the market, the Nucleus Accumbens brings fear.
Fear leads to irrational decisions. And when those decisions involve managing large sums of money, that can be a very bad thing.
Like I said, it’s hardwired into our brains. Just like that “fight or flight” response that is automatically triggered when someone is presented with a dangerous and stressful situation, like confronting a bear in the wild. This is the same kind of response. It’s automatic.
Think of a casino: you walk in and you’re immediately greeted with comfort and the promise of great riches. Free drinks are sent to your seat at the blackjack table, neon lights flash jackpots, and everything there is a game. A game, for crying out loud! Casinos do all this on purpose because they know it tickles that part of your brain that anticipates rewards, the Nucleus Accumbens. If you’re getting all these free perks and you’re nice and comfortable – goes the thinking – why not gamble a little more fast and loose? Could you resist these manipulations?
Economic markets operate much like casinos, only they take a more refined route. Economic markets are all about losses and gains. That’s how they operate. So when a novice investor dips their toe in the market for the first time, it’s very easy to be swept up by the fear of losing your money. A person who allows themselves to be swayed by fear makes for a bad investor.
In fact, many of the large trading firms on Wall Street subject their employees to some pretty serious psychological testing to see if they’re likely to crack from fear. Those that are still able to operate with a level head, even when the prospect of a large loss looms, are put on the trading desks. And just to be clear, it’s not that these individuals have different brain chemistry and that their Nucleus Accumbens are smaller or anything, it just means that they can put that fear aside – compartmentalize it, if you will – and go forward and make rational decisions when they need to.
Wall Street firms that promise a safe total wealth management want to convey a sense of confidence and control. They know that when clients experience a loss in their stock portfolio, the portion of the brain that looks at the long-term or relative value decisions – the Anterior Insula – kicks in and people start to feel the fear. That’s where that carefully crafted image of confidence and control comes into play and keeps their clients assured and the firm prospering.
Remember, when it comes to trading, fear is your worst enemy. Unfortunately, it’s hardwired into your brain. But you can learn to override that fear when you have to. Just like people with certain phobias are able to overcome them by confronting them little by little, you too can learn to stop fear from ruining your trades, and instead (and this is the real trick) to accept and roll with the punches as long as you’re in profit overall. Cut your losers early and ride your winners as long as you dare- that’s how a pro trader makes good, consistent money from only getting it right half the time! Think about it…
Best,
Jim.
